By Richard Vedder
As I and my sidekick Bryan pointed out a couple of days ago, the world is waking up to a reality: lending to college kids with zero credit history and highly uncertain future earnings is a risky business --unless the feds guarantee repayment. As a consequence, those in the private student lending business are taking a bath, and Wall Street investors are looking at these companies roughly the same way that 14th century Europeans looked at plague victims during the Black Death --warily and with more fear than love.
We have heard of how our great banks have been seriously damaged by the subprime crisis and defaulting mortgages. However, it is interesting to compare the share prices of broader based financial services companies with those of companies mainly involved with student loans. Below we look at the prices of five big financial services companies, including the three largest commercial banks --Citigroup, JP Morgan Chase, Bank of America, Merrill Lynch, and Bear Stearns --and compare them with three student loan firms --SLM Corp. (Sallie Mae), Nelnet Corp., and Student Loan Corp. We calculate two stock market indices --a broad based index of the first five companies (using an unweighted average of prices), and a student loan index of the last three companies, all indexed around the closing stock prices last June 29 being set equal to 100.
Here are the two index values for various dates:
|Date||Financial Services Index||Student Loan Company Index|
|June 29, 2007||100||100|
|September 30, 2007||93.02||83.60|
|December 30, 2007||73.06||47.46|
|Febuary 15, 2008||70.95||45.19|
The point made here is that, on average, the bad home equity, subprime and mortgage loans made by mainline banks and other companies have hurt them far less (29 percent stock price decline on average) than the loan activity of the student lenders (55 percent average stock price decline). LENDING TO STUDENTS IS RISKY. The price of Citigroup stock has fallen less (49 percent) than that of Sallie Mae (62 percent). (Citigroup, by the way, also is in the student loan business, but it has been relatively less important than it is for Sallie Mae).
All of this realization is leading to the Great Student Loan Credit Crunch of 2008.
Congress, as usual, deserves part of the blame, with its stupid laws slashing administered fees (which should be set by market forces) on government guaranteed loans --so even that segment of the market is in some trouble as companies exit the business. The private market is in worse shape, as some of the lenders (including the Michigan Student loan authority) are unable to borrow money themselves at any reasonable interest rate. Where is junk bond king Michael Milken when we need him?
Will students be able to get loans this fall? In general, the answer is yes. Markets are innovative and responsive. People want to make a buck. The industry giant, SLM Corp. says it has lined up mega bucks worth of financing. But the costs will rise to students --at a time when the college-high school earnings differential may have stopped widening. If college and universities persist in raising tuition rates at double the rate of inflation something novel might happen: applications might start falling (demographics are pointing for that to happen anyhow in a couple of years). Will this lead to some real price competition in higher ed? I doubt it given the non-profit third party payment driven nature of the industry, but who knows? Out of crises and distress markets solve fundamentally unsustainable economic situations, and this appears to be the case here, although government involvement, the machinations of the Accreditation Cartel and other forces mute the ability of markets to work their magic. Watch for more from CCCAP on this topic: I expect my colleague Andy Gillen will soon finish an expanded and polished version of his "bubble" blogs that attracted some attention on this site earlier. They were insightful and spot on, as the world is finally realizing.