When the bottom fell out of the subprime mortgage market, the real story was always the number of foreclosures that were down the pipeline. The news continued to warn that the worst was yet to come. I guess that we are trying to maintain the illusion of stability, because the powers that be are afraid to pump fear back into the market? How so, you ask?
Well, the comments on my post from last week reveal how the student loan market resembles the now infamous subprime mortgage market:
EvrenSeven (a regular BIDER reader) wrote: Does anyone know if student loan debt has been repackaged and sold off as securities like mortgages were? [DAMN good question, man]
Anonymous answered: Oh, yes, it has been. In fact, it's even better than that. By manipulating the cohort default rate, the private banks for "federal" loans (like Sallie Mae) can make it appear that a very low percentage of students actually default on their loans. So, using a two-year cohort default (which was the standard until recently when it was changed to a three-year default rate), the banks can claim that only 4 or 5% of their student debtors default. Using that data, the federal government then decides how much of each bank's portfolio they are going to guarantee. Then the banks take that guarantee, and use it to market securities based on the student loan payment streams. The then sell the securities to the market as "safe" investments because they are backed by the government to 97% of the underlying debt obligations, for example. It's the same as the rating agencies getting it horribly wrong with home mortgages, or not really caring about whether they got it right. It's just the federal government pricing the securities instead of Standard & Poor's. Of course, by excluding anyone in default for more than two years, the banks can get a low default rate, a high federal guarantee percentage, and a "safe" security to sell. Of course, there IS less risk because no one can discharge the loans in bankruptcy. But at some point, when it becomes pointless for the students to even try to pay on the debts, then trouble still comes to town.
Now, THAT'S a story!
Let's do a headcount. How many of the BIDER readers have loans that are in forbearance? Are you running out of time? Will you be able to handle the payments when you finally get a job, considering that the interest will be compounded and added to the loan? Are there more loans in forbearance than there are mortgages that are delinquent? According to this news story, "about 10 percent of the loans were more than 90 days delinquent by the end of 2009."
Am I the only one that sees the connection here?
I'm a nay sayer, I know. But the worst is yet to come. But there is a silver lining:
Under the current rules, schools with default rates of 25 percent or more for three consecutive years, or a default rate higher than 40 percent in a single year, lose their eligibility for the federal student aid that provides most of the revenues for for-profit colleges.
Congress! Please don't change that law!
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