By jim mooney (dr. debt)

The banking crisis in the US has spread to the student loan industry. Student loan companies are in turmoil and banks are tightening their standards and raising rates. Some companies are leaving the student loan business altogether. The Pennsylvania Higher Education Assistance Agency (PHEAA), one of the largest student lenders in the country, has ended its participation in the federal student loan program. But, overall there is movement toward direct borrowing from the government as lender of last resort. The public pressure on Congress and the Administration is reaching a fever pitch. And timing is everything. High School Seniors typically make deposits at their chosen colleges by May 1. The application process for student loans for 2008-09 is just now getting under way.

In response to this crisis, the federal government is launching at least two major national initiatives: legislating the infusion of significant cash for lending institutions and buying student loans from lenders so that they will have adequate capital available to meet the demand. One of the remarkable aspects of this response is that it is uncharacteristically swift and far-reaching. The banking crisis and the collapse of big Wall Street firms happened rapidly during the past Winter, dangerously close to the student loan season of 2008. The Federal Reserve stepped in to rescue Bear Stearns from outright collapse and Congress is debating legislation to help millions of homeowners avoid foreclosure. But, while the mortgage crisis has stimulated partisan debate in Washington, there is an unusual consensus about the need to save the student loan business. There seems to be an urgency in Washington to fix this problem so that alternative lenders are ready to meet the demand with adequate cash from hastily organized sources, and for this year. This kind of urgency is rarely seen in social programs, at least not since the New Deal responses to the Great Depression of the 1930s. A Katrina-like pace of action would be unacceptable and leave many students in the lurch with tuition bills to pay in a few months. The start of classes in August and September is a deadline that is rapidly approaching and is perilously close to election day in early November. Nothing seems as sacred to Americans as starting a college education after high school graduation and the government knows that the collapse of that dream would have devastating consequences, economically, socially, and politically. Is anyone thinking "election year?" Students need to borrow now. College students become the leading edge of the national credit crunch, the canaries in the coal mine.

In late April, the Education and Treasury Departments sent a letter to members of Congress endorsing a provision in a bill passed by the House last month. By buying loans, the government would provide capital to lenders to make new loans. Dr. Debt would like to know whether the lenders involved will continue to issue student loans given the tightness in the credit system. It is difficult to understand why lenders would leave the student loan business since all student loans are guaranteed by the government. The original idea behind this system is that such guarantees would encourage financial institutions to lend to college students since there is zero risk to the lender. Otherwise, an unemployed 18-year-old would have a hard time meeting the same credit requirements that working Americans have to meet to qualify for car and home loans. Even with these guarantees, lenders are leaving the student loan market. A side question is what will the Education Department do with the student loans it acquires and will students then make their eventual repayment to the federal department? The bureaucracy could become even more complicated.

Last year, students borrowed $60 Billion in federally guaranteed loans. This figure is expected to grow since the government may increasingly become the stop gap lender. Families borrowed even more for their college-aged children in the forms of home equity loans through their commercial banks. But home values are falling as we enter the recession. That means less home equity to borrow against. A recent New York Times/CBS News poll showed that 70% of parents surveyed were "very concerned" about how they would pay for college; only 6% were not concerned. In future issues of Gianni, we will report the developments in this story. When Gianni goes online, even daily updates will become possible.

In future issues, Dr. Debt will explore the cost of refinancing loans when it comes time to repay them. Banks have been willing to consolidate loans and spread out payments, but at higher interest rates. The long term cost of student loans is actually much higher than it would appear. Gird your loins.

For more information on this subject check out: Toward Better Student Lending