There is no doubt by now that you've heard lots of stories in the mainstream and industry press about problems in the credit markets and the impact that it's having on student loans. It's a lot to take in and confusing to many of us that don't watch what happens on Wall Street on a daily basis. We thought we'd try to sort out some of the details to explain how we got here and give you some insight into what's being done to deal with the situation.

Background
For more than a year now, we've heard about problems in the sub-prime mortgage industry and how a number of factors, including higher interest rates and price correction in an inflated housing market, contributed to the situation.

As interest rates on adjustable rate mortgages increased and housing prices dropped, a large number of recent home buyers could no longer afford their mortgage payment nor could they sell their homes for what they owe on their mortgage. This has led to a large number of defaults and foreclosures.

Many of the institutions that granted sub-prime mortgages would bundle the loans they made into a securitized asset and would then sell that asset in auctions on the financial markets in order to achieve liquidity (a process to get more money they could then use to make more loans). When defaults started to occur more frequently, investors no longer saw these bundled assets as good investments and stopped purchasing them on the auction markets, or if they did, they demanded higher rates of return on their investments.

While there is generally no direct connection between mortgages and student loans, many non-profit, private and state-based lenders in the student loan program use similar financing models in order to raise capital to make these loans. Because investors had become fearful of purchasing these types of securitized asset investments (resulting from diminished returns in the mortgage market) they also became resistant to purchasing student loan assets and demanded higher rates of return from the student loan companies trying to sell the investments.

At the same time, these same lenders were dealing with two back-to-back years of significant cuts in the subsidies they receive from the federal government resulting from the Higher Education Reconciliation Act (HERA) and the College Cost Reduction and Access Act (CCRAA). The combination of the increased costs of securing capital in the credit markets (or an inability to secure capital at all) and the cuts in federal subsidies have made operating in the student loan market not only less profitable but in some cases even a losing proposition for lenders.
While most students have only felt the impact of these problems in the form of fewer borrower benefits and discounts, it is anticipated that the impacts of continued problems in the credit markets could eventually touch students in all sectors. For students attending higher priced institutions, lenders have already begun to tighten credit requirements and raise interest rates on private label (non federal) loans. Students who attend schools with lower graduation rates and/or higher cohort default rates could face problems finding lenders that are willing to make even federal loans available.

Legislative Action
As news of the problems in the credit market began to reach Washington, Congressional leaders began to take notice. From the education policy perspective, House Education and Labor Committee Chairman, George Miller (D-CA), and Senate Health, Education, Labor and Pensions Chairman, Ted Kennedy (D-MA), held hearings in early spring to hear from the education community and the Department of Education on the extent of the problem. The series of hearings resulted in both Chairmen introducing legislation that, while not “fixing” the problem, would provide some band aid provisions for borrowers who may have problems finding willing lenders in the upcoming peak loan cycle. Mr. Miller's bill, HR 5715, was approved in committee in early April, on the House floor on April 17 and would:

• raise federal loan limits by $2,000 for most students;
• clarify the Secretary's authority to provide federal funds to guaranty agencies under the Lender of Last Resort program;
• give the Secretary the authority to act as a “secondary market of last resort” in cases where attempts to auction securitized loan portfolios fail; and
• temporarily prevent lenders from looking at negative credit reporting resulting from medical expenses or mortgage default/foreclosure when considering credit eligibility for a PLUS loan.

Mr. Kennedy's bill contains some similar provisions, but has yet to be considered in committee where it is expected that more provisions parallel to the Miller bill will be added.

On the financial policy side, Representative Paul Kanjorski (D-PA) and Senator John Kerry (D-MA) have both introduced legislation that would provide what many analysts see as more of a core solution to the problem by giving state-based Federal Home Loan Banks the authority to step out of their role as financial facilitators for the mortgage markets and provide liquidity assistance to student lenders. Both sets of proposals have received bipartisan support in both the House and the Senate and are moving through the legislative process.

Department of Education and Industry Actions
While lawmakers look at legislative measures, the Department of Education is also working hard and fast within its scope of authority. As part of her testimony before the House Education and Labor Committee, Education Secretary Margaret Spellings assured Members that she is in talks with Treasury Secretary Paulson and will continue to explore possibilities of working together. She also informed the Committee that the Department had additional immediate capacity in the Direct Loan program. Finally, she discussed the Department's efforts on preparing the Lender of Last Resort (LLR) program for large-scale implementation, should it become necessary.

Since that time the Secretary held a meeting with the guaranty agency community to discuss LLR and what the Department and the industry are doing to put the infrastructure in place for a large-scale LLR program. All 35 guaranty agencies have joined the Secretary with a commitment to ensure a strong, streamlined LLR program is in place and that students who need these loans have them available in the upcoming academic year. EDFUND is actively engaged in this process and in discussions with lenders, the Department and our industry colleagues to ensure our customers and the students we serve receive the high level of service they have come to expect from EDFUND.

©2008 EDFUND
For more information on EDFUND products and services, contact Michael Amaloo, Senior client relations manager at 17011 Lincoln Avenue, PMB #504 – Telephone: Toll Free 1.866.299.1741 – Fax: 303.840.2851 - mamaloo@edfund.org - www.edfund.org.