Federal Reserve Answers Student Loan Liquidity Question

Forget the last post, the Federal Reserve has stepped in and settled the debate that was brewing between the White House & Congress. I referred to this in the last article – basically, the student loan companies need someone to buy some loans so they can have enough reserve cash to offer more loans in the future. Due to high default rates, high inflation rates, and overall low student loan return rates, no investors are showing up for the normal bond auctions.

Part of this, of course, is due to an over-correction by Congress during the financial boom period of 2004 to 2006. By the time legislation had passed to reduce student loan subsidies, the boom had gone bust in a bad way and now the industry threatens to lock up in a credit freeze. The domino effect of this would be massive cost-cutting measures in higher education, community college and ivy-league alike.

As of last week, Congress and the President were debating which department would bail out the student credit industry and how exactly it would be financed. On Friday, the Federal Reserve stepped in and shut down the debate by announcing its own plan. The Federal Reserve will invoke its traditional role as lender of last resort in two new sectors: credit cards and student loans. Now, the central bank will take student loan portfolios as collateral for the low-interest banking reserve loans, and this will free up enough liquidity to allow new loans to be generated.

The cost of this plan could be negligible if confidence is restored in the credit and finance markets. However, it is also taking on a big risk that might be priced into the value of the dollar, causing prices to rise on globally traded commodities like fuel, food, and metals. The upside is that colleges won’t have to worry about drastically declining enrollment and income this year.

For more information about the federal reserve’s history and the origin of conspiracy theories related to the organization’s history, check out this link.