More U.S. Help for Student Loan Providers

Education Dept. plans to replicate existing programs to ease flow of funds to students and colleges, and add a third to try to ease choked credit markets.
November 10, 2008

The U.S. Education Department will announce today that it is adding a third major component to its existing effort to ensure that, despite the worsening economic picture, student loan providers have sufficient financial backing to ensure, in turn, that students and families have enough federal help to pay for college. The new arrangement --

In May, in response to a federal law enacted quickly last spring in response to the credit crunch that was then seizing the financial markets, the education agency and the Treasury Department crafted a short-term plan designed to make sure that federal loan funds continued to be available to college students in the 2008-9 academic year (in addition to expanding access to the government's competing direct loan program). Under that two-part arrangement, the government (1) agreed to buy from lenders certain federally guaranteed loans made between May 1, 2008 and July 1, 2009, in an effort to reassure investors wary of buying loans because they might later be unable to sell them; and (2) to invest in pools of loans held by a custodian, in order to provide short-term liquidity to student lenders.

Those programs have largely worked, according to U.S. officials and most lenders. So far, under the first plank, only two lenders have sold $62 million in loans to the department, and four more are expected to sell another $350 million in November, the department reports. But nearly 800 lenders have indicated to the department that they would like to be able to sell loans originated for the 2008-9 academic year.

And 12 lenders have made use of the pool investment program to receive $8.7 billion in department payments, which represents nearly half of the total federal student loan disbursements made to students so far in 2008-9. A total of 19 lenders have been approved to participate in the latter program, in which the department purchases a 100 percent stake in pools of loans.

Department officials also said in May (encouraged by student loan providers) that in addition to those short-term efforts to reimburse lenders for loans they've already made, the government would consider some longer-term steps if the financial markets continued to be restricted. Since then, the overarching financial situation in the country has taken a turn for the worse, and many lenders have opted not to participate in the federal loan programs, finding themselves unable to persuade outside investors to give them the money they need to make loans.

"The continued tightening of the credit markets has created conditions making it difficult for lenders to secure the needed private capital," raising questions about whether sufficient loan funds will be available for disbursements to students next semester or to make loans for 2009-10, the Education Department said in a statement Friday. To put another way, a department official said, "We got a sense that if we simply replicated [what was done in 2008-9], and lenders didn’t see any hope for the long haul, they might not participate" in the loan programs.

That explains the third plan the department is unveiling. In addition to replicating the loan purchase and pool investment programs it put in place for 2008-9, which would cover loans made through September 30, 2010, the department plans to allow for the creation of "conduits" (likely to be banks or big student loan providers like Sallie Mae) that are designed to be a middleman between groups of lenders and outside investors. Under these arrangements, the conduits would (using funds from private sources, not federal money) purchase student loans that were fully disbursed between October 2003 and July 2009 (only non-consolidated loans would qualify), and the entities would then issue "asset-backed commercial paper" (a form of short-term investment vehicle) to private investors.

The key is that the U.S. government would agree up front to purchase, at a later date and at a set price, the commercial paper that is issued in exchange for the student loans if other investors cannot be found. This is designed to assure investors that their investment in student loans is a sound one, and to set it up in such a way that a borrower's loans remain with the same lender and are serviced by the same loan servicer. The repurchase would be done in a way that is cost neutral to the government.

The overall goal is to "reengage the private market back in student lending," a department official said.

Lenders welcomed the government's announcement. "The department kept its word," said Brett Lief, president of the National Council of Higher Education Loan Providers. "They described what they did in May as a backstop to ensure that schools and students would be okay in 2008-9, and everyone believes they succeeded in those goals. But they also said they might need to do more if the credit markets remained in a seized state and there was no liquidity, and in fact the markets have worsened in the last couple months."

While the department's plans so far to ensure the flow of student loans have generally won support from advocates for students and some lawmakers who are frequently critical of excessive federal backing of lenders, the newest effort is likely to get scrutiny from those who have feared a bailout of lenders. Early reviews from Democratic lawmakers in Congress, though, were cautiously supportive.

"I'm glad that the department is continuing to use the authority granted by Congress to provide students and families with access to the federal student loans they are counting on to help pay for college, while protecting American taxpayers," said Rep. George Miller, the California Democrat who heads the House Committee on Education and Labor. "I look forward to learning more details about the department's additional proposal to further safeguard federal student aid from the turbulence in our economy."


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