Student debt could hobble the economy
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?