NAICU Washington Update

Washington Takes Steps to Avert Student Loan Crisis

Both Congress and the administration took significant steps in the past 10 days to help avert a credit crisis in the student loan programs. In stark contrast to legislative progress on the Higher Education Act (now in its sixth year of consideration), Congress acted with unusual alacrity to pass legislation designed to avoid a potential breakdown of the student loan system. The bill, which gives the Secretary of Education new authority to buy back student loans, has already been signed into law by the President.

On a separate front, the Federal Reserve Bank announced it would accept assets backed by student loans as collateral for borrowing from the Term Securities Loan Facility (TSLF). Combined, the bill passage and the Fed action are important first steps in sending signals to consumers and lenders that the federal government intends to make sure education loans will be there for all students this fall.

What Will H.R. 5715 Do?

H.R. 5715, the Ensuring Continued Access to Student Loans Act of 2008, would do two things to help spur the markets. First, it would allow the Secretary of Education to buy back federal student loans from lenders, freeing up capital so that lenders could turn around and make more student loans. The bill also allows the Secretary to resell the loans back to the same lenders, should liquidity return to the markets.

Second, the bill takes a relatively obscure provision in the Higher Education Act called Lender of Last Resort (designed to help individual borrowers who cannot find student loans), and amends the provision to make entire colleges eligible for the program. Under this provision, if a college had all of its student loan lenders drop out of the program overnight, it could instead go to the designated state lender with its entire student loan portfolio.

The bill also provides a $2,000 annual increase in unsubsidized loan limits for independent students, and for students whose parents have been denied a PLUS loan. Also, all parents will be now allowed to capitalize their PLUS interest and defer payments until six months after their child has graduated from college. In addition, there is a loosening of the credit standards in PLUS for parents who have had difficulties with home loans or are in arrears on other debt.

Will It Work?

Since student loans still are reliant on private lenders, no federal legislative or administrative action can force market liquidity. However, the fact that the federal government is taking proactive steps is important in an arena where market impression is crucial.

There are other unknowns in what the federal government has done, however. For example, lenders claim that student loans are simply not profitable to make under current market conditions, given the cuts to lender subsidies last September, under the College Cost Reduction Act (see WIR, 9/13/07) and the unfavorable spread between federal payments and their cost of capital. However, lenders that are in the business for the long haul and have some equity may make loans anyway. Others may continue to jump out of the program.

The Term Securities Loan Facility action is also a bit of an unknown. Among other limitations, the entities that borrow from TSLF must have triple-A ratings.

How well the Secretary's buy-back authority works won't really become clear until this summer, when students go looking for loans to cover the fall semester. Some in the financial markets view the buy-back provision optimistically; others do not. If lenders find selling their student loans to the Department to be sufficiently profitable, then a crisis could be averted. Of course, that will depend on the price the Department is willing to pay, and the conditions they impose. The Department is actively reviewing ways to implement the mechanism that will be quick and efficient, plus acceptable to lenders. All in all, any action and signals from Washington are a step in the right direction.

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