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# Student Loan Crisis Next?

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Senior Manager
Joined: 30 Jul 2007
Posts: 385
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Schools: St. Gallen '09
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23 Jan 2008, 08:04
http://www.bloomberg.com/apps/news?pid= ... refer=home

SLM Reports Loss Amid Higher Costs, Reduced Subsidies (Update1)

By William McQuillen and Matthew Keenan

Jan. 23 (Bloomberg) -- SLM Corp., the largest U.S. provider of student loans, reported a net loss of $1.6 billion, or$3.98 a share, as it suffers from higher borrowing costs, cuts in federal subsidies for loans, and losing bets on its stock.

The fourth-quarter net loss compared with a net profit of $18.1 million, or 2 cents, a year earlier, the Reston, Virginia- based company, known as Sallie Mae, said today in a statement on PR Newswire. The so-called core result, which excludes gains or losses from derivatives, was a loss of 36 cents a share, compared with the average estimate of a profit of 55 cents a share by eight analysts surveyed by Bloomberg. Chief Executive Officer Albert Lord said last month that restoring Sallie Mae's finances is his top priority. The quarter's result includes a$1.5 billion loss on contracts in which Sallie Mae bet that its stock would rise. Instead, after the collapse last year of a $25.3 billion takeover offer from investors led by J.C. Flowers & Co., the stock declined. While there were some bright spots, we are obviously disappointed by our fourth-quarter results overall,'' Lord said in the statement. Our cost of funds and loan loss expectations were impacted by weakening credit markets.'' Sallie Mae fell$1.45, or 7.6 percent, to $17.57 at 9:32 a.m. in New York Stock Exchange composite trading. GMAT Club Legend Joined: 10 Apr 2007 Posts: 4318 Location: Back in Chicago, IL Schools: Kellogg Alum: Class of 2010 Followers: 89 Kudos [?]: 755 [0], given: 5 Re: Student Loan Crisis Next? [#permalink] ### Show Tags 23 Jan 2008, 09:01 Yes a loan crisis is already happening...there is an article about it on BW right now. I think that its going to affect undergrads coming from families who are already in credit trouble already the hardest. Anyone who has less than stellar credit score is going to have a tough time getting loans at reasonable rates. Getting federal loans is going to get tougher cause of the elimination of subsidies, so companies are not taking these anymore…why would they when there is far more profit in private loans. I think MBA students to top schools have an advantage over a lot of other grad students, the post grad careers typically pay very well. You aren’t going to owe more than you can pay back like is possible for some masters degree careers. That said if you don’t have very good >740/750 credit and aren’t a US citizen its going to be substantially more difficult than three years ago. It will still be possible but fees and rates are definitely going to be higher than they will be for someone who has a 770 FICO and a working spouse who is going to co-sign. _________________ Kellogg Class of 2010...still active and willing to help. However, I do not do profile reviews, don't offer predictions on chances and am far to busy to review essays, so save the energy of writing me a PM seeking help for these. If I don't respond to a PM that is not one of the previously mentioned trash can destined messages, please don't take it personally I get so many messages I have a hard to responding to most. The more interesting, compelling, or humorous you message the more likely I am to respond. GMAT Club Premium Membership - big benefits and savings Senior Manager Joined: 30 Jul 2007 Posts: 385 Location: Europe Schools: St. Gallen '09 Followers: 6 Kudos [?]: 59 [0], given: 5 Re: Student Loan Crisis Next? [#permalink] ### Show Tags 28 Jan 2008, 05:41 http://www.nytimes.com/2008/01/28/busin ... ref=slogin January 28, 2008 Sallie Mae Settles Suit Over Buyout That Fizzled By ANDREW ROSS SORKIN and MICHAEL J. de la MERCED Sallie Mae, the embattled student lending giant, reached a settlement on Sunday over its scuttled$25 billion buyout, ending months of legal fighting that had cast a cloud over the company, according to people briefed on the agreement.

The company, formally known as the SLM Corporation, agreed to settle with its onetime buyers, which include the private equity firm J. C. Flowers & Company, JPMorgan Chase and Bank of America, in exchange for a deal to refinance about $30 billion in debt that was due next month. Both Sallie Mae’s lawsuit and the buyers’ counterclaims will be dismissed, and the merger agreement has been terminated, these people said. A trial in Delaware Chancery Court had been scheduled for December of this year. A spokesman for Sallie Mae declined to comment, as did a spokeswoman for the buyers’ consortium. The announcement concludes one of the bitterest legal fights to emerge from the end of the buyout boom. After a two-year feast in which private equity firms gobbled ever-larger targets, a handful of deals have collapsed, but few disputes became as heated as that between Sallie Mae and its buyers, whose$60-a-share deal collapsed shortly after its announcement last April.

Securing the $30 billion credit line solves one of Sallie Mae’s biggest problems and will very likely serve as a vote of confidence on the company’s prospects. Since the near shutdown of the credit markets last summer, the company has been unable to issue new debt that is backed by its student loans, depriving it of a huge source of capital. As a result, it drew down its credit line, which had been provided by JPMorgan and Bank of America as part of the buyout deal. The company also has suffered financially from the deteriorating economy. It reported a$1.6 billion loss for its fourth quarter after preparing for a jump in student loan defaults. It also took a hit from bad bets on its stock price, which it settled by issuing $3 billion in new capital. Sallie Mae’s stock has plummeted more than 56 percent over the last year, and closed at$19.88 on Friday.

A settlement will end a war of words between Sallie Mae and its former buyers over a $900 million breakup fee, which Sallie Mae sought after arguing that the consortium illegally scuttled the deal. The buyers claimed that new legislation to cut federal subsidies to student lenders had substantially harmed the company’s financial health. By exercising an escape hatch in the deal agreement, known as a material adverse effect clause, the buyers tried to walk away without paying the$900 million fee.

Had the buyers been forced to pay, the brunt of the fee would have been borne by J. C. Flowers, a firm far smaller than its two bank partners.

Relations between the two sides had become so toxic since last summer that they refused to talk to each other for months, a situation that only worsened as Sallie Mae’s chief executive, Albert L. Lord, took a hard-line stance in negotiations. Under Mr. Lord’s guidance, the company rejected a revised buyout offer that would have paid $50 a share and potentially more if the lender met or exceeded its financial targets. A thaw began earlier this month when the company appointed Anthony P. Terracciano, who turned around struggling financial firms like Dime Bancorp and First Fidelity Bancorp, as chairman, and John F. Remondi as chief financial officer. Mr. Remondi reached out two weeks ago to James B. Lee Jr., JPMorgan’s vice chairman and senior rainmaker, people briefed on the matter said. Mr. Lee, who has already played the role of peacemaker in several challenged deals this year, led the consortium’s efforts to reach an agreement, these people said, and brought Gregory L. Curl, a vice chairman at Bank of America, into the settlement discussions. JPMorgan and Sallie Mae have a long history; they ran a joint student loan venture for nearly 10 years, though it was dissolved in 2005. As recently as last Wednesday, when Sallie Mae held its annual shareholder meeting, Mr. Remondi said the company was “very, very close” to refinancing the credit line. At the time, he said that the company had been holding discussions with “more than 10” potential partners. JPMorgan and Bank of America will take the lead in offering the new financing, worth about$31 billion and good for 364 days. Others involved in the financing are Barclays Capital, Deutsche Bank, Credit Suisse, the Royal Bank of Scotland and UBS, Sallie Mae’s banker in the failed buyout. J. C. Flowers is expected to contribute tens of millions of dollars into the deal, the people knowledgeable about the settlement said, although they refused to provide exact figures.

Sallie Mae is expected to pay an interest rate of about 4.5 percent.

With its financing and buyout-related legal issues settled, Sallie Mae can now focus on its other pressing issues. Chief among those is stemming potential losses from student loan defaults. The $1.6 billion loss it reported last Wednesday included a$575 million loan-loss provision.
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Re: Student Loan Crisis Next? [#permalink]

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22 Feb 2008, 10:14
Thanks to these auction rate loans it is next!
Senior Manager
Joined: 30 Jul 2007
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Schools: St. Gallen '09
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Re: Student Loan Crisis Next? [#permalink]

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15 Apr 2008, 10:19
http://www.bloomberg.com/apps/news?pid= ... refer=home

Loan Demand Outstrips Supply,' SLM's Remondi Says (Update1)

By Christopher Stern

April 15 (Bloomberg) -- The shortage of student loans will become increasingly evident as demand builds next month, John Remondi, chief financial officer of SLM Corp., told a U.S. Senate committee today.

For the current academic year lending season, we are facing a scenario where demand for student loans will significantly outstrip supply,'' Remondi said in testimony to be delivered today to the Senate Banking Committee. The gap between available loans and the demand for them could manifest itself as early as May.''

The panel is considering the effect of the credit crunch on the student loan market. At least 50 lenders have ceased writing some form of student loans as the cost of raising money in the asset-backed market has skyrocketed.

Senator Christopher Dodd, the panel chairman, said today that the withdrawal of these lenders, the ongoing turmoil in U.S. credit markets and the illiquidity in the student loan market have fueled concerns that a potential student loan credit crunch may be looming.''

Credit Markets

Democrats have introduced several proposals to help college students borrow money as credit markets tighten. Senator Edward Kennedy, a Massachusetts Democrat, proposed raising loan limits for students. Representative George Miller, a California Democrat and chairman of the House Education and Labor Committee, would authorize the U.S. Education Department to buy loans from companies that need capital to lend more money to students.

Pressures from a global credit crunch have hurt the student loan providers. Last month, Moody's Investors Service downgraded its rating for SLM, known as Sallie Mae, the largest U.S. education lender, citing a decline in federal subsidies for student loans and an aborted buyout of the company.

Last month, the Education Resources Institute Inc., a lender that says it is the largest nonprofit provider of student loans, filed for bankruptcy. CIT Group Inc. and NorthStar Education Finance Inc. have said they will stop making new loans to U.S. students because lending costs have soared.
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Re: Student Loan Crisis Next? [#permalink]

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16 Apr 2008, 06:17
By Robert Greene
April 16 (Bloomberg) -- Citigroup Inc.'s Student Loan Corp.
said it will suspend lending at certain schools and withdraw from the Federal Consolidation Loan market.
Citigroup cited dislocation in the capital markets and recent federal legislation,'' according to a Business Wire statement distributed today.

--Editor: Robert Greene
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Senior Manager
Joined: 30 Jul 2007
Posts: 385
Location: Europe
Schools: St. Gallen '09
Followers: 6

Kudos [?]: 59 [0], given: 5

Re: Student Loan Crisis Next? [#permalink]

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18 Apr 2008, 15:33
If anyone is trying to get an international student loan or a loan for US citizens to attend a foreign school, good luck!

TERI, the Education Resources Institute, has filed for Chapter 11 Bankruptcy. They were the guarantor for these types of loans and other alternative/private loans. Since their bankruptcy filing earlier this month, all their loan partners pulled out of this market and have stopped their lending.

Even with IEFC, the International Education Finance Corporation, both Bank of America and Wachovia have pulled out of the International Student Loan Program (ISLP). Again, these loans were guaranteed by TERI.

According to their website, Wachovia will be coming out with a new product offering on May 19th with a new guarantor for these types of alternative loans.

Senior Manager
Joined: 30 Jul 2007
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Schools: St. Gallen '09
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Re: Student Loan Crisis Next? [#permalink]

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24 Apr 2008, 10:27
http://www.bloomberg.com/apps/news?pid= ... refer=home

Students Lose Billions as Colleges Petition for Loan

April 24 (Bloomberg) -- Students in the U.S. have lost access to more than $6.7 billion a year in education loans after private lenders fled the market, spurring schools including Pennsylvania State University and Northeastern University to turn to the Education Department's Direct Loan Program. Dozens of lenders, led by College Loan Corp. and CIT Group Inc., stopped making federally guaranteed loans because the U.S. cut subsidies and investors hurt by the subprime-mortgage crisis shunned bonds backed by student loans. At least 178 schools have applied since Feb. 28 to let students borrow from the direct program, compared with 80 that applied for the program in all of last year. Students took out about$68.2 billion in new U.S.-backed loans this academic year, according to Mark Kantrowitz, the publisher of FinAid.org, a scholarship and loan information Web site. The borrowing is projected to rise by almost $4 billion for the next school year as both the student population and costs increase, he said. More schools say they are seeking access to U.S. direct loans as private lenders drop out. Certainly, having students have secure access to funds is of the utmost importance,'' said Anthony Irwin, the director of financial-aid services at Northeastern, in Boston. The school will switch to the U.S. program after two private lenders that served its students stopped making federally backed loans. The U.S. Education Department supports legislation allowing the federal government to buy student loans of banks and other private companies to ensure funds are available for further lending, Lawrence Warder, the acting chief operating officer of federal student aid, said yesterday. June Target Date The legislation, passed by the House of Representatives on April 17, needs to be on the president's desk by June 1 to help students in next school year, he said. Warder also said the direct-loan program is preparing to double its volume. Colleges' shift to direct loans means that students won't get discounts that banks and other lenders offered until recently. Those incentives included waivers of fees, which amounted to 2.5 to 4 percent of the borrowed amount, or a percentage-point reduction in the interest rate after three years of on-time payments, FinAid's Kantrowitz said. Lenders that remain in the market have reduced or eliminated those discounts, he said. Democrats, including presidential aspirants Senator Barack Obama of Illinois and Senator Hillary Clinton of New York, say the 15-year-old direct-loan program is less costly to the government because it avoids the subsidies. Republicans say private companies provide better service. Exodus From Program The Federal Family Education Loan Program, or FFELP, requires lenders to cap annual interest rates at 6.8 percent for the most-common type of loan and guarantees that the government will reimburse them for any defaults. The exodus from the program so far is equivalent to 13.6 percent of FFELP loans in the fiscal year that ended in September 2006, Kantrowitz said. The effects on the$400 billion loan market will start to appear in coming weeks, as families start seeking loans for the academic year starting in September. Loan originations typically peak in the third calendar quarter. No qualified applicants have failed to find loans, according to schools and government officials.

The influx to direct lending reverses a decade-long trend of schools' opting to deal with banks and other lenders, led by Reston, Virginia-based SLM Corp., known as Sallie Mae.

The government has projected that direct-lending volume, excluding consolidations, will total $13.6 billion in the academic year ending in June, according to Kantrowitz. Decreased Share Direct lending, now with about 1,000 participating schools, grew rapidly after going into full operation in 1993, capturing by 1997 about a third of the federal-loan market from private lenders. Its share decreased to 19 percent in 2007 and the number of schools dropped 18 percent as private lenders offered borrowers incentives, such as waiving fees or giving lower interest rates. The plain and simple fact is, for the borrower and the schools, the private program has worked better,'' said Joe Belew, the president of the Consumer Bankers Association, a trade group based in Arlington, Virginia. You had universities and colleges vote with their feet by trying the direct program, and they left it in droves.'' Lenders say Congress cut the default guarantee, the interest rates that private FFELP lenders will be able to charge in the future, and subsidies, making the loans less profitable. Meanwhile, the meltdown in the credit markets cut off capital for Sallie Mae and other lenders. Issuance of securities backed by student loans dropped 65 percent during this year's first quarter, according to UBS Securities LLC in New York. Lack of Assurances Officials at Penn State, in University Park, say they were surprised when the Pennsylvania Higher Education Assistance Agency said in late February it would no longer make federal loans. That move affected 90 percent of the 45,000 Penn State students who receive such financing. Penn State, whose students borrowed$411.3 million in private government-guaranteed loans in 2006, considered finding other companies to recommend as lenders.

What assurances would we have?'' said Anna Griswold, Penn State's assistant vice president for undergraduate education. Could we find lenders that we think are in it for the long haul? Nobody knows what's going to happen.'' As a result of the uncertainty, the school has turned to the direct-lending program, she said.

Clinton and Obama have said they want to completely replace the guaranteed private loans with direct lending.

Eliminating Middlemen

We're going to go back toward direct lending and cut out the middlemen who charge so much,'' Clinton said at a rally last week in Pennsylvania.

Some Republicans still say direct U.S. lending should be ended.

When markets run into difficulty, it shouldn't be used as an excuse to say, Let's have the government do it,''' said Representative Peter Hoekstra, a Michigan Republican on the House Education and Labor Committee.
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25 Apr 2008, 04:57
WOW!

http://www.bloomberg.com/apps/news?pid= ... refer=home

Auction-Bond Flops Stick Student-Loan Investors With 0% Rates

By Michael B. Marois and Jeremy R. Cooke

April 25 (Bloomberg) -- More than $9 billion of auction- rate bonds sold by student-loan agencies in states from Pennsylvania to Utah have trapped investors in debt that's not paying interest. Rates on Pennsylvania Higher Education Assistance Agency bonds backed by student loans were set at 0 percent April 4 after auctions to determine interest costs attracted too few bidders. The same occurred on more than 10 percent of the$86 billion of student-loan debt, as failures triggered provisions in bond documents that limit the interest agencies must pay, according to data compiled by Bloomberg.

The collapse of the auction-rate market drove interest costs paid by states, hospitals and student-lending agencies as high as 20 percent, and froze investors in securities they couldn't sell. Now, holders of student-loan debt are stuck with bonds paying less than the 0.76 percent rate on the one-month Treasury bill.

It's hard to explain, to conceptualize or even understand how someone can borrow money and not pay you interest,'' said Mike Saunders, who manages $1 billion in taxable student-loan bonds for Acton, Massachusetts-based Roundstone Advisors. The bonds pay nothing because of a formula designed to ensure that borrowers don't pay more interest on their debt than they receive from their student-loan clients. The mechanism kicked in as rates climbed above 10 percent since February, when dealers stopped buying securities that went unsold at auctions. The investor loves you when he sees the 10 percent coupon, but how do you explain to him that it's gone from 10 percent to zero?'' Saunders said. Dropping Down A Utah State Board of Regents bond with interest that changes every 35 days jumped to 16.58 percent on March 5, up from 3.8 percent in January. The same bond's interest then dropped to 0 percent on April 9, when the provision took effect. Rates on$97 million of bonds sold by the Pennsylvania lending agency more than doubled to 9.85 percent on March 7 before falling to 0 percent this month.

The formula typically is based on a 12-month average of benchmark money-market yields, which have fallen as the Federal Reserve slashed its target rate for overnight loans between banks to 2.25 percent from 5.25 percent in September.

Auction-rate bonds are long-term securities with interest rates determined through bidding run by dealers every seven, 28 or 35 days. When there aren't enough buyers, the auction fails and the rate resets to a level proscribed when the obligations were initially sold.

Dealers Retreat

The $330 billion auction-rate market unraveled in February after investors shunned the debt and dealers that had routinely stepped in as buyers of last resort stopped supporting the securities under the weight of subprime-related losses. More than 60 percent of the thousands of auctions conducted each week have failed since Feb. 13, data compiled by Bloomberg show. The collapse left public student-loan issuers unable to raise additional capital in the market. No new municipal bonds backed by student loans, including auction-rate debt, were sold in the first quarter, the first time that happened in almost 40 years, according to Thomson Reuters. We need bonds that are out there for 30 to 40 years,'' said Jamie Wolfe, chief financial officer of NorthStar Education Finance Inc., a nonprofit organization in St. Paul, Minnesota, that provides student loans to medical students. That's what these auction bonds do for us.'' Halting Loans Without access to funds, NorthStar stopped processing applications this month for federally backed loans, joining dozens of state agencies, private firms and nonprofit groups that have curbed lending to students. NorthStar bundled$800 million, or 20 percent, of its loans into auction-rate debt sold to investors since 2002. One $30 million issue of NorthStar bonds reset at 0 percent on March 5 from 6.9 percent in January. I'm dealing with people who have tax payments and payroll to meet with what they thought were liquid funds,'' Wolfe said of NorthStar's investors. JPMorgan Chase & Co. this week said it will buy as much as$1.1 billion in auction-rate notes from three student-loan trusts, providing limited relief to some investors.

Municipalities, hospitals and universities are refinancing at least $54 billion of auction debt by June 2, according to a compilation of disclosure notices by Bloomberg. Senior Manager Joined: 30 Jul 2007 Posts: 385 Location: Europe Schools: St. Gallen '09 Followers: 6 Kudos [?]: 59 [0], given: 5 FED bail-out of student lenders next? [#permalink] ### Show Tags 05 May 2008, 01:47 http://www.bloomberg.com/apps/news?pid= ... refer=home Fed Rogue Operation' Spurs Further Bailout Calls (Update1) May 2 (Bloomberg) -- A month after the Federal Reserve rescued Bear Stearns Cos. from bankruptcy, Chairman Ben S. Bernanke got an S.O.S. from Congress. There is a potential crisis in the student-loan market'' requiring similar bold action,'' Chairman Christopher Dodd of Connecticut and six other Democrats wrote Bernanke. They want the Fed to swap Treasury notes for bonds backed by student loans. In a separate letter, Pennsylvania Democratic Representative Paul Kanjorski and 31 House members said they want Bernanke to channel money directly to education-finance firms. Student loans are just the start. Former Fed officials and other Fed-watchers say that Bernanke's actions in saving Bear Stearns will expose the central bank to continuing pressure to use its$889 billion balance sheet to prop up companies or entire industries deemed important by politicians. The Fed satisfied Dodd's request today, expanding the swaps to include securities backed by student debt.

It is appalling where we are right now,'' former St. Louis Fed President William Poole, who retired in March, said in an interview. The Fed has introduced a backstop for the entire financial system.''

Critics argue that the result will be to foster greater risk-taking among investors emboldened by the belief that the government will bail them out of bad decisions.

The Fed's loans to Bear Stearns were a rogue operation,'' said Anna Schwartz, who co-wrote A Monetary History of the United States'' with the late Nobel laureate Milton Friedman.

To me, it is an open and shut case,'' she said in an interview from her office in New York. The Fed had no business intervening there.''

There are already indications that investors perceive the safety net to be widening as a result of the actions by Bernanke, 54, and New York Fed President Timothy Geithner. The Bear Stearns bailout and an emergency facility to loan directly to government bond dealers triggered a decline in measures of credit risk for investment banks and for Fannie Mae, the Washington-based, government-chartered company that is the nation's largest source of funds for home mortgages.

Yield differences between Fannie Mae's five-year debt and five-year U.S. Treasuries have fallen to 0.55 percentage point, from 1.15 percentage points on March 14, the day the Fed's Board of Governors invoked an emergency rule to lend $13 billion to Bear Stearns. The market understood that this is the method by which Fannie Mae and Freddie Mac could be bailed out if necessary,'' Poole said. Wall Street Impact The cost of default protection on Merrill Lynch & Co. debt fell to 1.4 percentage point by April 30 from 3.3 percentage points on March 14, CMA Datavision's credit-default swaps prices show. The cost of protection on Lehman Brothers Holdings Inc. securities has fallen to 1.5 percentage points from 4.5 percentage points over the same period. Fed Board spokeswoman Michelle Smith declined to comment, as did New York Fed spokesman Calvin Mitchell. On March 16, two days after the Fed provided its Bear loan, it agreed to finance$30 billion of the firm's illiquid assets to secure its takeover by JPMorgan Chase & Co.

The Standard & Poor's 500 Financials Index had lost 12 percent in the three weeks prior to March 14; Geithner defended the loans before the Senate Banking Committee on April 3, saying that the Fed needed to offset risks posed to the entire financial system.

Everyday Life'

A systemic collapse on Wall Street would also mean higher borrowing costs for housing, education, and the expenses of everyday life,'' Geithner, 46, said.

While the Fed must by law withdraw its financing backstop for investment banks once the credit crisis passes, investors will probably still bet on its readiness to intervene.

There is no way to put the genie back in the bottle,'' Minneapolis Fed President Gary Stern said in an interview with Fox Business Network on April 18. What worries me most about where we wind up is that we will have an expansion of the safety net without adequate incentives to contain it.''

Stern noted that he supported the Fed's moves to restore financial stability.

Fed Board officials haven't explained in detail how they plan to curtail moral hazard, the danger of encouraging investors to take on more risk out of confidence in a rescue.

Heat of Battle

It is very hard in the middle of a crisis to know where to draw lines,'' said Harvard University professor Kenneth Rogoff, a former research director at the International Monetary Fund. They reduced the immediate risk of a crisis, but upped the ante of raising the possibility of a bigger crisis down the road.''

Lawmakers plan to debate the management of risk and role of supervisors in coming weeks and months. House Financial Services Committee Chairman Barney Frank said April 23 that new rules are needed to deal with a lack of regulation of risk.

Geithner told Congress April 3 that the direct lending needs to be complemented with a stronger set of incentives and requirements for the management of liquidity risk.''

The risk to the Fed is that it is routinely asked to step in and support insolvent companies whose creditors are on the run, economists say.

Discount-window accommodation to insolvent institutions, whether banks or nonbanks, misallocates resources,'' Schwartz said in a 1992 lecture available on the St. Louis Fed Web site. Institutions that have failed the market test of viability should not be supported by the Fed's money issues.''

Moral-Hazard Problem'

Richmond Fed chief Jeffrey Lacker and policy adviser Marvin Goodfriend wrote in a 1999 paper that central bank lending creates ever-expanding expectations. The rate of incidence of financial distress that calls for central bank lending should tend to increase over time,'' they wrote. That creates a potentially severe moral-hazard problem.''

Whatever regulations and incentives the Fed tries to put in place now would be evaded by the market's innovation of new types of products, Goodfriend said in an interview. Investors would nonetheless still count on the safety net, he added.

We have to start now to recognize the strategic instability of the path we are on,'' said Goodfriend, now a professor at Carnegie Mellon University's Tepper School of Business in Pittsburgh. The Fed needs to prepare markets for how it won't intervene, which it didn't do before the Bear Stearns meltdown, he said.

Lending Treasuries

The Fed also influenced market incentives when it introduced the so-called Term Securities Lending Facility. The program is designed to lend up to $200 billion of Treasury securities from the Fed's holdings to Wall Street bond dealers in return for commercial and residential mortgage bonds among other collateral. Congress has noticed the program favors mortgage credits, and Dodd asked the Fed to swap some of its$548 billion in Treasury holdings for bonds backed by student loans.

While Bernanke rebuffed Kanjorksi's request for direct loans in a March 31 letter, Fed officials today expanded the collateral they accept under the TSLF. The facility now includes all AAA rated asset-backed investments, including bonds backed by student loans. Former Fed officials say it is risky for the central bank to use its portfolio to address specific markets and satisfy Congress without saying where it will stop.

If there is a public purpose in lending to investment banks, and taking dodgy mortgage securities as collateral, then it is a question of degree about other potential lending,'' Vincent Reinhart, former director of the Fed board's Division of Monetary Affairs, said in an interview. That's the consequence of crossing a line that had been well established for three- quarters of a century.''
FED bail-out of student lenders next?   [#permalink] 05 May 2008, 01:47
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