Exploring Economics: Part 4

College loans feel waves from 'Ripple-effect'

By: Sun Cha, Editor-in-Chief

Posted: 11/7/08

College students around the country are discovering how difficult it is to find funding for their education as many lenders are left in the wake of the recent financial crisis of the nation's economy.

Due to a surge of risky investments in the subprime mortgage market, many financial institutions are now hesitant or unable to give out loans.

In a New York Times article published on Sept. 30, 1999, Steven A. Holmes covered the Fannie Mae Corporation's move to ease credit requirements on options that it purchased from other lending institutions.

Instead of placing emphasis on the Republican's part in de-regulation, Holmes found that the Clinton Administration and stockholders in Fannie Mae had something at stake as well. Not only is Fannie Mae one of the biggest home loan underwriters, it also holds a large market share in the student loan industry.

"Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgages among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits," Holmes wrote.

Since the crisis has emerged, 111 lenders have suspended their Federal Family Education Loan Programs (FFELP), this according to a list published by the National Association of Student Financial Aid Administrators, or the NASFAA. Of the 20 preferred lenders at ASU, only two have suspended loans and 4 have suspended consolidations.

But still, Sophomore Jessica Leonard is worried about her future at ASU without the assistance of financial aid, especially since the institution she has chosen as her preferred lender is Wells Fargo, a San Francisco based bank, which has already removed itself from the list of lenders who consolidate existing student loans.

"I still haven't received my financial aid check from this semester and it's almost over. I mean, why haven't I gotten it and what if I don't get the check for the next semester either? This is really stressing me out."

While Leonard admits there were some problems with her application in the beginning, she is still worried there might be more to it than that. It is unknown whether ASU has experienced issues with Wells Fargo, but Te-Ping Chen of The American Prospect reports one college has already experienced fallout from one lender and expects more to follow suit.

In a September 2008 interview, Bill Spiers, financial aid director for Florida's Tallahassee Community College told Chen that he wasn't surprised when he got a call from a Chase Bank representative alerting him to the fact that his bank would no longer be offering loans to the school.

Speirs said the representative also told him that, "In weeks to come, Wells Fargo, Key Bank, SunTrust and Citibank would all follow suit."

Since Chen's report, Key Bank, Citibank (Texas) and SunTrust have all suspended lending FFELP loans. Wells Fargo has yet to make any more announcements about its future in the financial aid market.

The "Ripple Effect" as Dr. Murat Kara, associate professor of economics, states it, began in 1994 when the Republican Party took over the majority in both the US House and Senate, a first in 40 years. Republicans vying for seats in the US House ran under the slogan, "Contract with America," a 10 point plan that promised, among other issues, deregulation. One of those deregulations would be the banking system.

Under the old system, banks would have to make safe, lower-yield investments, while under the deregulated system, that was no longer the case, Kara said. Financial institutions were able to take much riskier, high-yield investments. One of those investments would be in the subprime mortgage market, which targets borrowers with less than average credit. Lending money to higher-risk consumers would mean having the ability to charge these borrowers more in interest rates than would be charged to someone with excellent credit.

"You had to play it safe; that was under regulation," Kara said. "When they opened the floodgates, these people who are very smart, graduates of Harvard and Yale and Colombia, these very smart people started to wonder how they could make more money. They started to think that a good way of making money would to get into the subprime market. This was opening a virgin market which meant discovering a new territory for them."

The "Ripple Effect" happened when the high-risk subprime mortgages went into default. Some institutions were having success in the student loan industry, but hemorrhaging in their mortgage sectors. At that point, all lending institutions became fearful and lending between banks came to a halt. When that happened, even though the student loans were guaranteed by the government, loan companies did not have the funds to lend.

"This is the problem, this is the connection with the financial aid business, that intermediary companies that are supposed to make these loans happen can't connect the dots between the schools and the government and the student," Kara said. "They can't give out the loans because the money isn't circulating. When the circulation of funds stops, it's like your heart stopping the circulation of your blood."