How to Head Off a Potential Student Loan Crisis

April 16, 2008

Even as those who spoke were careful to tiptoe around embracing it, the word "crisis" loomed over the cavernous Senate Banking Committee chamber on Tuesday. It may have become an apt or commonly accepted word to describe the deflating bubble in the housing market, the panic spreading into other areas of the financial system and the havoc being wrought on individual banks, but none of the panelists assembled there to discuss the student loan market were ready to declare a crisis in their corner of the economy -- at least not yet. (Unlike some national newspapers, which seem to have decided that a crisis is already here.)

But Senate hearings don't tend to be convened when no one's planning to take some sort of action -- especially in an election year -- and this one, called "Turmoil in the U.S. Credit Markets: Impact on the Cost and Availability of Student Loans," was no exception. Chaired by a former presidential hopeful, Sen. Christopher Dodd (D-Conn.), the committee showcased testimony from two basic constituencies: private colleges whose students often depend on federal or private loans, and non-depository financial institutions that issue loans (in other words, lenders that aren't banks).

Most, if not all, of the panelists endorsed two solutions backed by Dodd that they believe would avert a potential crisis -- which we aren't necessarily in, they reminded the committee -- and restore liquidity to the credit markets on which lenders depend for the sale of asset-backed securities. The relatively short-term relief measures wouldn't require legislative action to initiate and would involve lesser-known governmental entities called the Federal Financing Bank and the Term Securities Lending Facility, which proponents suggested could be easily adapted to new uses in educational financing.

The former, created in 1973 to help finance federal agencies' debt burdens, would under the plan inject some measure of "liquidity" to providers of federally backed loans, although pricing details weren't discussed. Panelists also suggested that the TSLF, created last month by the Federal Reserve to scoop up mortgage-backed securities and other financial products in response to the credit crisis, could expand eligible collateral to include securities backed by student loans that lenders could temporarily swap for Treasury dollars. Dodd is preparing letters to Treasury Secretary Henry Paulson and the Federal Reserve chairman, Ben Bernanke, asking them to consider the ideas.

"Last month, the Treasury and the Fed demonstrated their willingness and ability to take strong action to preserve liquidity and order in the capital markets. Their actions were unprecedented. But so are the times in which we find ourselves," Dodd said. He continued: "If the Fed and Treasury can commit $30 billion of taxpayer dollars to enable the takeover of Bear Stearns by JPMorgan Chase, then surely they can step in to enable working families to achieve their dream of a college education for their kids. If they do not, then I stand to act legislatively to prevent a deepening of this crisis."

Of course, all the proposed measures presume there's something to avert. So far none of the major banks that provide the lion's share of student loans have pulled out of the market, even though, as Mark Kantrowitz, the publisher of the oft-consulted Web resource FinAid.org, said at the session, "[a]s of today, 57 education lenders have suspended their participation in federally guaranteed student loans and 19 lenders have suspended their private student loan programs." (Also on Tuesday, officials at Chase Education Finance said they would be more selective in their origination of federal loans, declining to make them available to students at institutions with many financially high risk students.)

Even Dodd noted that there wasn't a single documented case of the market downturn affecting a student's ability to take out a loan for college, although several of the panelists reminded the committee that starting next month, families of newly accepted freshmen would start to apply for their first loans in what would be a test of the market's stability this year.

"While I am unaware of an instance to date when a student has been unable to secure a loan," Dodd stated at the outset, "the withdrawal of these lenders, the ongoing turmoil in the U.S. credit markets and the illiquidity in the student loan market have fueled concerns that a potential student loan credit crunch may be looming -- one which could leave millions of students in a last-minute dash to secure the financial assistance they need to attend college this academic year."

That nightmare scenario has led most for-profit colleges (whose students disproportionately rely on loans) and lending officials to call for governmental intervention -- whether through existing authority as some urged on Tuesday or through more far-reaching legislation, such as the bills making their way through both the Senate and the House of Representatives -- although most private colleges haven't joined in. While some have chosen to switch to the federal government's competing direct loan program to avoid disruptions in federally backed, lender-based loans, most haven't yet felt the impact of the credit crunch and are waiting to see how the situation plays out over the next several months.

The session was a balancing act in which college and lending officials at the panel warned about the would-be crisis but stopped short of making predictions that could induce jitters in the markets (or among students and their parents). “It is potentially a terrible crisis," said Patricia McGuire, the president of Trinity University in Washington, D.C., but she later tempered her remarks by adding: "We are not seeing problems at colleges yet, and we don’t want to scare families."

Some of the "warning signs," said Sarah Flanagan, vice president for policy development at the National Association of Independent Colleges and Universities, are evident in the organization's March survey, with responses from a third of its 953 member institutions. Although the group represents private colleges of all kinds, she noted that Trinity -- which has a $10 million endowment and serves many students from disadvantaged backgrounds -- is "much more typical" of its membership than are elite wealthy institutions.

Of the institutions that use private loans -- a majority found private borrowing either "very important" or "critically important" to their financial well-being -- 45.6 percent said their lenders informed them of stricter credit requirements and 43.2 percent had their lenders stop serving them entirely. Only 13 percent noted no change in policy. Even while private lenders were tightening requirements or raising interest rates, 48.2 percent of respondents said they had "no plan" on how to assist students if the availability of private loans diminishes. The responses were even more severe for federally backed, lender-based loans, known as the Federal Family Education Loan program, with 67.8 percent reporting a decrease in benefits and 56.7 percent affected by lenders leaving the market.

Sen. Edward M. Kennedy (D-Mass.) wrote a letter on Tuesday to the president of the American Council on Education, David Ward, urging his member institutions to exhaust federal lending options (including federal loans and grants and the direct loan program) before students turn to private loans as a last resort. On Thursday, the House will vote on the bipartisan Ensuring Continued Access to Student Loans Act, sponsored by Rep. George Miller (D-Calif.), which would increase the amount in federal loans students could borrow and put in place safeguards for borrowers if lenders' resources ever run dry.

Lenders aren't happy with Kennedy's proposal to elevate the federal direct loan program above FFEL loans. "Anyone familiar with the challenges of running a large-scale student lending operation will doubt whether the direct loan program could handle a sudden and dramatic increase in student loan volume," said Joe Belew, president of the Consumer Bankers Association, in a statement the group released to coincide with the hearing. "To rely on the Direct Loan program to meet the needs of borrowers who may suffer loss of access to student loans in coming weeks would be a mistake. This option should be rejected by all."

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