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Exit of College Lenders Sets Off Scramble To Fill Breach

Then a second critical source of funds collapsed. Many student lenders receive funding through auction-rate securities -- variable-rate bonds that are put up for bid as often as once a week to determine their interest rate. Normally, the bidding process produces a lower rate than that of traditional bonds. But over the past few months, as the credit crisis spread across the financial system, bidders have been unwilling to buy these bonds except at high rates.

Now, only student lenders with large cash reserves, such as banks, may be able to survive. "We have an impending crisis in terms of loan availability," Kantrowitz said.

At least one firm, the Education Resources Institute, has filed for Chapter 11 bankruptcy protection. Revenue for the firm, which provided insurance for private loans, evaporated when these loans could no longer be securitized, said Willis J. Hulings, the company's chief executive. Meantime, the firm also had to cover increasing defaults.

Federal officials said that most students will still be able to get federally guaranteed loans. In addition, a few major lenders, including J.P. Morgan Chase, said they plan to expand their lending business in an effort to take a larger market share.

Spellings said that her staff is try to ensure that federal loans will be available to students this fall. She plans to meet tomorrow with about 30 designated lenders to provide guidance on the department's emergency lending program. Late last month, she huddled with senior Treasury officials to make sure the initiative would have enough funds.

"We are all aware that there are serious issues in the economy and credit markets that have implications in the marketplace, in car loans and student loans," she said. "Obviously as the secretary of education, I'm most concerned about kids going to school this year."

If firms continue to get out of the lending business, the federal government could expand the number of loans it provides to students, Spellings said. In addition to federally backed and private loans, there is currently $12 billion worth of direct loans that the government makes to students through their schools. Spellings added that the government is prepared to do more.

She said many families are confused by the complexity of student lending and overlook lower-rate federally guaranteed loans. She said she hoped the mounting attention to this troubled lending sector would lead to improvements.

"Families should have concerns about big tuition increases, year over year, and our broken financing system," she said. "It's as if we are trying to keep kids out of college."

The bills in Congress seek to address these issues by increasing the amount of grants available to the poor and raising the cap on how large a federal loan students can take out. Federally backed loans now cover 25 percent of the cost of higher education, Spellings said.

Some education advocates said the congressional proposals needlessly alarm students.

"The congressional action and the media coverage on this issue is doing a massive disservice to students and families, many of whom are concerned about paying for college already," said Luke Swarthout, higher education advocate for the U.S. Public Interest Research Group. "We know many of them are adverse to debt, and for lenders to be sending out a message of crisis in order to secure themselves a bailout potentially could dissuade families from seeking available financing options."

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