Unless you have a degree in finance, the current credit market upheaval—and how it impacts the student loan marketplace—may be a confusing topic for school staff. In a nutshell: since the money that students borrow to pay their tuition bill is needed up front (i.e., today) and the repayment of those loans is spread out over many years, non-bank student loan providers themselves must borrow funds from the capital markets. The overall financial goal of education lenders is to meet the needs of students by ensuring a stable, predictable source of funds in any interest rate environment.

While the details are complex, the general idea behind how lenders borrow from the capital markets can be easy to understand. Like other consumer loan providers who usually do not keep loans on their books for years, education lenders sell the loans into a trust, which sells securities (also known as asset-backed securities or ABS) to investors.

This process, called securitization, provides lenders with the original principal balance of the loans plus an upfront return on the investment, thus enabling them to make new loans. The investors who purchase the ABS are paid back over time by the payments of principal and interest on the underlying student loans. In other words, instead of having a lender’s resources tied up for many years and waiting for the payments from individual borrowers, this process allows lenders to continually put money right back into creating new loans for new students.

The ABS market has traditionally been very efficient because loans made under the FFEL program (i.e., Stafford, Plus, GradPlus) are guaranteed by the federal government and thereby offer a predictable and lower risk to investors than other types of consumer loans. But the sub-prime mortgage crisis has hurt the ABS market, making it difficult for many lenders, including education lenders, to get the funds they need to make student loans.

Education lenders also use the secondary market to raise funds. Some banks, for example, sell their loans to other non-bank education lenders. By tapping the secondary market, banks are able to free up the funds they need to make new loans. This process has also been impacted by the sub-prime mortgage crisis as a growing number of education lenders have had difficulty refinancing their holdings to free up money to buy additional loans

In theory, the sub-prime mortgage crisis should have had little effect on student loans. But investors’ fear of purchasing mortgage-backed securities has spread to a general fear of all ABS, even those guaranteed by the federal government whose value is not in question. The result is that as demand for ABS has dropped, education lenders have had to offer much higher premiums to investors to encourage them to buy even a limited amount of securities. And that has resulted in higher borrowing costs.

At the same time, education finance companies have seen their rates of return on federal loans dramatically reduced by recent legislation. In 2007, Congress cut the Special Allowance Payment (SAP) paid to FFELP lenders, reduced the guarantee provided by the federal government in cases of default, and increased the lender-paid origination fees.

Student loan providers have felt the pinch of severe legislative cuts and a turbulent credit markets. More than one-third of the top 100 FFELP originators have left the student loan program, displacing more than 17 percent of Federal Family Education Loan Program (FFELP) loan originations. In addition, lenders that accounted for 82 percent of all FFELP consolidation volume have stopped making new consolidation loans.

As more lenders, almost daily, continue to leave the program, the loan demand on remaining lenders is exploding.

An injection of capital into the student loan marketplace is also favored by leading policymakers and representatives for college and university financial aid professionals.

At an April 15 hearing on the topic, Sen. Christopher Dodd (D-Conn.), chairman of the U.S. Senate Banking Committee, urged government action and pledged to write letters to both Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke to ask them to consider using the Federal Financing Bank and other mechanisms to help private lenders get money to make loans.

“If the Fed and the Treasury can commit $30 billion of taxpayer dollars to enable the takeover of Bear Stearns by JP Morgan Chase, then surely they can step in to enable working families to achieve their dream of a college education for their kids,” Dodd said.

On April 11, National Association of Student Financial Aid Administrators (NASFAA) President Philip R. Day, Jr. sent a letter to NASFAA members urging them to contact their representatives to support legislation that would bring needed capital to the student loan market.

“The lack of liquidity in the credit markets threatens to create a wide-spread Federal Family Education Loan Program (FFELP) loan access problem,” Day stated, adding, “We risk too much by waiting. The nation's students and families depend on our help to ensure continued financial access to college.”

Sallie Mae and others in the higher education community agree that the most effective way to provide needed capital to lenders for student loan originations is to use the government’s existing mechanisms on a temporary basis. We urge policymakers to act expeditiously to provide liquidity to the capital markets serving federal student loan providers. This solution would help ensure students and families avoid disruptions that could impact college enrollment for the upcoming academic year.