Admissions scandal, student debt hurting higher ed — here's what should be done, says Sheila Bair

The college admissions scandal is coming at a bad time for higher education, which has already seen its reputation tarnished by other issues like student debt, said Sheila Bair, former president of Washington College.

"I really hope colleges understand that their reputations are really on the line here. The public is losing faith and they need to get ahead of this," she said in an interview with CNBC's "Closing Bell" on Tuesday.

"They have to have more transparency around admissions. They need to get ahead of the student debt problem, do a better job to contain costs, [and] find more affordable options for financing higher education," added Bair, a member of the CNBC Financial Wellness Advisory Council and a former chair of the FDIC.

Last week, dozens of people — including actresses Felicity Huffman and Lori Loughlin — were arrested in the admissions bribery scheme. The charges included the bribing of college athletic coaches and having other people take students' admission tests.

However, those standardized tests may not be the most effective gauge of students' abilities, Bair said.

"At Washington College, we actually found that grades were a better predictor of students' success than standardize tests because there are ways to hire people to train you ... to take the test and that's perfectly legal," she said.

Changing student loan funding

Bair is a big proponent of changing the student loan system — and she has plan she thinks could solve the problem. There is now $1.5 trillion in outstanding student loan debt in the U.S.

The main issue is the way the current loans are structured, she said. For one, it isn't known what the repayment capacity of an undergraduate is going be after graduation. Plus, economic incentives are misaligned, Bair noted.

"All the risk on the student to repay the loan. If they default, it's on taxpayers. But the proceeds of those loans are going to colleges, which don't have financial risk if the student does not succeed."

Instead, Bair proposes something that isn't debt, but is instead an income share. The financer and student would sign a contract that has the student pay a certain percentage of his or her income over a certain period of time, subject to a cap. She said the percentage is "affordable" and only kicks in once the now-graduated student has a "decent" income.

In fact, she said the Trump administration's suggested changes to the Higher Education Act are a step in the right direction. The proposal suggests consolidating repayment options so that the government would offer just two plans: one standard 10-year fixed plan and one income-driven repayment plan. The latter would limit monthly payments to 12.5 percent of a borrower's discretionary income and offer loan forgiveness after 15 years.

"This would actually move us nicely in the direction of income share," Bair said. "I hope that particular proposal gets some serious consideration in Congress."

— CNBC's Abigail Hess contributed to this report.

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