(Guest post by Larry Bernstein)
When you hear about the current financial crisis, most of the focus is on foreclosed subprime loans. But, the financial crisis has spread to all financial products as delinquencies have increased for credit cards, auto loans, and other secured and unsecured borrowings. Direct lenders and securitization lenders are now demanding more spread to compensate for the perceived increased risk of default.
Student loans are no different from any other form of debt. Defaults have surged in the past few months. Despite the fact that most loans are guaranteed by parents of the students with terrific FICOs (credit ratings), many more loans are delinquent. How bad is it? One of the largest insurance companies that guarantee private student loans filed for bankruptcy last week. First Marblehead, which securitizes private student loans, stock price is down more than 90% from its highs of last year as investors rightly perceive that First Marblehead’s residual claims on student loan securitizations may not be very valuable. Bank of America which is one of the largest direct lenders in private student loans announced last week that they will discontinue making private student loans, and Bank of America will only make Federally Guaranteed student loans.
Based on these three events described above, the number of private student loans will decline dramatically in the week’s ahead. There are financial and social consequences to this problem. Students with limited access to financial means will not be able to attend their school of choice next semester. For most students, if you cannot pay, you cannot attend. I suppose, some students will go to school part-time, or will work part-time to make ends meet. But for many students, they will either choose a less costly collegiate experience, defer, or will discontinue their college education.
I expect for-profit colleges’ earnings to suffer with fewer students. I have not yet shorted these company’s shares, but I will be looking into it in the days ahead. We should expect not-for-profit college institutions to suffer as well. Clearly Harvard will be fine. Harvard’s endowment and student body can afford the education. It is the poorer schools with a limited endowment and a student body that depends on private school loans to be truly hurt during this financial crisis.
Whenever the financial markets curtail borrowers, there will be those that cry out for additional government assistance. We are seeing this particularly in the residential home loan market. The government cannot make the defaults disappear. The government will be making loans to those citizens who the market believes are not creditworthy or at a rate of interest that is insufficient for private actors to lend. I fully suspect that if the government increases the loan sizes that it is guarantees, then we should expect substantial losses on the government’s loans. There is no free lunch.
The time of reckoning for private and public actors is next semester.