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Panic is the Enemy
Repeat after us: There is no federal student loan crisis. There is zero danger that federal Stafford loans will not be available in the foreseeable future. Zero danger. At some point in the future, there may be a squeeze on private student loan availability for some high risk borrowers, particularly those attending proprietary schools of questionable quality and limited track record as opposed to all proprietary schools. Should a large private student loan access issue arise, extending even beyond proprietary schools, there are options for federal action to ensure the availability of capital. But let’s not get ahead of ourselves.
Shaky News Coverage
Breathless and not very nuanced accountsof credit market turmoil affecting student loans have appeared in The Wall Street Journal and elsewhere over the last two weeks. These accounts note two phenomena:
Two, the subprime mortgage mess is making lenders take a more careful look at the risk associated with issuing private student loans, all non-government backed loans really, to high risk borrowers. Because proprietary colleges of questionable quality and limited track records are the most dangerous for high risk borrowers and lenders, the money people who make private loans are requiring those schools to put more of their own skin in the game for their students. Essentially, the lenders are requiring proprietary schools to agree to assume a greater portion of private loan default costs.
Unfortunately, much of the media has conflated the credit market’s potential impact on private student loans and federal student loans. They have created a sense of fear, if not panic. There is a danger that the fear might lead to hasty policy changes. The bigger danger is that the fear, if not panic, could depress college access for students who think they can’t get a loan.
They can. The mainline press should be ashamed for conflating questions of access to private student loans with guaranteed access to federal student loans.
Federal Student Loans are Widely and Safely Available
There are thousands of federal Stafford Federal Family Education Loan (FFEL) providers in addition to the Department of Education’s Direct Loan program. And Stafford loans require no credit check. If 10, 20, even 100 FFEL providers suddenly suspended their Stafford loan originations because of an inability to raise capital, there would still be widespread availability of federal student loans.
The lenders who are having the most trouble raising capital through asset-backed securities are in the secondary market. Regular old banks continue to make federal Stafford loans. In fact, JP Morgan Chase announced it was cutting interest rates and fees on federal and private student loans.
If for some reason a sustained private credit meltdown actually resulted in reduced availability of federal student loans, the Higher Education Act includes a "fail-safe" that ensures federally sponsored guaranty agencies act as "lenders of last resort" with federal capital. If guaranty agencies don’t have capital, they can get an advance payment of capital from the U.S. Department of Education. There is no risk that a student will not be able to access a FFEL Stafford loan.
But if any school is worried that its students will have difficulty obtaining FFEL Stafford loans, that school can always switch to the U.S. Department of Education’s Direct Loan program, which offers the same Stafford loans at the same government-set interest rates. Currently, a little over 20 percent of federal loan volume runs through the Direct Loan program. With the advent of the Common Origination and Disbursement system, any school that participates in the Pell Grant program could easily originate Direct Loans and draw down federal funds from the Department of Education. And despite the fear FFEL industry insiders are spreading, we have been assured by high-level federal officials that the Direct Loan program’s volume could more than double very rapidly, if need be.
Please Take out a Federal PLUS loan Before a Private Loan
Some may object to our take noting that the federal Stafford loan program carries limits on the amount of federal Stafford loan debt that can be borrowed -- $23,000 in the aggregate for an undergraduate. They may ask, what about students who need to borrow more?
Our first response is that the parents of those students should apply for a federally guaranteed PLUS loan. As with federal Stafford loans and for the same reasons, there is zero risk that capital will not be available for PLUS loans. And PLUS loans, unlike Stafford loans, are available in amounts up to the total cost of attendance for a student. Moreover, PLUS loan interest rates are capped at 8.5 percent and have low fees. They beat most private student loans.
There’s a catch to federal PLUS loans in that they require credit worthiness. In the current credit market environment there is a fear that PLUS loans won’t be as easily available, because lenders fear risk.
But let’s keep in mind that PLUS loan borrowers total about 525,000 each yearas compared to about 7 million new FFEL Stafford borrowers. That’s less than 10 percent and most of those borrowers will continue to not have a problem accessing PLUS loans. For those borrowers that do get turned down for a PLUS loan because of credit worthiness, Stafford loan limits double to $46,000 in the aggregate. And Stafford loans have even lower interest rates than PLUS loans.
Private Loans
Up to $46,000 a year in universally available federal student loan debt generally is enough for undergraduates. It is more than twice average undergraduate debt. But there are outliers and there are cases when for family reasons PLUS loans are not an option. Those borrowers may well have to turn to private loans.
Still the fact is private loans affect a much smaller number of people than federal loans. Private loans are taken out by 10 percent of undergraduates. At least half of those are to or for students with excellent credit, and those students will continue to have no problem accessing a private student loan. Their interest rates may be 50 to 100 basis points higher than before the credit crunch, but they will continue to have access to private student loan capital. At least half of remaining private loan borrowers have access to guaranteed low cost, federal Stafford student loans, but don’t exhause their eligibility. So in terms of access to capital, what we’re looking at is maybe two or three percent of undergraduate students who may in the future confront a private loan availability issue based on circumstances reflected in the current credit market.
For now, Higher Ed Watch recommends that policymakers keep their powder dry. Panic is the enemy. Next week, we’ll discuss further the relationship between the credit crunch and student loan capital, and we intend to float a policy response should a problem that seriously affects actual students arise. As of now, despite the headlines, we’re unconvinced.
Stay tuned, and stay cool.
Lenders Are The Enemy
It’s good to know that consumers have the NAF in their corner in times of uncertainty like these! Why, just five months ago NAF was concerned that “Undergraduates are getting buried in private loan debt”-Private Loan Borrowing, October 25, 2007. Fast forward to today, and NAF apparently has a different opinion: “But keep in mind that private loans affect a much smaller number of people than federal loans. Private loans are taken out by 10 percent of undergraduates.” That’s quite a turn of events there NAF! Did all the students who were buried in October 2007 dig themselves out here in February 2008? Ah shucks! I guess anything’s possible! It is interesting to note that the “buried” comments were made when the industry was under the gun from pending Congressional regulation for all the “improprieties” your intrepid staff had documented. Today we have the “much smaller number of people” comments made when private lenders are again under the gun, this time from the capital markets. How does one reconcile these contradictory statements? Hmmm!
Our Congressional lawmakers were really prescient when they came up with the “federal direct loan program” weren’t they NAF? They knew that the “general welfare” would one day be in danger (like today). Of course, by the “general welfare”, I mean the 30% or so of adult Americans who obtain a college degree. And of those fortunate few, the 66% who borrow (roughly 20% of the adult American population) from federal programs like the “direct loan program” to finance the degree. (Although we should note that the “direct loan program” only provides for roughly 20% of the federal borrowing today, so the “general welfare” associated with this federal program is much smaller-call it roughly 4% of that adult population). Ah, there I go again…getting caught-up in the numbers! I should recall the multitude of studies that associate, but do not correlate, many positive externalities with a person obtaining a higher education! Anyway, back to Congress! They sure devised a creative way to make the use of the “commerce clause” of the Constitution more efficient with respect to their duties vis-à-vis student loans! If you have a benevolent government program like the “direct loan program” replacing private enterprise, there’s no need to regulate interstate commerce because the government would be in effect, regulating itself-genius! It makes you wonder why the Founding Fathers bothered to put the “commerce clause” in the Constitution in the first place if they meant for the government to 100% run commerce (like student lending) in lieu of private enterprise! It’s superfluous if they are regulating their own activities isn’t it NAF?
In summary, nobody’s worried NAF! Americans know we are only a few scandals away from complete government domination of student lending! We rest easy tonight knowing that you will bring them to our attention!
PLUS Loans
As you noted, PLUS loans require a type of creditworthiness. Specifically, to be eligible for a PLUS loan the borrower must not have an "adverse credit history". One of the criteria for an adverse credit history is a foreclosure within the last five years. Since the subprime mortgage credit crisis was precipitated by an increase in foreclosures, it is reasonable to expect that PLUS loan denial rates will increase.
When a dependent undergraduate student's parents are denied a Parent PLUS loan, the student becomes eligible for increased unsubsidized Stafford loan limits: an extra $4,000 per year during the freshman and sophomore years, and an extra $5,000 per year during the junior and senior years. This falls short of the average PLUS loan amount, which is roughly $11,000. (Graduate and professional student borrowers who are denied a Grad PLUS loan do not become eligible for increased unsubsidized Stafford loan limits.) Borrowers with an adverse credit history are unlikely to qualify for private student loans. This problem affects both the FFEL and Direct Loan programs.
For this reason, Congress needs to consider increasing the limits on the unsubsidized Stafford loan for undergraduate students, and to provide a safety net for graduate and professional students. Since the President's FY2009 budget shows negative subsidy rates for the unsubsidized Stafford loan for both the FFEL and Direct Loan programs, Congress could increase the unsubsidized Stafford loan limits at no cost to the taxpayer. In fact, by increasing the loan limits Congress would obtain up to $500 million a year in additional revenue, enough to increase the maximum Pell Grant by $125.
Mark Kantrowitz
Editor's Note: Mark Kantrowitz is the Publisher of Finaid.org, a financial aid information website sponsored by Monster, Inc. and Citibank Student Loan Corporation.
typical "ut,oh" response from leftists
Congratulations. You and your posse succeded in wiping out an industry (mortgage and credit card lenders next?). A few items require more detail:
"Should a large private student loan access issue arise, extending even beyond proprietary schools, there are options for federal action to ensure the availability of capital. But let’s not get ahead of ourselves."
Care to enlighten us on how ED will fund non-secured education loans?
"Regular old banks continue to make federal Stafford loans."
Don't you mean three to five mega-banks that already originate more than $3B in FFELP loans will be ok, in other words a monopoly industry? All of the other ones will either exit the program (e.g. WAMU, Sovereign Bank) or make losses on FFELP to try and salvage traditional banking customers.
"But if any school is worried that its students will have difficulty obtaining FFEL Stafford loans, that school can always switch to the U.S. Department of Education’s Direct Loan program"
Wasn't that the goal of your concerted effort to begin with? To force borrowers to use the government product that cost more and could not compete in an open market?
"Zero Danger..."
I would be extremely carefull of blanket comments like: "There is no federal student loan crisis. There is zero danger that federal Stafford loans will not be available in the foreseeable future. Zero danger. "
Yes, schools do have the choice to switch over to the Direct Lending program but what happens when DL is overloaded? Like say, during tax season? I work for a FFELP company and just around this time of year dispersements, refunds and overpayments usually start getting delayed for as much as 90 to 120 days if they are coming from Direct Loans. All funds sent from Direct Loans come from the Department of Treasury so during this time of year everything starts to get back logged. If this occurs during current demand for Direct Loans what is going to happen when there is a mass immigration of schools switching over to DL loans...? Even a 90 day delay on a student's stafford loan dispersement can begin to start jepordizing current student's ability to stay enrolled and new students from starting on-time. What is going to happen when the delay on new loan dispersments begin to creep to 3-4 months, if not longer. The borrowers that need these loans the most are going to be the ones left out in the cold.I do not have any numbers confirming this but working in this industry for a number of years, I have heard horror stories from many students about the DL program in its current state. I shudder at the thought of DL dispersing all new stafford loans for students. NAF , you claim "The overriding mission of this blog is to support programs and policies that make post-secondary education more accessible, affordable, and rewarding for all", but your mission statement and your rants about the FFELP program are diametricly opposed.
An enormously successful 40
An enormously successful 40 year old education finance program is melting down. Direct lending will not be able to support the need. The Department of Education does not have the expertise to resolve the problem. Those who do not understand it or are unwilling to admit it are just contributing to the approaching train wreck.
Told You So????
I would like the author of this article to publicly apologize to the hundreds of thousands of students in America that no longer have access to private student loans. Let me know how the whole "no student loan crisis" is working out for the students in America today.
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