7) a. Sallie Mae is a quasi-governmental agency that packages individual student

Question

7)

a. Sallie Mae is a quasi-governmental agency that packages individual student loans into pools of loans and sells shares of these to investors as “Sallie Mae bonds”.

i. What is this process called?

ii. How is it different for investors from a situation where investors could only buy and sell individual student loans?

iii. How do Sallie Mae’s actions affect the ability of students to get loans?

iv.The recession of 2008 was very severe. Many graduating students were not able to get jobs and had to default on their student loans.

1. Is it likely that investors will buy Sallie Mae bonds?

2. Is it likely that Sallie Mae bonds are now perceived to be riskier than before?

3. How will this affect the availability of student loans?

Explanation / Answer

i. What is this process called?

By pooling individual loans and selling shares of those pools as bonds, Sallie Maehas engaged insecuritization

ii. How is it different for investors from a situation where investors could only buy and sell individual student loans?

Because the likelihood that a default by one student isusually unrelated, or independent, from the likelihood of default by some otherstudent, buying a Sallie Mae bond provides greater diversification for an investorthan an individual student loan. It also provides liquidity because it can be boughtand sold like a typical bond

iii. How do Sallie Mae’s actions affect the ability of students to get loans?

With Sallie Mae bonds, investors will be more willing to supply funds for studentscompared to a situation in which only individual loans were available. As a result,students should be able to receive more loans at a lower interest rate

iv.The recession of 2008 was very severe. Many graduating students were not able to get jobs and had to default on their student loans.

Widespread defaults by students will result in losses for investors who hold SallieMae bonds. Investors will come to believe that due to the recession that the likeli-hood of defaults among students are no longer unrelated events and so are riskierthan they expected.As a result, there will be fewer investors willing to buy SallieMae bonds at any given interest rate. Students will find it harder to get loans andwill have to pay a higher interest rate on those they do get.

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