Interest Rate Roundup

Thursday, April 10, 2008

Student loans the latest credit crisis "mole" to pop up

A handful of observers have used the "Whac-A-Mole" metaphor to characterize the credit markets today. In other words, just when you beat down a crisis in some corner of the credit market, another pops up somewhere else. The latest "mole," in case you haven't been following things closely, is the student loan market.

Just like auto loans, credit card loans, residential mortgages, commercial mortgages, and leveraged buyout loans, student loans are originated, then bundled together and sold as securities to fixed-income investors. And just like they did with RMBS and CMBS, investors have now decided they don't want to hold student-loan asset-backed securities (SLABS). So liquidity is drying up in the student loan market.

As the Washington Post noted this morning:

"Nearly 50 student lenders, including some of the industry's biggest names, have stopped issuing federally guaranteed loans in recent weeks because of paralysis in the credit markets, confronting students with higher borrowing costs just as they are starting to apply for financial assistance for the coming school year.

"These companies represented 12 percent of the market before they left, and analysts say this is just the beginning of an exodus. That is because virtually all student lenders have been shut out of their traditional funding sources on the debt markets. Dozens of other lenders that offer private loans, which have no federal backing, have also dropped out.

"The escalating problems have persuaded the Education Department to prepare a "lender of last resort" program, which would provide emergency funds to a few dozen lenders designated to help students who are unable to secure federally backed loans."

This excerpt gives some more color on the magnitude of the problem:

"The tumult is likely to push hundreds, if not thousands, of firms out of the student lending business, said Mark Kantrowitz, publisher of FinAid, a Web site that provides financial advice for students. Of particular concern is the number of firms leaving the business of making federally guaranteed loans, which, besides parents, are the primary source of financing for students' higher education.

"The list of dropouts includes such major players as College Loan Corporation, HSBC Bank, CIT Group and Washington Mutual. Among the 100 largest lenders, which represent 92 percent of the federal loan market, 19 have left. In addition, firms have cut nearly 2,300 jobs."

How is the industry responding? It's asking the Fed to start accepting SLABS as collateral for Fed borrowings (on top of everything else, including CMBS). Here's a Reuters story from a few days ago ...

"The financial services industry has urged the Federal Reserve to accept as collateral triple-A rated student loan asset-backed securities as collateral for firms seeking to borrow from new Fed facilities aimed at thawing frozen credit markets.

"The American Securitization Forum and the Securities Industry and Financial Markets Association wrote Fed Chairman Ben Bernanke and New York Fed President Timothy Geithner on April 2, saying those securities are safe and should be among those financial firms can pledge to borrow from the central bank.

"Given the very limited credit risk inherent in triple-A rated government guaranteed and private (student loan asset-backed securities), we believe this proposal appropriately balances managing federal government risk exposure and meeting with urgent need for additional sources of liquidity to help fund student loan originations," the industry groups' senior officials wrote."

I understand the urge to help the credit markets and certainly, we don't want Americans to suddenly be unable to go to college. But at some point, I think we have to start asking: "Where does it all end?"

Is the Fed going to start buying more credit card-backed paper if it becomes less liquid? What about auto loan ABS? Demand is pretty weak there. Or what about other assets that are losing value? REO property? Risky stocks? Former Fed Chairman Paul Volcker already noted this week that some of the things the Fed is doing are on dangerously thin ice in terms of legality. Others are setting dangerous long-term precedents. Some key quotes:

“The Federal Reserve has judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending in the process certain long-embedded central banking principles and practices.”

and (in regards to the Bear Stearns transaction) ...

“What appears to be in substance a direct transfer of mortgage and mortgage-backed securities of questionable pedigree from an investment bank to the Federal Reserve seems to test the time-honored central bank mantra in time of crisis: lend freely at high rates against good collateral; test it to the point of no return.”

One thing is certain: We are definitely living in interesting times.

2 Comments:

  • I would advice a young parent to think about FEDERAL STUDENT LOAN as early as a child is preparing to go for high school. This is important because you will avoid any enormous strain on rush loans that most especially are unavoidable. The federal student loans information is available online, in your local library, high schools and even in the colleges and universities. You need to be advised on why you should try the alternative of federal student loans or why you should not leave it out as an extra way of funding your child's education.

    By Blogger Poly Muthumbi, at May 13, 2008 at 2:57 AM  

  • Hey, great blog you have here! Just bookmarked you!

    I have a Student Loans site & blog. It pretty much covers Student Loan related stuff.

    Come and check it out if you get time :-)

    Cheers, Greg.

    Loans Blog

    By Anonymous Learn More About Loans, at May 19, 2008 at 4:30 AM  

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