Financial crisis hits students

By Julie Fry

New York City FIST

For most students, borrowing money has become a necessary part of going to college. The average student now graduates with at least $21,000 in debt and it is not at all uncommon for students to graduate with $100,000 in debt or more. At the same time, tuition at private universities and colleges has enormously increased—far ahead of inflation.

Parents are losing their jobs or their salaries are declining, so family contributions to education costs are decreasing. These factors mean that students from an increasingly broader economic spectrum are more dependent than ever on student loans.

That is why every student who is attending or is applying to college right now must be horrified by what is taking place in the financial markets. In February, it became clear that what was originally reported by the mainstream press as a crisis in the risky subprime mortgage market, was now affecting what have been traditionally thought of as incredibly stable investments—like bonds for student loans.

Here’s what is happening: many state and local governments secure money for public or quasi-public programs through a venue that most people have never heard of called the market for auction-rate securities. Before the financial crisis, auction-rate securities offered the government borrowers a very low interest rate and it offered lenders (banks and other corporations) ready access to their cash investment through regularly scheduled auctions for the bonds, where they could sell their investment and get their cash back on sometimes a weekly basis. They were earning a higher return than they would with their money in a bank.

All the investments were insured by companies called bond insurers, which specialize in guaranteeing this kind of debt. Here is where things started to unravel. These bond insurers also insure other types of debt—like subprime mortgages. Now that these insurance companies are going to have to secure those loans, the banks don’t think they can guarantee student loan debt as well.

But that is really just one aspect of the crisis. Sallie Mae, the biggest lender to students, reported a $1.6 billion loss in the last financial quarter. This was largely reported as resulting from a huge increase in defaults on these loans. The amount of debt that the Department of Education alone has accumulated from student loans is now more than $40 billion dollars. In fact, right now the only bright spot in the student loan market for investors is in the private collection agency market, which is reporting record profits.

On top of that, the federal government, which subsidizes many student loans and regulates the interest rates as well, cut its subsidies in 2007, further aggravating the default situation and the credit crisis.

All this means that what was once considered one of the safest investments is now among the most risky, with students failing to pay off their debts and no one available to insure the loss.

Therefore, at the auctions for these loans lately, no one has been showing up to buy them—which means that the source of money for student loans is drying up and, not only that, the interest rates on the loans are spiking sharply.

What does this mean for students? States and universities all over the country are cancelling their student loan programs. Several private lenders are withdrawing from the market altogether. And even loan programs backed by federal government guarantors, like the Pennsylvania Higher Education Assistance Agency, a state institution, has announced it is abandoning its federal student loan program. State agencies all over, including Michigan, Montana, Massachusetts, Pennsylvania, New Hampshire, Iowa, and more have announced cutbacks in their student loan programs in recent weeks.

Most students will not be applying for their loans for next year until this summer. So far, the federal government has been telling them they have nothing to worry about. U.S. Secretary of Education Margaret Spellings told Congress on March 14 that students could just borrow directly from the Department of Education, through what is called the direct-loan program. When asked whether the Treasury Department—the same one that is busy bailing out huge banks like Bear Sterns and funding the multi-billion dollar war in Iraq—is going to be able to come up with enough money to account for the loss of much of the state and private student loan industry, the Secretary merely replied that she would be ready.

But despite the rosy and calm picture presented by the Department of Education, the student loan industry continues to crumble, and students are bound to be affected by either enormous interest rates or no loans at all. Students from the states affected so far have already reported deciding to leave their four-year university for a community college, or having to drop out of school altogether. Many of these students have already completed some of their education and are already in debt. Leaving school early will leave them high debt burdens and few prospects for well paying jobs.

Although there have been many struggles over the rising cost of education over the years, the readily accessible access to funds through loans and the promise of a relatively high-paying job upon graduation have kept some of the broader layers of students out of the movement. Now, neither of those factors is a guarantee. With students over the summer facing the prospect of being locked out of access to higher education altogether, this economic crisis may quickly become a political one amongst youth.


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