The Latest Sub Prime Mortgage Victim — Student Loans

As a result of the sub prime mortgage crisis and skittish lenders, the federal government is expected to declare Thursday that California’s Student Aid Commission will become the state’s lender of last resort for federal student loans. 

The increasing reluctance of some private lenders to remain in the student loan market comes at the time applicants are receiving their letters of acceptance from colleges around the country. 

More than 10 million of the nation’s 18 million college pupils receive some type of federal student loan. Student loans are a more than $400 billion enterprise. 

The student aid commission worries that if too many lenders drop out of the federal program the remaining banks and lenders won’t have the capacity to cover the credit needs of all students. First to get left out are likely to be low-income students — the very people the program was created to assist.  

“We all understand the anxiety that students and families experience when they hear news accounts suggesting that federal student loans could be at risk, We also understand that credit markets are under stress and conditions may change rapidly,” U.S. Secretary of Education Margaret Spellings told a March 14 hearing of the House Education and Labor Committee. 

Other than conferring lender-of-last-resort status on California’s student aid commission and any of the other 34 student loan guarantors around the country who also don’t have that status, it’s unclear what additional actions Spellings will take. 

Spellings has the power to advance federal funds to cover last-resort loans. She may announce she is doing so at a Thursday April 10 teleconference scheduled with loan guarantors, entities who pledge to repay private lenders if students default on their loans. 

In a March 26 letter, Spellings told the agencies to provide an updated lender-of-last-resort plan to her department within 30 days. 

Although receiving federal funds up front would be helpful for the cash-strapped student aid commission – already under orders from the Schwarzenegger administration to cut back — California law prohibits the commission from lending. 

EdFund, the non-profit entity that does the day-to-day guaranteeing of the Federal Family Education Loan program for the commission, is also not empowered under its operating agreement to lend. 

The state could contract with an outside lender, as it does now. But if lenders were eager to participate in the loan program then the state probably wouldn’t be declared the lender-of-last-resort. 

Four banks serve as California’s current lenders of last resort. Two told the commission last month they no longer wish to participate. The remaining two don’t want to commit more than the $10 million they do now.

In 2007, there was approximately $100,000 in last-resort loans made in California. 

Last resort lenders must make subsidized and unsubsidized federal student loans to any eligible student who qualifies but has been unable to get a loan from another lender. 

Twenty-five of the 35 guarantors already act as lenders of last resort. Those loans represent about 2 percent of total loan volume. 

Stung by the fallout of sub prime mortgages, investors are balking from buying bundled student loans. Student lending giant, Sallie Mae, told the Securities and Exchange Commission in January it plans on being more selective in its loaning. 

Much of the queasiness of lenders centers on what are called “proprietary” schools, for–profit businesses like the University of Phoenix that provide education and training. They are sometimes called private career schools. 

A U.S. Department of Education survey from 2005 shows proprietary school attendees with a default rate more than three times higher than private colleges or universities – 8.2 percent to 2.4 percent. 

Public colleges or universities have a 4.3 percent default rate. 

Sixty percent of EdFund’s loan portfolio is proprietary and private schools.  Fifty percent of its business is outside of California. 

Schwarzenegger is also trying to sell EdFund to help balance the state budget’s $16 billion gap between revenue and spending commitments. 

This year’s budget is partly out-of-whack because it was premised on EdFund being sold for $1 billion. This year, the GOP governor hopes to sell it for $500 million. 

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