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Revised Federal Reserve Plan Could Boost Student Loan Lending
February 11, 2009 at 6:52 pm

Student loan lenders and holders of student loan securities are set to be among the beneficiaries of a $1 trillion government plan unveiled by Treasury Secretary Timothy Geithner this week to jump-start the credit markets and encourage private sector lending, CNNMoney reports ("$1 Trillion To Boost Lending," Feb. 10, 2009).

As part of the Consumer & Business Lending Initiative, an expansion of the Bush administration's $200 billion Term Asset-Backed Securities Loan Facility, the Federal Reserve will commit an additional $100 billion to be used for the purchase of top-rated securities backed by debt, including student loans, auto loans, small business loans, and credit cards. The Obama administration said the program could deliver as much as $1 trillion to public and private sectors to revitalize lending.

Despite skepticism from analysts about the program's potential to boost activity in the credit markets, Geithner emphasized that the plan is one part of the two key components needed for economic recovery to take effect. The other component would be addressed by the Obama administration's stimulus bill if it passes.

"It is essential for every American to understand that the battle for economic recovery must be fought on two fronts," Geithner said. "We have to both jump-start job creation and private investment and we must get credit flowing again to businesses and families."

The Federal Reserve will use the $100 billion it has committed to the program to offer loans to investors in exchange for securitized collateral — student loan debt included. Investors would be required to provide the Fed with a small portion of the total cost of the securities upfront, before being able to receive the loan from the Fed to buy the securities.

CNNMoney explains, for example, that if a bank issues a batch of securities worth $1,000, a hedge fund investor could give the Federal Reserve $50 in return for a $950 loan that the hedge fund investor would use to buy the bank's securities. The bank would then recoup its $1,000 investment in the securities, enabling it to make new loans, while the hedge fund would get a new infusion of cash that would have the potential to increase in value if the security's value goes up.

If the program succeeds in helping to unfreeze the credit markets, which Scott Hoyt, senior director of consumer economics at Moody's Economy.com says "it certainly has the potential" to do, it may encourage more lenders to return to the student loan market and it may allow student loan lenders to be able to loosen their credit requirements for lending, making it easier for more students to qualify for college loans.

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Defaulted Student Loans Stuck in Credit-Freeze Induced Limbo
February 11, 2009 at 1:52 pm

Thousands of student loan borrowers who have defaulted on their student loans — including 15,000 additional borrowers each month — are being forced to remain in default despite their efforts to bring their loans back into good standing, The Chronicle of Higher Education reports ("Credit Freeze Leaves Thousands of Student Borrowers Stuck in Default," Feb. 13, 2009).

"I've done what I'm supposed to do, and they're holding me hostage," says Judy Ellis, a borrower who has made nine on-time payments to bring her student loan out of default. "I want to make this right, and I want to move on."

But Ellis can't move forward because the stagnant credit markets have made it harder for student loan guarantors to sell these "rehabilitated" loans back to lenders. A borrower must wait for the guarantor to find a lender to buy the defaulted loan before the loan, and the borrower's credit, can be restored to good standing.

Currently 19 of the nation's 35 student loan guarantee agencies, the companies who insure student loans against default, have no buyers for the rehabilitated student loans they hold. The market for rehabilitated loans has been effectively shut down for months due to the credit crisis, and in November, SunTrust, the only commercial bank that was still buying rehabilitated loans, exited the market.

Now, says Timothy Fitzgibbon, vice president for debt-management services at the National Council of Higher Education Loan Programs, nearly $150 million in debt is piling up every month on top of an existing backlog of loans awaiting rehabilitation.

Guarantors Awaiting Legislative Action

Consumer advocates say changes need to be made quickly before borrowers get so fed up with being "stuck" in default that they stop paying their student loans altogether, which could lead to more defaults and re-defaults.

"The last thing we want is for people to pack it in and say, Oh, never mind," says Michael Ryan, vice president of borrower services for American Student Assistance, the student loan guarantor in Massachusetts.

Legislation passed by Congress last year authorized the Department of Education to buy up student loans from guarantors, but the legislation only approved the department to purchase loans made after 2003, and most rehabilitated loans that guarantee agencies hold predate that.

Guarantors believe that with creative interpretation of the law, allowing almost-rehabilitated loans to be considered "new," the Education Department could use its authority from the bailout to buy up more loans. But Fitzgibbon argues that "it would be much cleaner to get a legislative fix," which could come as part of a proposed spending bill or as part of revisited legislation from the previous session of Congress, than for the Education Department to reinterpret its purchasing authority.

"While this is being sorted out," says Deanne Loonin, a staff attorney with the National Consumer Law Center, guarantors should stop collecting on the loans — a step guarantee agencies aren't likely to take. Guarantors are encouraging borrowers whose student loans are currently frozen in default to continue making payments until buyers can be found.

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