Student Loan Bailout Bills Rife with Fiscal Pitfalls

This post comes from Martha Sherwood, 2nd time GovTrack blog submitter and a legal researcher in a consumer law office. Martha works for a lawyer who blogs at . Martha holds a doctorate in biology

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There are currently four bills pending in Congress to address the credit crunch in the Student loan industry. All of them were introduced in the last month in response to an acute situation that has only become apparent since the beginning of the year: lenders participating in the Federal Guaranteed student loan program do not have the money to loan to students, and as a result, more than fifty of them, including some major players, have withdrawn from it altogether, and most of the remainder have warned the government that they anticipate not being able to originate such loans at the level of previous years, because they cannot find buyers for securitized student loan bundles. The situation is very similar to what has been happening in the mortgage lending market in the last year and a half, but it is considerably more acute. Unless students planning to attend college in the fall can obtain loans, colleges will be without operating expenses, and many will be forced to shut their doors. This explains why the Democrats who have been most vociferous in opposing any government bailout to subprime mortgage lenders appear as sponsors for a set of bills providing equally unwise government sponsorship for student loan lenders and guarantee agencies.

The four bills in question are ,

, , and .The latter two are more limited in scope, authorizing lenders to borrow funds from the Federal home loan bank using student loans as collateral. At the very least this looks like a robbing Peter to pay Paul situation, since there is also a credit crunch in the housing industry. There is also a fundamental difference between a home mortgage, which is backed up by an asset with intrinsic value, and a student loan, which is backed up only by the student’s future earning power and by the government’s own guarantee.

and are similar in their provisions. I will focus on HR 5715 since this legislation passed the House of Representatives on April 17, by a vote of 283-27, with very little debate. Its sponsor, , introduced it solely as a response to the acute crisis in loan funding for students entering college in 2008. Since it is also an industry bailout, no Republican stood up to speak in opposition, although a few voted against it.

Sections 2-4 of HR 5715 raise the dollar limits on unsubsidized Stafford loans and Parental PLUS loans, and make some minor adjustments to other terms. Since lenders have already given notice that they do not have money to fund the old amounts, these provisions would have no effect whatsoever on college access in the absence of the remaining three sections: 5. Lender of Last Resort, 6. Mandatory Advances, and 7. Temporary Authority to Purchase Student Loans.

Five and six, together, direct Guarantee agencies such as the New York State Higher Education Services Corporation and Educational Credit Management Corporation to make loans to any student unable to find a participating lender. Once the guaranty agency has exhausted its own funds, section 6 mandates that the Federal Reserve loan money to the guarantee agency to continue serving as “lender of last resort.” Guarantee agencies already have this authority, but it has never been invoked on a large scale. Both the language of the legislation and information on several Guarantee agency websites imply that the anticipated number of such loans is small and that large amounts of funding from the Federal Reserve will not be needed. This assumes a best-case scenario as far as the economy is concerned. Are more probable outcome is that the US government will end up funding a substantial proportion of federally-related student loans originated in 2008.

Section 7 is the most problematical of the provisions of HR 5715, as it directs the Secretary of Education, in consultation with the Secretary of the Treasury, to purchase student loans made since 2003 from lenders in order to ensure those lenders’ continued participation in the Guaranteed Student Loan Program. The amount of money involved is potentially huge, especially when one considers that consolidation loans probably qualify.

One respect in which student loans resemble home mortgages is the degree to which lending practices obscured the fundamental unaffordability, to the consumer, of the underlying commodity. For the Federal Government to buy up huge numbers of student loans at face value, including capitalized interest and default fees, would be the equivalent of paying subprime home mortgage lenders the full value of a note on a house which was under water due to the declining real estate market, so that those lenders could continue marketing mortgages with unaffordable terms. In either case the taxpayer would have been bamboozled into a costly bailout whose only clear beneficiary is the lending industry.

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2 Comments

  1. How about on the other end of the stick. Students who are graduated and unemployed who cannot pay their student loans, and it is unrealistic for that person to be able to do so without adequate income, then the student loan keeps accruing interest until the loan owed is so outrageous that ther person will never be able to pay it back? How about a bailout for these individuals?

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  2. How many corporations are getting billions and then filing for bankruptcy
    when there are many of us with student loans and are unemployed and cannot get loan forgivness and cannot pay the loans back as the interest gets bigger and bigger

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