Student loans: Another bubble pops?

By The Wall Street Journal

Has the U.S. created an "education bubble" fueled by easy money and over-borrowing by families desperate to pay rising tuition costs?

Expect a hastily sputtered "no way" from economists, university officials and student-lending specialists. They attach a high monetary value to academic degrees, no matter how fast tuition rises. As proof, they cite the big and growing income gap between college graduates and people with just high-school diplomas.

But the student-loan market has been riddled with signs of trouble lately. Default rates are rising. Big-name lenders are pulling out or scaling back. And investors who used to snap up bonds backed by bundles of student loans have instead snapped their checkbooks shut.

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Borrowing to pay for higher education may be a lot like mortgage-financed home ownership: a great idea that can be badly tarnished when financial markets lose all remnants of discipline.

The obvious casualties are the stock prices of companies that specialize in student lending. Shares of Nelnet and industry leader Sallie Mae have fallen 40% or more in the past year.

Nor are the companies' executives offering much cheer in their quarterly conference calls with investors. Last month, Sallie Mae Chief Executive Al Lord described overall market conditions as a "train wreck." Jack Remondi, Sallie Mae's chief financial officer, added: "To say that the funding environment is difficult is a tremendous understatement."

Lenders vulnerable to capital market

Figuring out why student lenders are in such a pickle is a tricky task. Their business models are vulnerable to short-term capital-market gyrations, independent of the true economic value of education. The general seize-up in credit markets has made it harder for student-lending companies to raise money or refinance old lines of credit on favorable terms.

In addition, many lenders' profit margins were squeezed last autumn when Congress passed the College Cost Reduction Act. Among other things, the law shrank the subsidies student-loan issuers get on certain federally guaranteed loans.

Even so, it is a good time to ask whether something more profound is going on. Runaway college expenses are straining many families' borrowing capacity. While some families can handle the load, others are starting to look like homeowners who bought too much house for their budgets.

Private loans a bellwether

A key statistic to watch is the default rate on "private" student loans. These are the loans students or their families seek after exhausting borrowing limits for cheaper, federally guaranteed loans.

The volume of private student loans has grown from almost nothing a decade ago to more than $17 billion in the 2006-07 academic year. (By comparison, federally guaranteed loan volume totaled $59.6 billion that year.)

Private loans don't carry federal guarantees of repayment, so they generally come with higher interest rates. Think of them as the educational equivalent of a second mortgage. Borrowing rates typically range from 6% to 11%, compared with the 6% to 8% on federally guaranteed debt.

Continued: Students likely to feel the pinch

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