The Coming Student Loan Crisis?

By Bryan O'Keefe

By now, the daily stories about subprime mortgages and the credit crunch are old news to just about everyone. But there is a fresh angle on this problem, one that could tremendously influence students, families, colleges, and overall higher education costs.

The Wall Street Journal reported yesterday that a student loan crisis could be on the horizon this fall -- both for private loans and even government backed loans. The general problem is that the credit crisis has driven away investors from the types of securities that typically finance student loans. In some cases, the panic might be irrational, especially in the case of government backed student loans. As our friend Sandy Baum from the College Board points out in the WSJ article, these loans are very safe from an investor's standpoint. That's because these loans can not be discharged, have relatively low interest rates, low rates of default, etc. The situation is much more complicated for private student loans.

Nevertheless, it doesn't matter if Wall Street is being irrational or not -- sometimes markets don't behave rationally and you just have to deal with the cards you are dealt. The "cards" in this situation could be a very poor hand for students -- namely, they are just simply NOT able to obtain student loans. Period. Gone will be the days when a student walks into a financial aid office, signs a sheet of paper, and walks right back out with a ton of Stafford loans.

What happens then? It could be a very, very interesting time for the colleges and universities themselves. For years, they have denied that rising college costs are related to the greater availability of student loans. But if students can't get the loans, they simply will not be able to enroll. The price of college is beyond the means of most families, even relatively affluent middle class and upper middle class households. Parents and families simply don't have the money. We could be facing an unprecedented situation.

Chances, however, are likely that if student loans really do dry up that colleges and universities might start acting like all of the desperate home builders in Arizona and Florida. They might offer students their own incentives to still come to school -- i.e. scholarships or tuition discounts provided by the school (possibly even funded by the endowment; if this credit crunch isn't a "rainy day", I don't know what is). The other option is that they can just simply lower their cost. This is exactly what home builders have been forced to do. They now offer terrific incentives or they have slashed costs entirely. Sometimes they have done both. Of course, if that happens, our much larger point about college costs and student loans might be proven true.

For now, most of the higher education establishment is just crossing their fingers that this whole problem will go away. A lot of students considering school this fall (myself included) are probably praying for the same thing. But the stark reality is that student loans as we know them are in some jeopardy and the fallout could impact colleges and universities for years to come.

One possible scenario is explored in one of our working papers available here and outlined in previous blog postings here.