Student debt could hobble the economy

May 15, 2012

Are student loans the new subprime mortgages? Among professional skeptics, the comparison has become something of a cliché, and in last weekend’s front page story, entitled “A Generation Hobbled by College Debt,” the New York Times invoked it in recounting the nightmare that student loans are becoming for so many. At the same time, others have pointed out important differences between the two kinds of debt. But history never repeats itself exactly – and there are reasons to fear that the growing mountain of student debt could have every bit as profound an impact on our economy as the housing bubble did.

Start with the structure of the student loan market. Of the roughly $1 trillion in student debt outstanding, according to a recent estimate by the Consumer Financial Protection Bureau, $848 billion consists of federal student loans, like Stafford, PLUS and Perkins loans – meaning they are explicitly backed by the U.S. government, aka taxpayers. The rest are so-called private loans, meaning they’re made by private lenders without government backing; students usually turn to these more expensive loans when they’ve exhausted other alternatives, just as homebuyers turned to subprime mortgages when they couldn’t qualify for more conventional loans .

The involvement of the government in student lending is both important and scary, because the government backing removes a level of discipline. It’s doubtful that private lenders who had to evaluate and bear the credit risk of students would extend this much money. Of course, that was also true in the housing market, where the presumed (and, as it turned out, actual) government backstop of Fannie Mae and Freddie Mac allowed debt to proliferate.

Right now, that roughly $1 trillion in student loans outstanding is paltry compared with the amount of mortgage debt outstanding at the peak of the bubble, which was about $10 trillion. Indeed, at the peak, there were about $2.5 trillion in securities backed by subprime mortgages alone, says Barron’s. And while student loans outstanding have grown rapidly – debt is up ninefold from 1997, according to the College Board’s 2011 “Trends in College Pricing” – that too is small compared with the torrid growth in subprime lending before the collapse.

But taking solace in the face value of the numbers is probably a mistake, just as it was a mistake to look at the size of the subprime market and say the problem was “contained.” (Hello, Ben Bernanke and Hank Paulson!) For one thing, just because the student loan bubble is smaller doesn’t mean there isn’t a bubble. While some of the increase in the overall level of debt has happened because more people are going to college, tuition is growing far more rapidly than inflation or even healthcare spending; in fact, according to Barron’s, tuition and fees at four-year schools grew by 300 percent from 1990 through 2011. Over the same period, broad inflation increased just 75 percent and healthcare costs rose 150 percent. Perhaps more important, education inflation has also exceeded wage growth for decades. Former U.S. Secretary of Education Bill Bennett says that tuition has increased 400 percent in the last 20 years. So by definition, an education is becoming less and less affordable – just as homeownership became less and less affordable as that bubble reached its apex.

Nor does the amount of outstanding debt simply grow as more students attend college. The amount also increases when those who have left school can’t pay, and the balance can mushroom as the interest compounds. Have you read the horror stories about students who graduate with $70,000 in debt that turns into $200,000? Indeed, student loans are sort of like option ARM mortgages, where the amount of the mortgage grew if the borrower chose to pay less interest than was due. And if Congress doesn’t keep the interest rates on federal student loans from doubling on July 1, as they’re supposed to do, the numbers are going to get worse. (Although there’s another way to look at this, which is that allowing interest rates to rise will help prick the bubble before it gets even bigger, just as allowing interest rates to rise in, say, 2004 would have caused pain, but also would have pricked the mortgage bubble.)

Default rates on student loans are both high and hard to measure: According to a recent report by the Federal Reserve, about 10 percent of outstanding loans are past due. But the Times noted that when you include borrowers who are still in school or who have otherwise postponed their payments, just 38 percent of the balance of federal student loans is currently being repaid, down from 46 percent five years ago. Optimists cite a whole host of reasons as to why defaults on student debt aren’t as dangerous for the financial system as defaults on mortgages. Because student loan debt isn’t dischargeable in bankruptcy, historically, people have been unwilling to walk away from it. Indeed, the government eventually collects about 85 cents on every dollar. The average amount of student debt – $23,200, according to the Times – is much smaller than the average mortgage. And while student loans are turned into securities, just as mortgages were, Wall Street hasn’t, so far, created the crazy add-on debt instruments that made the mortgage defaults ricochet through the financial system. (Hello, AIG.) As far as I know, no one is selling credit default swaps tied to student loan debt – at least not yet!

But this time around, it may not be defaults that are the problem. Student debt will reverberate not through the financial system, but rather through the real economy, even if the amount of money that’s lost isn’t enormous in dollar terms. “Hobbled” is the word the New York Times used, and it’s more than apropos: It will hobble not just students, but our entire economy. In an ironic twist, student debt may prevent the revitalization of the housing market, upon which so much of our economic health rests. In his most recent annual report, Warren Buffett said he was bullish on housing because of hormones: As young people form families, they buy homes. But what does it mean for the housing market, especially as baby boomers look to sell their homes, if there’s less demand because the money that might have gone toward downpayments is instead going to student loan payments?

Nor is student debt just a problem for the young. The Washington Post recently cited research from the Fed showing that Americans who are 60 and older still owe about $36 billion in student loans. Many of these people have co-signed for loans with their children or grandchildren to help them afford the tuition. What will it do to our economy if people can’t afford to retire, especially given the strains on Social Security and Medicare? And there are side effects of too much debt that are hard to measure. As someone recently said to me: “Debt is a negative mindset versus a hopeful one.” Will the student with tens of thousands of dollars in debt be as willing or able to take a flyer on her entrepreneurial dream? We’ll never know what the value was of the business that wasn’t started.

There’s also a predatory aspect to today’s boom in student loans that is eerily reminiscent of subprime loans. Attorneys general – who also tried to be vigilant about subprime abuses – from more than 20 states have joined together to investigate for-profit colleges, which account for nearly half of student loan defaults, even though less than 10 percent of higher education students go there, according to the New York Times. The stories are horrifying, just as the stories about abusive mortgage lending were horrifying.

But as bad as the instances of blatant predation are, there’s an even larger, darker context. Students, and their families, are overextending themselves because they’ve been told that an education is the path to a better life, just as many people bought homes at the height of the bubble because they were told that homeownership was the key to a better future. But if education isn’t worth the cost – if people can’t get jobs that enable them to pay back their debt – then they’re being sold another lie. I often think that the worst carnage of the financial crisis wasn’t financial, but rather psychological. People were encouraged to pay for something that turned out to be worthless, and as a result, there’s been a societal breakdown in trust. Will we eventually conclude that the education market was as screwed up as the mortgage market, but only after it’s too late?


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Is educating America too big to fail?

Posted by Butch_from_PA | Report as abusive

What happened to the push to not lend to students attending private colleges with high tuition in fields they couldn’t hope to recoup their money in? Some of the for profit ‘art institutes’ are outrageously expensive and show horrible returns for the students for instance. There are reasonable ways to get a degree in nearly any field from doing a 2 year stint at a community college close to home to working hard and earning scholarships or going to a military academy or getting an ROTC scholarship. With extremely poor reporting from colleges on the actual job situation their graduates have, students can be lured into expensive schools studying topics they have little hope getting a job in and lots of debt.

Posted by oneofthecrowd | Report as abusive

Debt slavery is a very important feature in our economy, right under petroleum. Facilitating, ensuring, and then afterwards reaping the returns from consumer loans is part and parcel to keep Americans forever in financial debt.

University salaries, especially at the top, have also accelerated this process.

And like the Real Estate Bubble, I am opposed to any forgiveness of this type of debt. As unscrupulous as loan originators may be, if you took out a student loan, it’s your moral obligation to pay it off. Just like a credit card.

Posted by krimsonpage | Report as abusive

Thank you, krimsonpage, for your first two paragraphs, which make sense. Permit me, if you will, with a less agreeeable comment on your third paragraph because I hear it a lot and I’ll tell you why I disagree with your assessment. Bottom line, I think that your assessment is misguided and incorrect and consistent with “old school” (meaning like my grandfather and older’s generations) simpleton logic and not modern thinking and reality.

Moral obligation is generally a good concept both to my grandfather’s and our current generations; however, modern financial services marketing has de-coupled moral obligation from financial loan re-payment obligation. I say this because it is now clear that the bankers used fraud to get people to commit to these obligations. Obligation, if fraudulently obtained, is not obliged, and should be discharged (in your words, “forgiven”). Bankruptcy, which is a constitutional right, has recently (2005) been gutted with BAPCPA and this needs to change in order to return to “morally obligable” re-payment obligation. One (especially bankers) might say “prove the fraud” if it was there but in courts this has proven to be almost impossible, although anyone on the streets knows this to be the case. If this country is going to get back on its feet, we must repeal BAPCPA and return the ability of the citizen to have student debt and home mortgage debt discharged. Word.

Posted by joelrain | Report as abusive

Morale obligation no longer exists. Corporate America has weaned the new breed of Americans and taught everyone it’s all just business decisions.

In Corporate America morality is only used for marketing events (green, corporate citizen and all that).

Bankruptcy and restructure laws were created to protect corporations so they can easily exit and resurface debt free.

Since corporations are considered people – same thing applies to people – who can run their finances like a corporation.

When the debt load gets too unbearable – purge debt via going bankrupt. It’s the American way.

Posted by Butch_from_PA | Report as abusive

@krimsonpage says “it’s your moral obligation to pay it off”
Ummmm…no…not at all.
Not even a little bit.
It’s your moral obligation to follow the law and abide by your contracts, sure.
If you have a non-recourse loan, then it’s in your contract in black and white that you can walk away from that debt as long as you give up the collateral the contract secured. You and your debtor BOTH signed that contract.
If you live in a nation with bankruptcy laws that allow an insolvent individual to declare bankruptcy and have their remaining property liquidated to escape unmanageable debt, then this is a legal option written into the constitution, and hardly immoral.

Posted by RandomName2nd | Report as abusive

Statistically you will make more money with a college education than without (not sure if that equates to “a path to a better life”). But your mileage may vary widely; we do a lousy job of applying statistics to our individual circumstances. Field of study, college attended, intrinsic motivation, and just plain luck all play a part.

Posted by Curmudgeon | Report as abusive

Nice article.

Just one issue, when you state:

“Because student loan debt isn’t dischargeable in bankruptcy, historically, people have been unwilling to walk away from it.”

The truth is that only 3% of federal student loans were not being repaid before they were made non-dischargeable in 1976. So, while your theory explaining why people don’t walk away from college debt appeals to the moralistic depiction of people as amoral(like-a-corporation), it cannot be proven; and insofar as history is concerned, it is largely false.

Interesting to note that it was since about the same years that the cost of college tuition grew 400 fold in 40 years. It could be said that it was just such change that allowed colleges to inflate their costs.

Posted by pmagellan | Report as abusive

Students should not have to borrow money to study. Where is you public education.

Its a disgrace that a rich country such as the US cannot provide its people with education.

Posted by stathis | Report as abusive

The alarming increase of the total outstanding student loan not only adds more burden to the federal debts but also indicates a waste of manpower that otherwise could have joined the labor force producing wealths. Now we have millions of “educated” youths who are only want to work as paper pushers.

Posted by jlpeng | Report as abusive

Congress should change the law to allow Federal students loans to be discharge in bankruptcy court. Right now, the law is that these debts can’t be discharge unless there are extreme circumstance that rarely are the case.

To offset the loss to the lenders whose contract rights would be taken away with a law change, Congress should set up a fund to cover the losses. Part of the funding could come from lenders or even schools that may have deceptively given the loans. It is a bad law that Congress should fix.

While people morally should pay off their debts, bankruptcy laws exists for circumstance when things go wrong. It will be harder for those who choose bankruptcy to borrow again. However, it will allow people to have a new start and perhaps pump up the economy.

I also don’t think that there will be a huge rush to file bankruptcy for professions. Most professions (e.g. lawyers) have morality requirements that include bankruptcy.

Posted by sittingduck | Report as abusive

This is one of the costs of offshore outsourcing.

The remedy would be simple.

Posted by robb1 | Report as abusive

“Are student loans are the new subprime mortgages?” Is this an example of a sentence anyone should take out a loan to learn how to write?

I am under 60 and put myself through college and grad school. I had an academic scholarship for tuition, but my living expenses were all my own as my family had nothing. It is called working and not expecting someone else to pick up the tab for you. When I was not a railroad track crew worker, a janitor, a desk clerk in a hotel I was an associate instructor during my grad school year. What infuriated me then and now were the “entitled” students who would take their loans and backpack to Europe for the summer.

Nothing happens unless parents take it seriously and students are motivated. Community colleges and specialty schools at lower costs are superb ideas. It is the responsibility of the student to formulate a goal and achieve it. If this means working while going to school I find that to be not just completely acceptable, but preferable. The janitor, who recently graduated from Columbia taking 12 years to do so, happily cleaned the toilets for the fortunate students. Who do you think has the best work ethic?

Posted by RGanshorn | Report as abusive

Oh Bethany, the extra ‘are’ in “Are student loans are the new subprime mortgages” ruined the opening line. You did make up for it in the excellent conclusion, though. Haven’t seen a piece by you since the appearance on the ‘Daily Show’, keep up the insightful work!

Posted by ShakaZulu84 | Report as abusive

Maybe the government shouldn’t be facilitating loans to people who really shouldn’t be going to college? Do people delivering the mail or driving trucks need college degrees? The notion that they do has been pushed on them by the government (and the colleges) but the reality is that what they mostly end up with is a lot of debt, and four years (or more) of time spent not earning an income. Having a college degree doesn’t make you a better person, and the push to make everyone a “college graduate” is very expensive and mistaken public policy.

Posted by USA4 | Report as abusive

All that is needed is to forget any moral context and create laws that can go along with an anything goes mentality – as long as it’s legal it’s o.k.. Go along to get along is the way to a happy society I say. This will solve all problems because they can be rationalized away as long as a constituency is large enough to pass a law. Any inconvenience imposed on individuals can be rationalized and removed with a law. Dictatorial countries are run this way – make a law and all is well -at least for those in power and without a conscience. Want to create an immature, pathetic, and sick society – then forget about human morals.

Posted by keebo | Report as abusive

Student loan debt is NOT the problem.

The problem IS a lack of jobs.

Address the issue of “exported/imported” jobs of all kinds in the US, and you automatically solve the problem of student loans — including the issue of housing, which is also a problem of lack of adequate jobs for US workers, which translates into diminishing demand and rising debt across the board in the economy.

Your article also contains many inaccuracies. For example, “Because student loan debt isn’t dischargeable in bankruptcy, historically, people have been unwilling to walk away from it.”

The truth is that student loans not being dischargeable in bankruptcy is a relatively recent ruling by Congress to protect the banks who, like subprime mortgages, have been using yet another class of vulnerable people (remember the infamous NINJA loans for home mortgages?) as a means to bleed our economy for their own enrichment.

It is the banks, through their lobbying efforts with Congress, who have managed to carve out for themselves a position even the Mafia would envy in terms of debt collection.

You also fail to mention that not all student loans are “created equal”, with many student loans to students in “for profit” schools that are hardly anything more than a massive scam to defraud both the students themselves and the US taxpayer who gets stuck with the loan.

At a minimum your data should include an explanation of this fact and the reasons for it, instead of using averages which mislead the reader.

For many decades, student loans were once of a great benefit to those students (like myself) with a hunger for education and a desire to succeed, but unfortunately born poor and otherwise unable to afford college — remember the “American Dream”, which has now turned into the “American Nightmare” mainly due to wealthy greed at the American taxpayer expense? — but like the rest of the US economy for the past 30+ years has been misused by the wealthy class for their benefit.

Hence, we return to the SINGLE underlying issue of JOBS and the associated free trade legislation that are designed to benefit only the wealthy class, which is the real reason why this country is in financial difficulty.

Before writing an article like this, I suggest you do some serious research on the real nature of the problem, instead of resorting to whining and hand-wringing about student loans problems that you clearly don’t understand.


Posted by PseudoTurtle | Report as abusive

The root problem is that education today costs more than it’s producing in economic terms, and it’s too-easy availability is causing “degree-inflation”. For example, when I was young it didn’t take a college degree to become either a factory foreman or a fast food manager. The jobs haven’t changed a bit, but today a degree is necessary in both fields. Real-world experience leads me to believe that the college grads aren’t doing a noticeably better job in these roles than the high-school grads of yesteryear. Therefore, in dollars-and-cents terms society has invested four extra years of education for these individuals– and in addition robbed itself of the economic productivity of the four best, healthiest years of their lives– in return for nothing at all.

Posted by Lapine_Rider | Report as abusive

Just like the housing crisis the existence of goverment backed financing has helped “bid” up a college education. Colleges can add staff, amenities, pay high salaries and pass it all along to parents and working students. The market place has been distorted. As Ms. McLean mentioned, the cost of college has gone up twice as fast as medical care. Why? What is driving these cost increases – salaries?, Energy?, what -exactly. It appears that higher-ed has created a bit of an entitlement mindset for itself. Even though these are non-profit, does not prohibit an institute to pay administrator $500,000 salaries or more. It is time we examine what is really being delivered. Another factor is limited access to the “best” schools. Let’s face it with thousand of applicants for every freshmen spot, many institution have taken the opportunity to just plain over-charge.

Posted by RockyCPA | Report as abusive