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Thread: I hope nobody is looking for new student loans !

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    Banned Melonie's Avatar
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    Default I hope nobody is looking for new student loans !

    (snip)"April 25 (Bloomberg) -- More than $9 billion of auction- rate bonds sold by student-loan agencies in U.S. states from Pennsylvania to Utah have trapped investors in debt that's not paying interest.

    Rates on Pennsylvania Higher Education Assistance Agency bonds backed by student loans were set at 0 percent April 4 after auctions to determine interest costs attracted too few bidders. The same occurred on more than 10 percent of the $86 billion of student-loan debt, as failures triggered provisions in bond documents that limit the interest agencies must pay, according to data compiled by Bloomberg.

    The collapse of the auction-rate market drove interest costs paid by states, hospitals and student-lending agencies as high as 20 percent, and froze investors in securities they couldn't sell. Now, holders of student-loan debt are stuck with bonds paying less than the 0.66 percent rate on the one-month Treasury bill.

    ``It's hard to explain, to conceptualize or even understand how someone can borrow money and not pay you interest,'' said Mike Saunders, who manages $1 billion in taxable student-loan bonds for Acton, Massachusetts-based Roundstone Advisors.

    The bonds pay nothing because of a formula designed to ensure that borrowers don't pay more interest on their debt than they receive from their student-loan clients. The mechanism kicked in as rates climbed above 10 percent since February, when dealers stopped buying securities that went unsold at auctions.

    ``The investor loves you when he sees the 10 percent coupon, but how do you explain to him that it's gone from 10 percent to zero?'' Saunders said.

    Dropping Down

    A Utah State Board of Regents bond with interest that changes every 35 days jumped to 16.58 percent on March 5, up from 3.8 percent in January. The same bond's interest then dropped to 0 percent on April 9, when the provision took effect.

    Rates on $97 million of bonds sold by the Pennsylvania lending agency more than doubled to 9.85 percent on March 7 before falling to 0 percent this month.

    The formula typically is based on a 12-month average of benchmark money-market yields, which have fallen as the Federal Reserve slashed its target rate for overnight loans between banks to 2.25 percent from 5.25 percent in September.

    Auction-rate bonds are long-term securities with interest rates determined through bidding run by dealers every seven, 28 or 35 days. When there aren't enough buyers, the auction fails and the rate resets to a level proscribed when the obligations were initially sold."(snip)


    My take on these failed auctions for gov't backed student loan bonds is the same as the failed auctions for municipal bonds. A. the borrower (i.e. the state / gov't agency) sees the interest rate they must pay jump from a bargain 4-5% to an outrageous 10-20%. B. the private sector investors who provide the funds for these 'loans' see the interest rate they receive in exchange for their investment drop to near zero, with an illiquid auction market making it impossible for them to sell off their previous 'investments' and deploy that money elsewhere.

    A side effect of course is that the states / gov't agencies that have 'fronted' student loans are now caught in a financial vise. They already have millions of dollars worth of outstanding student loans with fixed interest rates in the 6-8% ballpark that were funded via the sale of auction rate bonds. Now these states / gov't agencies are being forced to pay out 10-20% interest to the auction rate bondholders while continuing to receive 6-8% from the students, which obviously creates a loss that must be passed on to taxpayers by one means or another. This will probably happen by the states / gov't agencies diverting other types of financial aid to education toward covering this interest rate gap instead of lowering state college tuitions, instead of providing grant money etc.

    If this continues, affordable student loans will become a relic from the past !
    Last edited by Melonie; 04-26-2008 at 10:06 AM.

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