U.S. Offers Plan for Bolstering Student Loan Industry

With new threats of lender departures, agencies unveil proposals that are seen as likely to satisfy banks (and Sallie Mae?).
May 21, 2008

For weeks, student loan providers and some college officials have been urging the U.S. Education Department to act aggressively to ease their pain, given the authority it gained in a new federal law designed to ensure the continued availability of federal student loans despite the continuing credit crunch.

In recent days, as proposals circulated by department officials suggested a more cautious intervention by the government, the lenders' pleas have been increasingly tinged with an implicit "or else." Simply put: if the department does not find ways to make loan capital available, ideally up front and at terms that make loans sufficiently profitable, even more lenders will bolt the federal guaranteed loan program, potentially leaving an inadequate supply of loans for students.

At a private meeting with loan industry representatives late Tuesday afternoon, officials from the Education and Treasury Departments presented their plan for providing relief to lenders who have found themselves unable to raise money from the investors and markets that have historically purchased existing loans to give lenders money to make new ones.

The department's plan, according to sources familiar with what unfolded at the meeting, includes two short-term proposals and the promise of negotiations for a longer-term solution beginning next week.

Under the first of the short-term solutions, the government would agree to buy loans made after May 1, 2008 (and through July 1, 2009) from lenders using a fee structure that would include the full value of the loans plus accrued interest, rebates of certain fees paid by lenders, and a $75-per-loan flat fee to cover some of the lenders' costs. This proposal -- which those familiar with it defined as a kind of "price support" -- is designed to reassure investors wary of buying loans because they might later be unable to sell them that there will ultimately be a buyer for them (the government). This proposal is reportedly contingent on being shown as cost neutral to the federal treasury.

Under the second option, which the government hopes to have in place by July 1, the government would establish a fund (financed with Treasury Department money) from which it would essentially make upfront loans to lenders to finance their own loan-making operations; the lenders' student loans would be used as collateral. The government's loans to lenders would be made at a rate of half a percentage point above the rate of commercial paper, a standard rate.

In preparing their proposals, federal officials have been walking a tightrope between (a) not wanting to be seen (by Democrats in Congress and critics of the loan industry) as selling out to banks and other lenders and (b) not displeasing lenders so much that they bolt the loan program and leave students without a way to finance their educations.

In recent days, several news outlets have reported rumors that Sallie Mae, the largest provider of federal student loans, would join other major lenders in ceasing its origination of federally guaranteed loans. Some loan industry observers have characterized the threat as a scare tactic -- an unlikely outcome put forward mainly to pressure the department to increase its offerings to lenders.

A first major sign of whether the department has struck that balance in a way that satisfies lenders will come today, when Sallie Mae holds a conference call it announced late last week for its customers to discuss the uncertainty in the student loan market and its implications for the coming academic year. Sallie Mae officials declined to say Tuesday what they thought of the government's proposal or to tip their hand about what if anything they would announce Wednesday about the company's intentions.

But if the stock market is any indication, the government's proposals may have done the trick. Sallie Mae's stock rose 5 percent Tuesday amid reports, as Bloomberg put it, "that terms of an industry rescue plan will be favorable for the company."


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