The New “Century Bond?”: Student Loan Maturities Stretched To 100 Years To Avoid Default

The New “Century Bond?”: Student Loan Maturities Stretched To 100 Years To Avoid Default

Does this sound familiar?

Ratings agencies colluding with issuers and bondholders to ensure that bonds that are almost certainly headed for default can maintain their investment-grade credit ratings and avoid rocking the boat of the US financial system.

If it sounds like the run up to the housing market collapse, well, you’re not wrong. But in this scenario, we’re talking about an entirely different kind of ‘safe’ debt: federally-backed student loans.

You see, back in 2009, Congress adopted a program of income-based repayment for some federally-backed student loans. This allowed borrowers like Julie Chinnock, a 50-year-old woman who owes roughly $250,000 in loans for two bachelors, masters and doctorate degrees, to limit their monthly payments.

This created a problem for certain lenders in a relatively small sliver of the student-debt market: loans that have been bundled into securities and sold off to investors. Investors once prized these loans since they offered higher yields than more-risky products backed by credit-card payments.

The new repayment laws created a problem for the issuers: Since borrowers would now take longer to pay back their loans, some of the debt securities backed by these loans were put on course for an all-but-certain default. Even though the loans are backed by the federal government, meaning that, in the event of a default, lenders should be made whole, the big ratings agencies would still consider it a technical default, and lower their credit ratings on the bonds to reflect this.

When bonds are downgraded, bondholders often end up with losses – at least on paper. Unless they’re planning to hold the bonds until maturity, downgrades often mean losses, especially when the bonds are held by funds with strict rules around what credit ratings they can and cannot hold.