Student Loan Bubble: Setting the Stage for the Next Crash

Mar 5, 2013

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Editor’s Comment: Except for the last paragraph about Obama being a communist, the article whose link is shown below is chock full of valuable information for students — both those entering higher education for the first time and those who are struggling with student debt they have no way of paying.

What is missing, just as the mortgage mess, is an understanding of the (1) the normal loan process, (2) the securitization of loans and debt and (3) the way Wall Street used securitization for a Ponzi scheme which they are repeating as we speak — declaring that the purchase of student loan-backed securities is driven by demand. That is crap just like the the mortgage bonds were crap. Nobody on or off Wall Street sat down and decided they wanted student loan backed debt which has the highest rates of default in the nation compared with all forms of other debt.

So we already know we are being set up. The scheme is the same — as long as pension funds and other managed funds buy the bonds backed by student loans, the longer this market will last, because the PSA and prospectus specifically allow the Wall Street banks to use the investor money to pay the interest and principal even if it is unearned and not likely to be earned. Like all Ponzi schemes (see Mortgage Meltdown 1999-2011) the entire infrastructure collapses of its own weight as soon as investors stop buying the bonds.

Investors would do well to think about the legal significance of converting a note receivable, with one set of terms, to a bond receivable, with an entirely different set of terms. (same problem in the mortgage mess). The specific legal question that pops out is whether there was ever a meeting of the minds on the terms of repayment, the principal, the interest rate and the identity of the parties involved in the transaction. (see mortgage meltdown as a primer for what happens — fabrication, forgery of documents and perjury).

It is true that investors are seeking high yields. It is also true that they think they are getting higher yields. But the truth is that they are being paid with their own money and, even worse than the mortgage meltdown, the investors are purchasing defective loans many of which are in de fault or about to go into default. As a financial analyst I would remove the pen from the hand of any family member who was about to buy what is clearly toxic waste carrying, once again, high ratings from S&P, Fitch, Moody’s et al.

How fund managers would believe anything said to them by the investment banks, rating agencies or the loan originators is beyond comprehension.

Of course direct loans from the government are not securitized — at least not that we know of. Remember that Fannie and Freddie were fronts for the securitization of loans in the secondary market.

The main protection for the lending banks entering the picture for student loans was that they could not be discharged in bankruptcy. Thus once ensnared by loans far in excess of prudence, and whose proceeds were often used for purposes other than education, the student is guaranteed a life of enslavement to a debt he or she will never be able to repay.

This has not slowed the rate of defaults. We are now at critical mass which means the implicit government guarantee is going to be called in like an IOU. The argument will be that the banks did us a a service by making loan dollars available for education and that society, as a whole, enjoyed the benefit. Thus, if the de faults get too high, the government should step in and pay them off.

The originating banks were in truth simply providing a fee based service to undisclosed lenders who could not be accused of predatory lending or other wrongful acts because they weren’t physically at the closing — or so they say. I doubt if many originating banks ever took the loans in and booked them as loans receivable. But we will wait an see on that.

The point here is that by allegedly subjecting the loans to claims from asset pools that were part of the securitization scheme they elected a different scheme to handle risk than the one offered by the government. The government offered them non-dischargeability and so far as I can determine, only chartered institutions need apply. The The trusts that were supposedly used to pool the loans were never funded with the investor money — they were ignored along with the rights of both the investor/lenders and the borrowers.

The investment bank that underwrote, issued and sold the bonds created the illusion that IT owned the loans in the “pool” and not the investors — just long enough to create the illusion of an insurable ownership interest in the debt. That way the investment bank got the insurance, proceeds of credit default swaps and other hedges. This left investors out in the cold, and young borrowers completely ignorant of their rights or obligations.