Student Loans and the Financial Crises

Posted: Nov 30, 2017 12:01 AM
Student Loans and the Financial Crises

Growth of Student Loans has Similar Symptoms to the Sub-Prime Mortgage Crisis

There are eerie echoes of the subprime mortgage crisis being seen today in the growth of student loan debt in the U.S. Much like subprime mortgages, student loan debt has exploded over the past decade, is being issued to unqualified candidates, and is now the largest it has ever been – and the market is growing faster than ever. Today, there is a combination of federal and private loans available for students and they are being sold and traded much like mortgages were in 2008. Obtaining a student loan is easier than ever and the risk associated with the space is growing larger. The trend of rising college tuitions combined with ease of obtaining student loans indicates a future where recent graduates are saddled with enormous debt, which will lead to reduced consumer spending and overall slower growth of the U.S. economy.

The Growth of the Student Loan Bubble

Over the past decade, student loan debt has increased by 170 percent to $1.4 trillion. This growth is faster than car loans or credit card debt and has eerie similarities with the mortgage market before it blew up. Within America, the entirety of the student loan debt burden is shouldered by 44 million people, of which eight million of these borrowers are in default, effectively a default rate of 18 percent. This is a huge default rate; it’s higher than default levels on mortgages before 2008, credit cards, and car loans. What’s even more concerning is that new loans are being issued every day while the cost of education is rising and job prospects are diminishing. Recent graduates are having more difficulty than ever when it comes to finding jobs to pay off their debt, all of which paints a grim painting for the future. If today’s trend continues, the future will see a huge increase in the percentage of graduates that are unable to pay off their debt and need to default on their loan.

The Economic Implications of Student Debt

In the event that the student loan space manages to trudge along, the forecast is still not good for economic growth in the U.S. Seventy percent of the country’s growth is driven by consumer spending – most of which are costs and purchases associated with owning a home, such as buying furniture, home improvements, and house repairs. However, the new generation of young professionals is poorer than any generation to come before them, meaning that their first big purchase of a home is going to be greatly delayed. Already, the housing market is getting squeezed by the fact that millennials are less inclined to purchase homes due to financial restrictions and are much more comfortable renting for longer periods of time. The fact that homebuying is being delayed also means that consumer spending is going to be much lower for the first few years of a recent graduate’s life – and the consumer spending slowdown will have a ripple effect in the U.S. economy since consumer spending drives the vast majority of growth in the economy. In other words, growing student debt will only slowly slow down the U.S. economy as a whole as time progresses.

The Dangerous Lack of Oversight in Student Loans

The student loan space used to be tightly managed and scrutinized. Historically, over 80 percent of student loans were made and managed by banks and other private student lenders and have been under the microscope of regulatory oversight. However, after the 2008 financial crisis, there was concern that banks and private lenders could go bankrupt, which would make financial aid to students impossible to come by. Thus, the U.S. government shifted the responsibility entirely to the Department of Education through its Direct Loan program. While the intentions were noble, the implementation of the initiative was poor – the Department of Education is propped up by a number of private non-bank companies that are exempt from oversight that nearly all other financial institutions have to comply with. By making this change, the government inadvertently allowed student loan servicers to operate outside of the oversight that the rest of the financial world follows. This means that student loans can be handed out to candidates who have extremely high chances of defaulting and have no real commitments to higher education and nobody would know until it was too late – much like how mortgages were issued to nearly anybody during the subprime mortgage crisis. The similarities are chilling.

Government Action needs to be Federal and Immediate

The U.S. government has already begun to take steps to address this issue, but the pace of change has been too slow. Individual states such as California have recognized that the student loan space has been operating outside of regulatory oversight for too long and has been taking advantage of the fact. There has been an initiative to introduce oversight back into the space and to bring transparency back into the space. However, it’s important that this change happens at a federal level instead of the state level – the change needs to happen soon or else the bubble will be too large to contain. In addition, more information needs to reach students and graduates so that they can construct a more advantageous payment plan. Many post-college students have declared bankruptcy not out of their inability to pay, but rather because their payment plan was far too high and aggressive. A combination of better financial planning and more regulatory oversight over student loans is a first step towards managing the runaway train known as student loans.