July 25, 2012 12:46 am

Student loan market a brake on US economy

Dysfunction in the US student loan market is holding back the economy and policy makers should act, a senior US regulator has told the Financial Times.

“As with the mortgage market, if it’s true that student loan debt is threatening consumers and the economy, policy makers cannot sit by as passive observers,” said Rohit Chopra, the official responsible for student loans at the Consumer Financial Protection Bureau.

Mr Chopra’s call for action comes at a time when the US Treasury is trying to boost mortgage refinancing and the Federal Reserve is studying whether it could use direct lending as a way to ease bottlenecks in the financial system. Rising concern about the student loan market could make it the next venue for action to stimulate the economy.

“What we see is not many refinancing opportunities to best allocate price to risk,” said Mr Chopra. “When markets are not appropriately allocating prices and risk, we do not see a well-functioning market. So borrowers may be paying higher rates than what their risk profile justifies.”

There is about $150bn of private student loans and the average rate on new student loans during the past three years was 8 to 10 per cent. After students graduate and get jobs, they become much better credit risks, but Mr Chopra said the market was giving them little chance to refinance at lower rates.

That, in turn, might prevent them from buying a house. “Student debt may be more intertwined with the housing market than we realise and it may prove more important every day to understand that connection,” said Mr Chopra.

The return of first-time homebuyers, who also struggle to get credit because of the need for large down payments, is considered crucial to a recovery in the troubled US housing market.

Most student loans in the US are backed by the government and carry a fixed rate of interest determined by Congress but there is also a large private market where rates have remained high despite low overall interest rates.

The Obama administration has pushed hard to make it easier to refinance a mortgage but so far there has been little action on student loans. The nature of the problems is similar: low quality servicing and a lack of competition for refinancing makes it hard for borrowers to take advantage of low interest rates.

The Fed has also indicated that it is looking for new tools beyond asset purchases as a way to support the economy. In recent testimony to Congress, Ben Bernanke, chairman, said that lending through its discount window could be one option.

In testimony to Congress, Mr Chopra cited a Fed financial crisis programme called the Term Asset-Backed Securities Loan Facility, or Talf, as an example of a successful recent intervention in the private student loan market.

Talf provided liquidity to support the issuance of a wide range of asset-backed securities including those made up of private student loans.

“I think all federal regulatory agencies, particularly ones that monitor the capital markets, have a role to play to make sure the market is liquid and well functioning,” said Mr Chopra.

Other potential policy options include action by Congress that would enable borrowers with private student loans to refinance into government-backed fixed rate loans. Sherrod Brown, a Democratic senator from Ohio, is considering introducing legislation to advance this.

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