June 4, 2008 in Business

Student loans survive credit crunch

Robert Tomsho Wall Street Journal
 

College students and parents are scrambling to line up student loans for the fall amid fears the credit crisis might put the squeeze on such lending. How bad could it be? That depends on the type of loan. Late last month the Bush administration took a big step toward heading off problems with federally guaranteed student loans by banks and other private-sector lenders. Using authority recently granted by Congress, the federal government plans to purchase and invest in such loans, freeing capital so lenders can make new loans.

But this initiative – which will last one school year – isn’t a fix-all for a loan market that is hard to sort out even in the best of economic times. For instance, loans not backed by the government still could be in short supply.

The federal government is the biggest participant in the market, having made or guaranteed about $109.4 billion in student loans during the 2007-08 school year. The debt includes Stafford loans for undergraduates, PLUS loans for parents and graduate students, and consolidation loans for graduates who want to combine and refinance previous loans. Borrowers get these loans through one of two channels.

Under the “direct-loan” program – which accounted for about 16 percent of federal student loans this school year – students and families borrow directly from the government, with colleges doing some initial paperwork.

The catch is that your college must participate in the direct-loan program. About 1,050 schools are active direct-loan schools; about 800 others have direct-loan authority but don’t use it.

The direct-loan program hasn’t been in jeopardy during the credit crunch. In fact, more than 280 schools have applied to join it this year.

The concerns have revolved around the government’s other lending channel, the Federal Family Education Loan program, or FFEL, which is used by about 4,500 schools. About 7.5 million borrowers took out more than $91.8 billion in FFEL loans this school year.

Under the FFEL program, banks and other private-sector lenders make loans and the government guarantees up to 97 percent of their value, so a lender takes on little risk if a borrower defaults. To encourage lenders to take part, the government also pays them a subsidy on each loan.

Those subsidies have been one source of trouble. Last fall Congress cut them roughly in half in the aftermath of ethics scandals.

While their profits from subsidies were clipped, lenders faced problems on another front. Most FFEL lenders package some or all of their student loans into securities they sell to investors, which generates cash they can use to make more loans.

In normal economic times those asset-backed securities, or ABSs, seemed like a good investment bet, given that they contained student loans guaranteed against default by the government.

But in recent years lenders also have been marketing ABSs containing subprime mortgages made to borrowers with poor credit histories. As that market collapsed, investors began backing away from all kinds of ABSs, including those containing FFEL loans.

Early this year lenders large and small began either curtailing or ending their participation in FFEL, saying they could no longer make such loans at a profit. SLM Corp., known as Sallie Mae and the nation’s largest student lender, was threatening to pull out of FFEL but opted to remain after the Bush administration unveiled its liquidity plan May 20.

Many observers think the plan will stem the exodus of FFEL lenders and ensure there won’t be any major shortages.

The biggest area of concern for the fall is alternative student loans, which don’t involve the federal government and are strictly between borrower and lender.

Though they typically involve higher rates and fewer protections, alternative loans have taken off as lending limits on some federal-loan programs have failed to keep up with college costs. Families took out an estimated $17.1 billion in alternative loans in 2006-07, up from $1.57 billion a decade earlier, according to the College Board.

Like FFEL loans, many alternative loans are packaged into ABSs, for which there is little demand. In April, Bank of America Corp. said it would stop making alternative loans.

Some believe the government’s plan to buy some FFEL loans from lenders will reassure investors and make them more likely to buy ABSs containing government-backed and, perhaps, private student loans.


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