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Next time you sit down to sign your monthly student loan check, consider this: Somebody out there is trading bonds made up of thousands of loans like yours, profiting off your inability to pay for college. And it's not just the guy that lives in a way nicer apartment across the street and dons spiffy suits on his way downtown every day. It's also high rollers like him in Chicago, London, and Tokyo.
Sound ugly? Well, that's the way the student loan business works. Private lenders like Sallie Mae, and even state agencies, are increasingly funding college loans through capital markets. The bonds are an easy sell because most student loans are 98 percent guaranteed by the U.S. government. If Joe College decides to move to Sweden and never pay a dime on his debt, Uncle Sam picks up the tab. Plus interest.
What investor could refuse an offer like that? "You put it out there, and people eat it up," said one veteran banker.
Congress is presently considering whether the government should, if not end the party, at least turn down the music and raise the lights. It's been one big bacchanal so far. Last month, the Senate passed a bill that would limit the growth of loans qualifying for one generous federal subsidy, but left other substantial handouts in place.
This year alone, industry leader Sallie Mae has already issued $31 billion in bonds guaranteed by student loans. Since the banks that help sell these bonds, known as underwriters, get about 1 percent of the sale for their efforts, Sallie Mae's issuance should translate into at least $310 million in bank fees. And that's just Sallie Mae. Over a dozen other lenders, private and public, are also sharing the profits of your misery with bankers.
There are similar markets for credit card debt and home mortgages, but right now the growth is in student loans. Each year, 13 million people apply for federal student aid; the Department of Education expects to grant about half those petitions in loans this year, to the tune of $52 billion. The typical undergraduate leaves school owing $19,000, or double what the average 1997 graduate owed. In the bigger scheme of things, 70 percent of all federal student aid comes in the form of loans, while grants account for just 22 percent. Thirty years ago that ratio was reversed. Meanwhile, the U.S. is experiencing a population explosion among 18- to 24-year-olds that rivals that of the baby boom generation. All of these trends are playing right into the hands of the nation's big student lenders.
As recently as 2001, student loan providers sold just $11 billion in bonds. That figure rose above $27 billion in 2002 and hit $52 billion last year.
Each bond consists of thousands of student loans, known as a pool, that investors scrutinize to guess what percentage of borrowers will make regular payments, default, or pay ahead of schedule. In a best-case scenario for investors, everyone pays on time. The average trader rakes in $500,000 to $2 million a year, and never considers that he is wagering on individuals.
"I think about it in pools," said Greg, a 38-year-old Sallie Mae bond trader at a top-tier bank. Greg (not his real name) is a family man who wears Burberry suits and lives in Connecticut.
Freddy, a trader at another top bank, said it doesn't make a difference to him whether he's trading bonds backed by credit card debt or student loans. When asked whether he's ever thought the practice might be morally questionable, Freddy (also not his real name) got defensive. "Sallie Mae could not possibly keep all the loans they have on their books. They have to sell them; otherwise they wouldn't be able to make any more loans."
Graduating students facing huge debt find it a bit harder to be grateful for the role the bond market plays. "That's just wrong," said Margarita Testa, a 29-year-old confronting $35,000 in loans after receiving her bachelor's degree from Florida International University in May. Testa said she wouldn't mind that so many people are making a living off graduates like her if the practice were more transparent.
Longtime bond analyst Jimmy Lawson says students shouldn't be bitter. "When I was a student, I didn't know a stock from a bond. This is life. People invest," said Lawson (not his real name). Lawson, like many other Wall Street veterans who spoke with the Voice, declined to have his name used in this article for fear of losing his job. "Are people in this business highly paid? Certainly. But I'm a huge believer that this is nothing but a world of good," he said.
One of the benefits of turning loans into bonds is that cash in the lending pot is quickly replenished. In theory, the availability of cash should lower the cost of borrowing for the average joe. But since interest rates on student loans are fixed by the government, the savings aren't passed on to borrowers. Instead, the banks reap the benefits of playing with cheaper money.
As the student loan industry thrives, a debate is heating up in Washington about how big a cut of the student loan business middlemen should get and how much the program ends up costing taxpayers. Government-backed student loans were born under the Higher Education Act of 1965, which needs to be reauthorized every five years. The main proposal now floating to update the actthe Republicans' College Access & Opportunity Actwould lower government subsidies for lenders. A separate bipartisan bill, the Direct Loan Reward Act, suggests giving schools an incentive to use the government's Federal Direct Student Loan Program, which was created under the Clinton administration to compete with the Federal Family Education Loan Program, or FFELP, in which private lenders like Sallie Mae participate.