Answers to the Student Loan Credit Crunch

With any panic, there comes a point when cool heads have to stop saying “don’t worry” and start offering solutions to real and perceived phenomena. Unfortunately, we’ve reached that point when it comes to fears about the credit crunch and student loans. Today, we float some policy options.

To be clear, we at Higher Ed Watch continue to believe there is no federal student loan crisis. There is zero danger that federal Stafford loans will not be available to every student in the foreseeable future, regardless of their credit history or income. Even if 100 or more lenders close shop, there will continue to be over 2,000 federal student loan providers, including big banks, such as JP Morgan Chase, which recently hired ex-Nelnet workers and announced a voluntary reduction in federal student loan interest rates and fees.

In fact, this week the Consumer Bankers Association said that “despite a series of negative developments that have increased their costs and reduced their margins, banks plan to continue making both [federal] and private loans in academic year 2008-2009. Joe Belew, the association’s president, said that banks “have a decades-long commitment to the student loan business,” and even as some lenders pull out, “some banks plan to expand their lending in the upcoming academic year to ensure that students have the funds they need.”

Moreover, the federal student loan program has two “fail safe” systems in the form of the Federal Family Education Loan (FFEL) “lender of last resort” program and the Direct Loan program, through which Uncle Sam’s dollars are made available to students and families. There is no federal student loan crisis.

But lenders seeking a bailout from past risky financing decisions and trying to roll back Congressional subsidy cuts, the “independent” analysts they sponsor financially, and their friends in Congress (who they also sponsor financially) are spreading fear that some old media outlets are happy to report. It’s easy for the media to get confused, because some private student loans are becoming more expensive and there may be an issue of access to private student loans at some schools — particularly low quality, for-profit trade schools.

But federal student loans remain the dominant form of lending for college. Some claim these government-sponsored loans are not sufficient to pay for college. But of course, federal PLUS loans are available to parents to cover the entire undergraduate cost of attendance to any accredited college. And any family that can’t get a PLUS loan because of adverse credit is eligible to borrow up to $46,000 in federal Stafford loans (page 6), which are guaranteed and universally available regardless of credit history.

Still, politicians are going to want options. Here are seven to consider. This list is for discussion purposes.

(1) Buy Outstanding Loans. Think of this as the Son of Sallie Mae option. The federal government could start buying existing FFEL loans. It could then send those loans over to the Direct Loan program for servicing and collection. Instead of paying subsidies to a FFEL lender for the next 10, 20, or 30 years, the government would own the relevant loan and collect it. Buying a FFEL loan at an amount higher than face value, but less than its net present value (future government subsidies to the FFEL lender included) would save taxpayers money. It would also ensure a stream of liquidity for FFEL originators. And it would provide borrowers with the Direct Loan program’s favorable repayment options like forgiveness for public service work. Of course, FFEL lenders would try to dump risky loans on the federal government, but they do that already through the consolidation loan program.

(2) A Debt Swap. Existing private loan borrowers often don’t exhaust their federal student loan eligibility. Lack of federal loan exhaustion before private student loan borrowing bothers us greatly at Higher Ed Watch, because federal student loans are almost always cheaper and safer for borrowers than private student loans. The federal government could make new federal Stafford loans available for all borrowers (out-of-school or in-school) with private loan debt and untapped Stafford loan eligibility. These newly borrowed funds would have to be used to pay off existing private student loan debt. Presumably, a debt swap policy would ease the financial burden of private loan borrowers and infuse liquidity into the private student loan market. We worry that high-risk borrowers will be dumped on federal student loan books, but these borrowers had an entitlement to guaranteed loans with no credit check when they began their post-secondary studies. They should still be able to tap that original student aid resource and save money going forward.

(3) Make Uncle Sam a FFEL Lender. The Direct Loan program should be identified as a FFEL eligible lender. There is already an existing requirement that the Direct Loan program have an “alternative originator” for colleges that do not have the administrative capacity to carry out the Direct Loan program. To our knowledge, it’s never been used. The Direct Loan program’s contractor should be allowed to originate Direct Loans at any FFEL school. Even if that school lacks the capacity to administer the Direct Loan program, it could take advantage of the alternate originator. In contrast to the schools that choose to participate in the Direct Loan program exclusively in order to ensure that they and their students deal only with one lender, FFEL schools choose to have multiple lenders for their students. What’s one more? Especially when it will doubly guarantee that their students have access to federal student loans.

(4) Increase Stafford Loan Limits. We’re reluctant to suggest higher Stafford loan limits, because we fear that for-profit trade schools in particular are apt simply to raise their tuition and fee levels in response. The one group of borrowers that might actually have an access problem in this credit environment – subprime private loan borrowers seeking to attend for-profit trade schools that are low quality – would get next to no help in such a circumstance. But federal student loan debt is better than private student loan debt. To the extent schools do not increase tuition and fees more than they otherwise would, a debt swap from high-cost and risky private loans to low-cost federal student loans is likely to occur — and that would be a very good development.

The House of Representatives passed a $7,000 increase in aggregate undergraduate Stafford loan limits (subsidized and unsubsidized) less than a year ago only to drop the proposal in conference with the Senate. The House plan could easily be resurrected — it cost only $1.5 billion over five years, according to the Congressional Budget Office (CBO) — and slipped into the pending Higher Education Act reauthorization conference agreement. If the federal government is going to raise Stafford loan limits, it at least should be sure to do it for low-income students getting subsidized Stafford loans instead of for upper-income students getting unsubsidized Stafford loans. It's low-income students, especially those who are subprime borrowers assuming private loans, who need federal loans more.

If there is to be an increase in Stafford loan limits, we at Higher Ed Watch would like to see it accompanied by a strong maintenance of effort requirement on state higher education funding and a truth-in-tuition provision where colleges have to provide students with multi-year price schedules. Otherwise, governors and legislatures will simply cut state higher education funding and increase tuition by $7,000 a year as soon as they can. They may still do it. The tuition inflation danger is the problem with increased loan limits, including poorly thought out proposals to make PLUS loans available to undergraduate dependent students up to the cost of attendance (i.e. a new Undergrad PLUS program). Nevertheless, a loan limit hike has to be on the table, albeit only in limited form.

(5) Order a Lender of Last Resort Emergency Test. Just as the Emergency Broadcast Network carries out those annoying one minute buzz tests during your favorite television program, the Department of Education should carry out an emergency test of its existing lender of last resort program. All 36 guaranty agencies are supposed to have in place a plan to issue lender of last resort loans. The Department of Education should be required to run a test whereby it advances some large amount of funds for 48 hours to guaranty agencies to see if their “lender of last resort” systems function. There would of course be strings attached to avoid guaranty agency theft or abuse. Perish the thought.

(6) Instant Direct Loan Program Participation Authorization. According to current Direct Loan schools, it takes about four to six weeks for a school to switch from FFEL to the Direct Loan program. Most of that time is taken up by a Department of Education verification process. Almost no school is turned down. During this credit crunch period of uncertainty, the Department should provide instant authorization to switch to the Direct Loan program for any school that administers the Pell Grant program and has at least a certain amount of annual FFEL volume. The Department can follow up to verify capacity in the weeks after instant authorization. In the meantime, the schools can get their disbursement systems switched. It’s safe to assume any school with more than $40 million in annual FFEL volume has the administrative capacity to carry out the Direct Loan program, which isn’t that hard. Over 1,000 colleges already do it.

(7) Accelerate the College Cost Reduction and Access (CCRA) Act’s Origination Fee Reduction Provisions. Lenders claim students are being hurt by CCRA, because subsidy cuts passed by Congress are taking the form of reduced borrower benefits, such as smaller than previously provided reductions in origination fees. In fact, the CCRA constitutes the single largest increase in student financial aid since the GI bill. Not only are lender supplied borrower benefits inequitably available, conditional on borrower behavior, and small in size, but the reductions were more than made up for by the law’s giant increase in Pell Grant aid, cuts to undergraduate subsidized student loan interest rates, and new public service loan forgiveness program. But if the lenders want us to think students are being hurt by the combination of the CCRA and the credit crunch in the form of reduced lender-supplied borrower benefits, fine. The government can step in and provide those benefits right away on its own and do so equitably and without condition. It’ll cost the Treasury, but we’d rather bail out students affected by the credit crunch than bail out lenders who are seeing heightened short-term borrowing costs, because of risky financing decisions they made long ago. Besides, we’ve suggested other options above that generate taxpayer savings.

We want to be clear. Federal student loans continue to be widely available. We foresee no widespread lack of availability of federal student loans in the future. We do think there may be a private loan issue for a small number of borrowers. But federal student loans and private student loans are conflated easily by the media, and perceptions are what they are.

Hopefully, policymakers will act with level heads.