Undergrad and graduate students may soon be feeling the pinch of the subprime mortgage default-induced credit crunch.

Securities tied to student loans have failed to generate investors' interest, leaving roughly $3 billion in a sort of limbo, The Wall Street Journal reported Tuesday (subscription required).

Typically, the banks involved in the deal -- in this case Goldman Sachs (NYSE: GS), J. P. Morgan Chase (NYSE: JPM) and Citigroup (NYSE: C) -- would step in to buy the securities when demand is weak. However, because the major banks are already flush with loans and bonds they're trying to get rid of, they have been allowing the auctions to fail, The Journal reported.

Student loan manager Sallie Mae (NYSE: SLM) fell 42 cents to $19.73 on the news in Tuesday morning trading.

Bond demand is weak

The auction process is similar to those held for municipal bonds, corporate debt and other debt securities. However, Wall Street is not obligated to step in and buy student loan-backed securities when demand is weak.

Economist Steve Affinito told BloggingStocks Tuesday that the failed auction demonstrates two current economic realities.

"First, debt aversion is increasing. It seems the U.S. market, and much of the global market, has gone from a state of total disregard for the risks implied by debt to a condition where very few players want any debt, any debt that's below high-quality, that is," Affinito said. "The failure of student loan bond auctions is troubling, to say the least. In theory, this is relatively high-quality debt, so it should be insulated somewhat from the mortgage bond problem. But it's clear the risk fall-out is spilling over to affect even distant bonds."

"Second, it means student loan interest rates are likely to increase because issuers like Sallie Mae will have to increase the interest rate they pay on these bonds issued to attract investors. It's just another unfortunate, sad consequence of the subprime mortgage default problem," Affinito said.

Costlier student loans

The auction portion of the student loan-backed securities market is about $90-95 billion, Affinito said, but he could not estimate the exactly impact higher bonds rates would have on student loan interest rates.

"That depends on a variety of interest factors, but use this as a rule: if issuers' interest rates go up about 100 basis points [one percentage point], students can expect a student loan interest rate increase of roughly that size, more or less," he said.