The very same loan-relief programs that the federal government has put into place to help millions of financially distressed student borrowers is wreaking havoc within the investment community.
According to a recent Wall Street Journal article, the issue is no longer a matter of whether these borrowers will be able to repay their debts; it’s become the uncertainty of when.
In a stable economic environment—when interest rates are higher for longer-term obligations and investments than they are for those that mature more quickly—loans (and the investment dollars helping to fund these) that are structured to terminate within, say, 10 years are priced lower than for those that span 20.
There are many reasons for that: longer-term inflationary, default and liquidity concerns (i.e., an inability to dispose the contract on demand), to name just a few. And that’s before taking into account overhead costs and target profitability.
As such, although loans that pay off more quickly are irksome to investors (because the resultant cash will have to be reinvested sooner than expected), debts that take longer to retire are a nightmare, particularly when interest rates have moved higher in the interim.
So in this Bizarro World of higher-ed finance, the more the feds succeed in restructuring their problem loans, the less inclined investors are to fund those deals in the first place. And when that so-called secondary market begins to falter, new loans become harder to finance because the money has to come from someplace.
Granted, we’re only talking about a $40 billion problem at this point—a mere drop in the bucket compared with the $1.2 trillion of education-related debts that are owed.
Or are we?
The Department of Education is currently sitting with approximately $1 trillion worth of student loans on its balance sheet ($924 billion as of Sept. 30, 2014, and growing at a rate of about $100 billion per year). At some point a portion, if not all, of these contracts will have to find their way into the capital markets because, as one of my former board members is fond of saying, “Trees don’t grow to the sky.” The government simply cannot afford to bankroll eight to nine out of 10 college students in perpetuity.
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