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Should You Be Worried?
College financial aid and the credit crisis

By Robert Shireman

I Can say with 100 percent certainty that every eligible student who wants a federal student loan will be able to get one. It is true that a number of loan companies have gone out of business, and as someone who has been laid off in an economic downturn, I feel for those companies’ employees and for their families. But the fate of those companies does not portend the future of federal student loans generally. In fact, there has not been one case of a student or parent who can’t get the federal loan that they are eligible for. And there will not be even one case. Perhaps this seems an audacious claim in the current economic climate. But I am not really going very far out on a limb.

It is no accident that federal student loans are the only consumer loans that have not suffered a serious retrenchment in this credit crisis. That is because they are not actually “consumer loans.” When a bank makes a federal student loan, the bank is not making the loan based on the expectation that the student—the consumer—will be able to repay the loan. The bank is paying attention to the cosigner on the loan: the U.S. government. As taxpayers, we are the ones who are borrowing the money, with the hope that we won’t actually have to pay the loan back, because the students will prosper and be will able to repay it.

Some student loan companies shut their doors, and some banks cut back on their lending because many had come to rely on the same financing mechanisms (asset-backed securities) that were being used for mortgages. When problems with subprime mortgages begin to undermine confidence in those markets, securities backed by student loans fell along with all of the other dominoes. For mortgages and other true consumer loans, the credit freeze has been difficult to thaw. Taxpayers can’t just make good on all those mortgages, because doing so would reward lenders who had made bad decisions about whom to lend to and how much the properties were really worth.

But the federal student loan program is different. Lenders don’t make any of those underwriting decisions. The federal government—in partnership with states, accrediting agencies, and financial aid administrators at colleges—determines which students should get loans, how much they should get, whether the schools are worth it, and what the interest rate and other loan terms should be. As Sallie Mae’s CEO explained in July, “There’s a master promissory note, servicing standards, and [subsidy levels], all determined by the Department of Education. We don’t control anything.”

That’s why it was not a monumental shift for the federal government to decide, last May, to give lenders direct access to cash for making federal student loans. Congress and the Department of Education took a system that was already wholly financed by the full faith and credit of the U.S. government, and turned it into a system that is still wholly financed by the full faith and credit of the U.S. government. In 1993 Congress had made a similar shift— inconsequential from a balance sheet perspective—by allowing schools to bypass the banks and make the federal loans directly to students.

Whichever way the funds are delivered to students, the money comes from investors who trust the federal government’s ultimate ability to repay. Indeed, during this economic downturn investors have been rushing to Treasury bills as one of the only places they feel safe putting their money. The federal government is borrowing those investors’ funds and funneling them to the student loan companies to make the same loans in the same amounts to the same students at the same schools with the same risk to taxpayers as before the credit crunch.

(The astute reader will notice one flaw in my confident assertion about unfettered access to federal student loans: What if the federal government is unable to borrow money? If our nation reached that point, it would mean that we are so close to a calamitous collapse of our political and economic system that no one would bother to remind me of my audacity regarding a little student loan program).

There are reasons to be worried, though.

While access to federal student loans is as secure as it can possibly be, nearly everything else about this economy is bad news for students and families trying to piece together the money they need for college. Families that had savings in mutual funds, or were counting on home equity for retirement or for college, now have less. Those who do have money are understandably reluctant to spend it, because of uncertainty about their own financial security in the coming months and years. More families are bracing for the possibility of losing a job, or failing to get an expected promotion or raise. Students who want to work to help pay for college costs are facing a tighter job market, with wages that have not kept pace.

That’s not all. Colleges that rely on donations to help finance scholarships and other programs are finding that donors—hit by declines in the stock market—do not have the same deep pockets they had in recent years. The colleges that have endowments will not see the returns they had hoped for, unless there is a dramatic reversal in the economy. Stagnant wages, frozen credit, and declining fortunes all mean that consumer spending is down, too, contributing to less economic activity overall. That means that states—which, unlike the federal government, have to balance their budgets—will have less revenue to fund state universities and state scholarship programs. State budget cuts will almost certainly lead to increases in tuition, cutbacks in course offerings, and/or reduced financial aid.

The federal Pell grant, too, could fall victim to the crisis. Congress a year ago promised much needed increases in the size of the grant and took steps to finance the boost. However, now that more people are applying for financial aid, and more of them qualify for a grant, the cost of the program is far exceeding the pre-recession projections.

Congress’s number-one priority for higher education should be to fill these holes in the college financing system. Doing so represents an urgent investment in improving skills and bolstering our economic productivity as a result. Accelerating increases in the Pell grant program will help to cushion students against the tuition increases they are going to face. The federal government should also provide funds to states aimed at maintaining the enrollment capacity of public college and university systems, and encouraging need-based grant aid. More than in good economic times, Americans need the option of an affordable and high-quality college education.

This brings me back to loans, because even if grant aid is increased, there will still be a rise in the demand for loans. To a large degree, the federal loan program will accommodate that additional demand without any further action by Congress. Parents who had previously relied on private student loans or on home equity lines of credit are discovering that they can tap federal PLUS loans, up to the total cost of tuition, books and student living expenses.

Congress already boosted the amount that undergraduate students can borrow, and cut loan costs. And most graduate students have access to loans up to full cost. (For more detailed information, please visit While there are borrowing limits for students, there is no cap on the total amount that the federal government can make available in loans, so even if more students than anticipated make use of the program, they will all get the loans they are eligible for.

The system as designed does not accommodate every circumstance, however. As in the past, there will be sympathetic stories of students facing financing gaps. These will tend to involve traditional-age college students at private colleges, with parents who are unable to help with tuition as much as they might have hoped. While these dependent students— those who are under 24, not married or a parent and not veterans—can now borrow $31,000 in federal loans for their undergraduate education, that may not be enough.

These stories, which are likely to appear more frequently than in the past, due to the state of the economy, will fuel a drive for large general increases in loan limits, or even lifting the limits altogether to allow students to borrow up to the full cost of college. That would be an imprudent, counterproductive and damaging step for the federal government to take. Some colleges would take advantage of the unlimited federal entitlement by cutting aid and sending tuition charges into the stratosphere.

Young adults’ optimism about their coming prosperity is the engine that fuels American ingenuity. But it also leaves many of them vulnerable, eager to do whatever it takes, whatever the college recruiter suggests. Federal loan limits serve as a stopping point, helping to ensure that these students take some time to seek out guidance and financial help from family and from counselors, and that they think twice about attending a “dream” college or trade school that may turn out to be a nightmare to pay for. Too much credit too easily: Without a hole in the budget that needs to be filled there is less reason to economize, to seek that scholarship, or to ask dad or grandma to pay a share. Much more of the costs would end up on the student’s shoulders, long after college.

I suggest a different solution to help the dependent students who genuinely need additional loans. College financial aid officials should have access to a substantial, but not unlimited, pot of additional loan funds to allocate to students who face exceptional circumstances as determined by the college. The additional loan funds should be available to colleges that, overall, do a good job of preventing students from having to take out a lot of loans. This approach respects the professional role that financial aid officials play in assessing students’ needs and family situations. It provides them with a tool they can use for those cases, while preventing schools from broadly taking advantage of students and of the federal government.

In the midst of this economic disarray, it would have been reasonable to expect that the student loan system would be in shambles. That is why editors keep assigning reporters to write stories about people who can’t get loans. But the real problem is not a lack of access to student loans. It is much bigger than that. The challenge is to make sure there is an affordable place in college for students from all backgrounds, in the face of growing financial need, increased demand for higher education, and underfunding at the state and federal levels.

Robert Shireman is executive director of The Institute for College Access and Success:

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National CrossTalk Fall 2008



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