Credit Crunch Spreading to Student Loans

As we constantly talk about this credit crunch is like a big, intricate web... many offshoots in thousands of directions. So while the Street will clap like happy seals at any bond insurer bailout, the reality of a system lacking transparency, full of (now obvious) useless ratings, and probably most important lacking confidence, continues on in the "real world" (outside of the Kool Aid party that is the equity market). Here is an article for MSN about the potential impacts on the student loan market, and frankly it is the same story we see in the mortgage market. A drying up of liquidity. Now the one great thing the government did, is apparently pull $20 Billion worth of subsidies for student aid... that pays for about 2 months of war, but hey we all have our "important" priorities. Or 13% of a "stimulus package" to get everyone back into the malls. I mean, what does a country competing with a hungry world full of aspiring engineers, doctors, and scientists need to focus on. Certainly not keeping universities affordable for the middle class. Well I am sure, come hell or highwater, we can keep churning out lawyers - Washington DC is full of politicians toting that background (and America has 8 of every 10 lawyers on the face of the Earth) ... priorities! Much like healthcare, I am unclear just how much longer tuition rates can continue at "double" to "triple" the wage gains before something simply breaks. Already we have a country full of 22 year olds saddled with $10K, $20K, $30K worth of debt just to get a basic bachelors - a tough way to begin adult life.

• College students heading off to campus in the fall will face a radically different student loan situation than they did just a year ago.

• The credit crunch that rattled mortgage lenders has spread to the education lending market, with dramatic results. If the situation doesn't ease in coming months, student lending experts say, borrowers can expect (a) Higher loan costs (b) Fewer lenders, which could mean tens of thousands of college students scrambling at the last minute to find money (c) Tougher standards that could prevent some students borrowing at all.

• "It's a very different situation from last year," when lenders were falling over each other to compete for students' business, said Kevin Walker, the president and CEO of SimpleTuition.com, a student loan site. "And it's probably not clear to the consumer that this problem is looming."

• Like mortgage lenders, student loan companies were criticized in recent years for loose standards that saddled many students with massive debts. Although student lenders didn't rush into the subprime market that eventually backfired with mortgages, they lavished loans on borrowers with little concern about their ability to repay.
• The biggest student lender, Sallie Mae, reported a massive $1.6 billion loss last quarter, thanks in part to spiking default rates, and plans to set aside an additional $700 million to cover bad loans this year. Although the U.S. government guarantees lenders will be reimbursed for federal student loans, the bulk of Sallie Mae's losses were from private student loans, which aren't guaranteed.
• As investors become increasingly spooked about the credit crunch and the rising risks that loans will go bad, they're avoiding buying bundles of loans, known as asset-backed securities, that are a major source of funding for some student lenders. This aversion applies even to federal student loans despite the government guarantee. Several recent auctions of federal student loan debt have failed, meaning that investors who hold the loans couldn't find any buyers. Without this critical source of funds, some lenders can't make loans. (I have to say I am surprised that federally guaranteed debt offerings are failing; but it shows the abrupt shift from greed to fear)

• Deborah Fox, who advises families on college funding strategies, predicts rates may climb as much as a percentage point as lenders struggle with the securities markets. "Variable rates that should be coming down in a low-interest-rate environment will be moving in the opposite direction," said Fox, of Fox College Funding, "which will put further pressure on the American consumer who is attempting to keep their head above water in what appears to be a recessionary environment."

• Not all lenders get their money from investment markets. Sallie Mae, for example, will tap a recently arranged $31 billion line of credit extended by Bank of America and JPMorgan Chase. But even lenders that don't rely on the asset-backed-securities market are paying more for the money because of the credit crunch, Kantrowitz said. Lenders will pass those costs along, he said, in higher fees and fewer discounts.
• Congress trimmed lenders' profits last year by reducing their federal subsidies by about $20 billion. That, combined with higher costs of funds, has persuaded some lenders to stop making certain federal loans or to concentrate on the private loan market. (Unlike federal loans, private loan rates aren't fixed and can range up to 19%. These loans grew in a single decade from less than 5% of the student loan market to more than 20%.)

• Another significant change has to do with credit scores. Federal student loan programs typically don't use credit information, but most private lenders in the past have required a minimum FICO credit score of 675, Walker said. (The traditional start of the subprime market, by contrast, is 620 on the 300-to-850 FICO scale.) "Now they're tightening up lending criteria so that instead of 675, 695 will be the minimum," Walker said.

Thankfully none of this will matter once that stimulus check hits the mailbox, because it will get us back into the malls, and clear all these minor problems out of the way. Whew! I was worried there for a minute that this was actually a problem....