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Friday, April 18, 2008

Political Pandering, Student Loans, and Market Realities

As part of her first 100 hours Nancy Pelosi slashed thecaps the banks could charge on student loans. (3.4% is the new cap) It was a clear attempt to show the voters that she cared about America's students. Here is the problem. Caps create a unnatural balance between supply and demand, and really low caps create a significant unnatural balance between the two. Now, we are facing a shortage of lenders that are in the student loan business. Of course we are. At 3.4%, the loan is simply not profitable. So what is the result...

The U.S. Congress moved closer on Thursday to putting a government safety
net under the $85 billion student loan market as millions of young people make
preparations to head to college in the autumn.

The House of Representatives overwhelmingly approved a bill to direct federal financial institutions, including the Treasury Department's Federal Financing Bank, to ensure enough money is available to provide student loans.

The student loan business is in disarray because of fallout from the subprime mortgage crisis, as well as deep cuts in federal subsidies paid to federally guaranteed student loan providers that were approved last year by Congress.


Dozens of lenders have exited the federal loan program altogether since the cuts in subsidies, prompting some analysts to predict a shakeout of smaller competitors and growth for larger players.


But Lord also told a conference call with analysts that the credit crunch meant most of Sallie Mae's new student loans would lose money. Loan demand was running at $3 billion a month, while it has only been able to access funding of about $1 billion a month -- and at record-setting costs, he said.

The last paragraph is the clincher. That is the real effect of the theory of what caps will do. While caps on student loans makes all the sense in the world politically, caps actually create an unnatural balance between supply and demand. That's because a lot more students will want loans at 3.4% than banks will want to give loans. Thus, we have the shortfall mentioned in the last paragraph. Of course, any reading of any first level macroeconomics textbook would have told Ms. Pelosi of this, but then again, that textbook wouldn't have mentioned how politically viable the idea is.

1 comment:

Anonymous said...

Your overall point is correct but you do not understand the economics to the lender. The 3.4% is a borrower interest rate, but it does not determine the lender yield. Lender yields are based on a complex subsidy program that is comparable to farm price supports. Those subsidies were slashed in last year's legislation.