Last month when we attended the Inman Real Estate Connect Show, a show packed with hundreds of real estate agents listening to leaders in the field and economists delivering the unfortunate truth that yes the housing market sucks, and yes, it should still get worse before it gets better. Or, as one noted professor of economics said but not in these words, "Sucks to be you." That economist, outside of his candor, humor, and scholarly disregard for the feelings of those in attendance also helped us and presumably other macro-economic newbies reorient our thinking away from simply sub-prime implosion and more towards a longer-term credit crunch whose impact will ultimately extend well beyond housing. The news this week seemed to bolster the accuracy of his assertions, as the Wall Street Journal, for example, ran a story whose opening lines included the none too optimistic, "A widening array of financial-market problems threatens to trigger a new phase in the global credit crunch, extending it beyond the risky mortgages that have cost banks and investors more than $100 billion in losses and helped push the U.S. economy toward recession." Ignore for a minute the recession comment, and let’s focus on how the expansion or the credit crunch beyond mortgages and more importantly what that means and has meant for our industry.
While the housing market certainly ignited the frenzy, both in initial run up and decline, mortgages make up only one type of product that investors have purchased. Lots of people take out mortgages, so collectively they comprise perhaps the largest quantity of loans bundled up and sold to the markets, but they represent only one of the main set of different loans that the average person has in their lifetime. For most, the home will represent our largest purchase, but if you stop and think about the number of things you take a loan out for, you start to realize how much our society runs on credit. Less technically, we might just say, you start to realize how much we rely on taking on debt. The mortgage/housing mess has brought to light a key aspect in this loan process, the role of securitization. Countrywide or any other major lender doesn’t have billions in cash to lend out, so they take a whole bunch of mortgages and rely on the financial markets to pick up the tab. The financial markets historically liked them because these bundled loans carried low risk (or so the "neutral" rating agencies had people believe) and good returns. Obviously, there were some major flaws in the process, but the overall principal of the broader markets buying loans made it possible for Americans to purchase large items relatively easily. If these buyers don’t buy, then lenders can’t lend, and that’s at the heart of the issue.
That we have some hesitancy from buyers of loans in the housing market makes sense, given the bubble like run up in home value and lax standards used when determining eligibility for a loan. Not everyone deserves a loan for a home, or even a car, because they want it, but some areas seem as inalienable as a Texan’s right to own more handguns than commonsense, one such right inalienable lending right – education. It costs a bundle to go to school, and for most people doing so means navigating the complex system of scholarships, grants, and loans, with the last making up the vast majority of payment options for those attending higher education across all levels. And while hard to make sense of the different types of loans available – federal or private, if federal Federal Direct Student Loan Program (FDSLP) or Federal Family Education Loan Program (FFELP), Stafford, PLUS, or other, etc. – you could always count on at least getting a loan and generally a low cost one given through the school. That is changing. As the Journal pointed out yesterday, the credit crunch, "now extends to students in Michigan, and it could soon hit many other borrowers, ranging from California museums to the prestigious Deerfield Academy prep school in Massachusetts." Given the complexity in types of loans, it’s no surprise that the way student loan providers both public and private raise money is complex; the takeaway though is that many are now struggling to raise the debt needed to offer loans to students, and even when they can find buyers for these securities, the portfolio of loans they will buy has shrunk – buyers if at all want higher returns and a safer pool of student borrowers. All of which means that fewer students will qualify, and it will cost them more in terms of higher rates.
This isn’t the first set of issues to hit student lending; if anything it seems more like icing on the cake for an incredibly important, once super profitable, and now much battered industry. The first disruption paralleled the housing market. With rates at historic lows, people with student loans found themselves doing what homeowners did, refinancing them. The spread between their existing rate and the new rate meant that, like housing, those who facilitated student loan consolidation could both lower the overall payment to the student and make a profit. As rates steadily rose, that spread decreased and much like the refinance market today, the number of people who can save has decreased and the amount of profit has as well, resulting in fewer people buying leads and for less per lead. Last year the news came out that student loan companies had made deals with college loan offices to have their products more favorably promoted to students, prompting an investigation by the new Spitzer, Andrew Cuomo, and ultimately a settlement where those kickbacks went back to the students. As though it weren’t tough enough, later in the year, congress passed the College Cost Reduction Act (CCRA), which according to house.gov, "will provide the single largest increase in college aid since the GI bill. And it will do so at no new cost to taxpayers, by cutting excess subsidies paid by the federal government to lenders in the student loan industry." And, it’s those two words,"excess subsidies", that changed the landscape of the student loan lead gen industry.
Private companies used to make money servicing these government backed loans, i.e. the fees, and they’d use these fees to market for student and differentiate themselves from other lenders, such as providing good customer service. They can still make these loans; they just can’t make money. And this is huge because these loans are the government backed loans, the ones that every student turns to first. Take that away from your mix, and you’re left with a still large market – the loans students take to cover the gap between the government loans and the real cost of school – but it’s a fraction of the overall, and as we’ve mentioned above, one that is shrinking with the current credit crisis. This is an amazing story, and given that the major legislation change happened last year one we missed but becomes ever more poignant with added pressures of the economic client. If you had operated in the space, you would never have thought that your entire business could disappear in a double-whammy, but that’s the position in which many in the student loan lead generation have found themselves. Now is not the time for doom and gloom, but it illustrates clearly the value of understanding all factors that could influence your business and staying both abreast and prepared if they do happen.
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