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Billions of dollars in defaulted student loans are going uncollected, lawsuit says

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A contractor for the Education Department is suing the federal agency, alleging that billions of dollars in defaulted student loans go uncollected because the government is not lining up new private debt collectors.

The allegation stems from a long-standing dispute between the department and the collection agencies it uses to recoup student loan payments that are past due. The department has tried to reduce the number of companies involved in the process since 2016, leading to legal actions that, at one point, prevented the government from collecting newly defaulted debt.

Although the search for debt collectors remains active, the Education Department has not chosen any companies. Instead, the agency said it will fold debt collection duties into student loan servicing as part of a broader overhaul called the Next Generation Financial Services Environment, or NextGen.

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That plan is the subject of a lawsuit filed Wednesday in federal claims court by FMS Investment, one of the private collection agencies working for the Education Department.

The company claims that despite a court ruling barring the Education Department from canceling the collection contract, the agency is circumventing the decision with three new solicitations for student loan servicers. Those requests for proposals seek to procure, among other things, default collection services.

“The Education Department has now illegally bundled defaulted student loan debt collection services with separate and distinct requests for loan servicing and, of all things, development of sophisticated IT platforms and systems,” the complaint said. “The effect of such bundling, as a substantial weight of case law holds, is to arbitrarily restrict competition, because nothing about bundling these three distinct services together is necessary to meet ED’s needs.”

The Education Department did not immediately respond Thursday to requests for comment on the lawsuit.

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FMS Investment is still working on the federal government’s behalf, although it no longer receives new accounts. The Education Department assigns defaults to 13 companies, while FMS and four other collection agencies handle older accounts.

Student loan default rates are far outpacing the rate of collection, and it could get worse as the Education Department plans to eliminate seven of the collection agencies in April, according to the complaint.

In fiscal year 2018, the Education Department recovered $10.4 billion on a $166 billion portfolio of student loan defaults managed by private collection agencies. By comparison, the federal agency recouped $9.2 billion of a $52 billion portfolio in fiscal year 2014 using 22 private debt collectors, according to the complaint. FMS anticipates that, this year, the federal government will recover about $6 billion on a projected $195 billion portfolio if just 11 companies are left to the task.

“With new contracts in place to bring [private collection agency] recovery capacity to the fiscal year 2014 level, the Education Department would be able to resolve an additional estimated $19 billion each year,” FMS said in the complaint. “This simple solution benefits all parties involved: the Education Department can work on developing its new servicing platform; the [private collection agencies] can continue operating; defaulted borrowers receive more responsive service in actively addressing their loan situation; and the government increases its collections on defaulted student debt. Everyone wins.”

Colleen Campbell, director for postsecondary education at the Center for American Progress, argues private collection agencies prioritize recovering money over providing struggling borrowers with sustainable solutions for managing their loans. Everyone could actually win once the Education Department moves forward with plans to revamp the collection system, Campbell said.

Critics of the existing default apparatus say it is exceedingly expensive and operates to the benefit of the collection agencies. An analysis by the Center for American Progress, a liberal think tank, found the federal government spent about $700 million on debt collection in 2017 for fewer than 7 million borrowers in default, almost the same amount it spent on loan servicing for more than 33 million people paying down their debt.

“A debt collector gets paid $1,700 per borrower who rehabilitates their debt, and within three years, about 40 percent of those people re-default,” Campbell said. “It’s not like the collectors are being exceptionally effective."

The Consumer Financial Protection Bureau estimates that, in some cases, the Education Department pays private collection agencies nearly $40 in compensation for every $1 in cash recovered from some borrowers whose loans are placed back into repayment through a rehabilitation program.