Posted by: Discover Scholars | May 19, 2008

Part I: The future of securitized student loans

This is Part I of a two-part post on the recent troubles in the securitized loan industry and how the situation relates to students who need help paying for college. Part II on Thursday will discuss in more detail why we believe that DiscoverScholars.org represents the future of financial aid and offers the best alternative for students who need financial assistance.

This post was originally titled “the need for DiscoverScholars.org,” because the current student loan crisis illustrates some of the strongest evidence for an alternative method of providing students with financial aid.

As many in the popular press have pointed out (see here or here), the student loan industry is in trouble. For many years, students received low interest rates on loans, because lenders could offload default risk to Wall Street by repackaging loans into asset-backed securities (ABS). As long as profit-seeking investors had sufficient demand for such instruments, lenders could “lock-in” profits and therefore offer lower rates of interest to students.

The problem, however, was that demand for such “collaterlized debt obligations” (CDOs) had little to do with the underlying quality of the investments. Due in large part to large federal subsidies, student loan providers looked more profitable than they actually were, leading investors to overlook many lenders’ poor management and questionable accounting.

Recently, however, the instability and scandals in the student loan industry are becoming more widely known among investors. The drying up of demand for CDOs has reduced lenders’ access to investors’ capital, exposing their unsound business practices. The slow realization that the industry needs fundamental reform, rather than more subsidies, is forcing lenders to cope with the consequences of less demand for their products.

What does this mean for students in need of additional funding for college? While the only solution for heavily subsidized Sallie Mae is likely to be a buyout, other banks such as Citigroup are left to pass on higher interest rates to students. In short, students who need financial aid will see their interest payments increase.

As an example, a friend of mine recently received this letter from her college’s financial aid office.

Among other things, it states that:

Effective with the 2008-2009 school year, your lender may assess a fee that will reduce the amount of Stafford Loan funds credited to your student account.

During the 2007-2008 school year many lenders offered “fee-free” Federal Stafford Loans by paying the federally mandated Federal Stafford Loan origination fee on behalf of the student. …

As a result of significant legislative cuts and severe credit market deterioration many Federal Stafford Loan lenders have announced that they will discontinue or reduce the amount of the origination fee they will pay on behalf of students for the 2008-2009 school year. When this occurs the lender will deduct the amount of the loan fee from the amount of funds disbursed to the student … [although] at the time of repayment, the student will still need to [the full loan amount].

In order to improve lenders’ profitability, costs will be passed off to the consumer — that is to say, students who need a line of credit. For this reason, alternative means of acquiring funding will prove increasingly critical to students in need of financial aid. Naturally, DiscoverScholars.org provides students with one such alternative to high-interest loans.

In Thursday’s post, we’ll address further why organizations like DiscoverScholars.org will not just be an alternative to loans, but the best alternative to students and donors alike.

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Responses

  1. […] Tags: educational giving « Part I: The future of securitized student loans […]

  2. […] few months ago, we discussed how the troubles in the sub-prime mortgage market would affect students’ ability to get colleg….  This morning, CNN reported that in the last year, 33 lenders have dropped their private loan […]


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