Panic is the Enemy
Repeat after us: There is no federal student loan crisis. There is zero danger that federal Stafford loans will not be available in the foreseeable future. Zero danger. At some point in the future, there may be a squeeze on private student loan availability for some high risk borrowers, particularly those attending proprietary schools of questionable quality and limited track record as opposed to all proprietary schools. Should a large private student loan access issue arise, extending even beyond proprietary schools, there are options for federal action to ensure the availability of capital. But let’s not get ahead of ourselves.
Shaky News Coverage
Breathless and not very nuanced accountsof credit market turmoil affecting student loans have appeared in The Wall Street Journal and elsewhere over the last two weeks. These accounts note two phenomena:
Two, the subprime mortgage mess is making lenders take a more careful look at the risk associated with issuing private student loans, all non-government backed loans really, to high risk borrowers. Because proprietary colleges of questionable quality and limited track records are the most dangerous for high risk borrowers and lenders, the money people who make private loans are requiring those schools to put more of their own skin in the game for their students. Essentially, the lenders are requiring proprietary schools to agree to assume a greater portion of private loan default costs.
Unfortunately, much of the media has conflated the credit market’s potential impact on private student loans and federal student loans. They have created a sense of fear, if not panic. There is a danger that the fear might lead to hasty policy changes. The bigger danger is that the fear, if not panic, could depress college access for students who think they can’t get a loan.
They can. The mainline press should be ashamed for conflating questions of access to private student loans with guaranteed access to federal student loans.
Federal Student Loans are Widely and Safely Available
There are thousands of federal Stafford Federal Family Education Loan (FFEL) providers in addition to the Department of Education’s Direct Loan program. And Stafford loans require no credit check. If 10, 20, even 100 FFEL providers suddenly suspended their Stafford loan originations because of an inability to raise capital, there would still be widespread availability of federal student loans.
The lenders who are having the most trouble raising capital through asset-backed securities are in the secondary market. Regular old banks continue to make federal Stafford loans. In fact, JP Morgan Chase announced it was cutting interest rates and fees on federal and private student loans.
If for some reason a sustained private credit meltdown actually resulted in reduced availability of federal student loans, the Higher Education Act includes a "fail-safe" that ensures federally sponsored guaranty agencies act as "lenders of last resort" with federal capital. If guaranty agencies don’t have capital, they can get an advance payment of capital from the U.S. Department of Education. There is no risk that a student will not be able to access a FFEL Stafford loan.
But if any school is worried that its students will have difficulty obtaining FFEL Stafford loans, that school can always switch to the U.S. Department of Education’s Direct Loan program, which offers the same Stafford loans at the same government-set interest rates. Currently, a little over 20 percent of federal loan volume runs through the Direct Loan program. With the advent of the Common Origination and Disbursement system, any school that participates in the Pell Grant program could easily originate Direct Loans and draw down federal funds from the Department of Education. And despite the fear FFEL industry insiders are spreading, we have been assured by high-level federal officials that the Direct Loan program’s volume could more than double very rapidly, if need be.
Please Take out a Federal PLUS loan Before a Private Loan
Some may object to our take noting that the federal Stafford loan program carries limits on the amount of federal Stafford loan debt that can be borrowed -- $23,000 in the aggregate for an undergraduate. They may ask, what about students who need to borrow more?
Our first response is that the parents of those students should apply for a federally guaranteed PLUS loan. As with federal Stafford loans and for the same reasons, there is zero risk that capital will not be available for PLUS loans. And PLUS loans, unlike Stafford loans, are available in amounts up to the total cost of attendance for a student. Moreover, PLUS loan interest rates are capped at 8.5 percent and have low fees. They beat most private student loans.
There’s a catch to federal PLUS loans in that they require credit worthiness. In the current credit market environment there is a fear that PLUS loans won’t be as easily available, because lenders fear risk.
But let’s keep in mind that PLUS loan borrowers total about 525,000 each yearas compared to about 7 million new FFEL Stafford borrowers. That’s less than 10 percent and most of those borrowers will continue to not have a problem accessing PLUS loans. For those borrowers that do get turned down for a PLUS loan because of credit worthiness, Stafford loan limits double to $46,000 in the aggregate. And Stafford loans have even lower interest rates than PLUS loans.
Up to $46,000 a year in universally available federal student loan debt generally is enough for undergraduates. It is more than twice average undergraduate debt. But there are outliers and there are cases when for family reasons PLUS loans are not an option. Those borrowers may well have to turn to private loans.
Still the fact is private loans affect a much smaller number of people than federal loans. Private loans are taken out by 10 percent of undergraduates. At least half of those are to or for students with excellent credit, and those students will continue to have no problem accessing a private student loan. Their interest rates may be 50 to 100 basis points higher than before the credit crunch, but they will continue to have access to private student loan capital. At least half of remaining private loan borrowers have access to guaranteed low cost, federal Stafford student loans, but don’t exhause their eligibility. So in terms of access to capital, what we’re looking at is maybe two or three percent of undergraduate students who may in the future confront a private loan availability issue based on circumstances reflected in the current credit market.
For now, Higher Ed Watch recommends that policymakers keep their powder dry. Panic is the enemy. Next week, we’ll discuss further the relationship between the credit crunch and student loan capital, and we intend to float a policy response should a problem that seriously affects actual students arise. As of now, despite the headlines, we’re unconvinced.
Stay tuned, and stay cool.