Are Student Loans The New Sub-Prime Credit Crisis?

Are Student Loans The New Sub-Prime Credit Crisis?

This is surely déjà vu, as the excesses of the sub-prime mortgages that caused such a major role in the financial crisis, now seem to be crawling out of the woodwork in another avatar – student loans.

In a new report by the Obama administration, cited by, The Department of Education, and the Consumer Financial Protection Bureau have highlighted that student loans granted around the time of the financial crisis, are now seeing heightened levels of default, and this may be a pointer to the reckless lending practices of that era, a la the sub-prime crisis.

The report, which emphasized its review on private loans to students from banks and private financial companies (as distinct from direct government loans), said that the loans may have been given to unsuspecting students, who may not have grasped the financial significance of the various terms, and may have agreed to more expensive, even prejudicial terms, now resulting in defaults.

In the rush to lend against approved collateral, and thereby create asset-backed securities, the lenders by-passed the school authorities, which, according to the study, may have resulted in the students borrowing beyond their real needs, or even taking private loans in preference to the federal option.

And just as in the case of housing, here too, the lenders ignored the credit standing of borrowers, and lent to those with poor credit scores.

The results are clear to see: Private student loans in default now stand at over $8 billion. Says Education Secretary, Arne Duncan, in a telling comment, “Subprime-style lending went to college, and now students are paying the price.” In 2011 Americans’ student loan debt surpassed credit card debt for the first time ever.

Yet, this may be an unfair remark, says Jason Delisle, director of the Federal Education Budget Project, at the New America Foundation in Washington. Students, by definition, often have low credit scores or no credit history. “Does that mean the federal government is a subprime lender? Policymakers should be careful in how we characterize this [issue] because [it could] undermine support for the federal student loan program.”