The Student Loan Bailout
As the economic crisis deepened during 2008, the turmoil in the housing and credit markets generated most of the more dramatic headlines. But higher education, and particularly the market for student loans, has also been feeling the effects of the ongoing recession. Loan availability is down while financing costs are up. Endowments are shrinking, the job market is stagnant, home equity loans are virtually non-existent, and as private loans dry up students and schools are relying more and more on Washington for support. The government response has been to throw as much as $500 million per week at an expensive public-private partnership growing less popular and more precarious every day, raising serious questions about the motivations behind the bailout.
The federal government provides students with college loans through two main programs. Through the Direct Loan Program, the federal government directly finances loans to students without a private intermediary. In the Federal Family Education Program (FFEL) private lenders--most notably Sallie Mae, cousin to mortgage lenders Fannie Mae and Freddie Mac--provide the money to students, while the government guarantees the loans against default and pays the financing fees during the years students attend school. This latter program accounts for a significantly larger share of overall college loans--$52 billion in FFEL loans were generated in 2007, compared to only $12 billion in direct loans.
Because the government does not have to outlay the entire initial loan, supporters often argue that the FFEL program is cheaper, but the cost advantage diminishes over the long term. According to the Office of Management and Budget, a $3000 dollar FFEL loan costs the state $157 dollars to service and finance, while a comparable direct loan only costs $23 dollars in fees. Projected across a year's worth of loans, the difference comes out to a potential savings of $4.4 billion. "Direct is almost certainly cheaper," says Sandy Baum, a senior policy analyst for the College Board, begging the question whether the additional federal money would not be better spent on generating new students loans, rather than covering the servicing fees of financial institutions.
Last year, Education Secretary Margaret Spellings announced that the Department would expand the amount of direct loans available, but thus far only $18 billion of a maximum of $30 billion has been disbursed. The shortfall in federal loans has exacerbated an already dire situation, as private lenders sent reeling by the financial meltdown have also shut off access to additional credit. Since the subprime crisis began, at least 168 lenders have dropped out of the FFEL program, forcing many schools to rely increasingly on direct loans for their students. According to a recent study by Student Lending Analytics, an independent group that evaluates potential lenders for colleges and universities, almost 30 percent of schools that currently use the subsidized FFEL program are considering switching to direct loans. Financial aid officers cite the administrative ease of dealing with only one lender and the related cost reductions, and shortened wait times for students as among the reasons for switching to direct federal loans.
Nonetheless, faced with rising budget deficits and a recessionary economy, the federal government recently moved to prop up the sagging private loan market. This past year, the Department of Education announced plans to support the FFEL program by creating a "private market financing vehicle" to provide capital directly to lenders. At the same time, the Department began buying up $6.5 billion in private FFEL loans, to provide a short-term bridge until the financing vehicle is operational. Supporters of the bailout argue that if the program collapsed, the fallout would overwhelm the government's resources. "A lot of these lenders are getting close to the edge. They're on very thin ice. And it wouldn't take much to push them over," says Mark Kantrowitz, publisher of FinAid.org.
But critics of the plan would rather see the money given directly to students in the form of new loans. "It seems that what we're creating is direct loans by another name," says Eileen O'Leary, assistant vice-president for finance and director of student financial services at Stonehill College and formerly the president of the Direct Loan Coalition. "One of the positives of the FFEL program is that it uses private capital to service a public need, but if the government is supplying the capital, they really ought to rethink it." When asked by a reporter why the Department chose not to simply channel the $6.5 billion through the direct program, Undersecretary of Education Sara Martinez Tucker said they would "meet the challenges of any schools that wish to transition," but offered no further explanation.
The short-term liquidity provided by the $6.5 billion does come with some important accountability measures. Lenders are not allowed to sell loans to the Department of Education that have been unpaid for more than 210 days, and cannot sell any loans that have been securitized or that have liens attached to them. But although lenders are technically required to use all the bailout funds for generating new loans, any money they use to free existing loans from liens or securities counts towards the total amount of new credit they disburse--creating an incentive for lenders to buy dubious loan securities back from investors and then dump the risk on the government. "They'll take advantage of anything that proves profitable," says O'Leary. "That's the business they're in."
At a recent Goldman Sachs conference, Albert L. Lord, vice chairman and CEO of Sallie Mae, practically glowed with praise for the new program. "We're beginning to see a few not so obvious signs that things are improving," he said, adding that the company was planning to add over $25 billion in assets over the next year. "We're going to do that," he went on, "with funding...not one dime of which was available to us a year ago. Our FFEL...program will be financed entirely by government financing, paid obviously by the Treasury through the Department of Education." With Sallie Mae and the Goldman Sachs investors gloating over the government money that will soon be rolling in, it seems that the student lending portion of the financial bailout is no different than the rest--a corporate giveaway for shareholders and CEOs, and cold comfort for the borrowers who need it most.