Tag Archives: student loans

Student Loans: The Next Financial Crisis? (Revised)

As I have been browsing the news the last couple of days, an article on the WSJ got me really thinking about student loan debt and the uncanny parallels shared with housing debt in the mid 2000’s. To preface, mortgage standards in the US were lowered in the early 2000’s in a push by the Clinton Administration to get people into houses. Loans that were issued by banks were sold to entities like Fanny & Freddy and then bundled into securities that were bought up and sold by different banks and hedgefunds around the US. Obviously we all know how this ended, but the issue as I see it, was two fold on the banking side of things. The first issue was the relaxed standards set by Washington for loans to be given out and the second issue was the moral hazard represented by the banks writing the loans because they could turn around and sell them just as fast as they could write them.

Almost 6 years now after all of the events of the financial crisis happened, I see a striking parallel between another type of debt and mortgages: Student loans. One of the bigger facets of Mr. Obama’s presidency has been the lowering of the barriers of entry for people to goto college. In 2011 the president enacted a program in which students can attend college and then pay after the fact as they earn at whatever jobs they may find– this program is aptly titled, “Pay As You Earn”. Under this plan, you would attend college at the cost of the government, and then 10% of your total discretionary income per year after school would be taken as repayment for the loans. If you find a job in the private sector after school then you pay for 20 years and then the remaining balance is forgiven, 10 years if you work in the public sector. (Student Aid Website)

Unsurprising to any market failure monitoring economist though, this plan is backfiring, even despite noble intentions. In an article from the WSJ we see that the plans have expanded to over 1.3 million people (originally less than a million before changes to debt forgiveness were enacted) and total debt balances rising to $72 billion from $52 billion before the easing in forgiveness measures were enacted. A moral hazard exists here between the tax payer and the schools who are now incentivized to raise their tuition prices and pay for more of the students bills because the government will pay them back regardless after 20 years and as everyone attending this great University of Michigan knows; tuition has been rising.

So the first ingredient in a recipe for financial crisis obviously being bad debt, the time must have seemed perfect for a dash of bundling; the bundling of asset backed securities. In another WSJ article, we see SLM Corp who happens to be the largest student lender in the US selling over a billion dollars worth of student loan backed securities (SLBS). The interesting part about this and other SLBS sales is that the majority of the demand for the offerings is for the riskiest parts (the most likely to default) of the securities. Why this appetite for risk? Low interest rates may be the answer. Thinking back to the early-mid 2000’s there was a refusal by Alan Greenspan to raise interest rates and people were hungry for yield; the mortgage backed securities promised a rate of return higher than what anyone could find in the bond market and was still rated AAA to top things off. Many believe that the mix of moral hazard and systemic risk present in the banking structure combined with the low rate environments was the catalyst for the financial bubble to blow up and eventually burst. These student loan offerings show that investors are indeed searching for yield wherever they can today.

With default rates on these loans continuing to rise, the government needs to act now to reform this pay as you go expansion for the student loan program. The best solution I think would be to work with colleges to lower tuition rates and quit forgiving the debt that these students take on. Because as long as people can have something for nothing, or rather, a college education at the expense of the US Taxpayer, they will continue to do just that until we are in the midst of another massive asset bubble.

Student Debt the Next Balloon to Pop In US?

As I have been browsing the news the last couple of days, an article on the WSJ got me really thinking about student loan debt and the uncanny parallels shared with housing debt in the mid 2000’s. To preface, mortgage standards in the US were lowered in the early 2000’s in a push by the Clinton Administration to get people into houses. Loans that were issued by banks were sold to entities like Fanny & Freddy and then bundled into securities that were bought up and sold by different banks and hedgefunds around the US. Obviously we all know how this ended, but the issue as I see it, was two fold on the banking side of things. The first issue was the relaxed standards set by Washington for loans to be given out and the second issue was the moral hazard represented by the banks writing the loans because they could turn around and sell them just as fast as they could write them.

Almost 6 years now after all of the events of the financial crisis happened, I see a striking parallel between another type of debt and mortgages: Student loans. One of the bigger facets of Mr. Obama’s presidency has been the lowering of the barriers of entry for people to goto college. In 2011 the president enacted a program in which students can attend college and then pay after the fact as they earn at whatever jobs they may find– this program is aptly titled, “Pay As You Earn”. Under this plan, you would attend college at the cost of the government, and then 10% of your total discretionary income per year after school would be taken as repayment for the loans. If you find a job in the private sector after school then you pay for 20 years and then the remaining balance is forgiven, 10 years if you work in the public sector. (Student Aid Website)

Unsurprising to any market failure monitoring economist though, this plan is backfiring, even despite noble intentions. In an article from the WSJ we see that the plans have expanded to over 1.3 million people (originally less than a million before changes to debt forgiveness were enacted) and total debt balances rising to $72 billion from $52 billion before the easing in forgiveness measures were enacted. A moral hazard exists here between the tax payer and the schools who are now incentivized to raise their tuition prices and pay for more of the students bills because the government will pay them back regardless after 20 years and as everyone attending this great University of Michigan knows; tuition has been rising.

Students are obviously carrying more debt now with this plan and the next question is what will happen to default rates now that there exists an economic incentive to not pay these loans back because the tax payer obviously will. The parallel between this easing in debt rules and mortgages while different in the total amount of money being given away is different than that of houses, still sets a bad precedent for us in a post 2008 economy.

(Revised) Rising Grad School Debt

Much of student-loan debt has recently been driven disproportionately by grad students. In what is now not the strongest economy, it is growing harder and harder to resolve these debt burdens. The typical debt load of a student leaving master’s, medical, or doctoral programs jumped 43% between 2004 and 2012. The point at which half of borrowers owed more and the other half owed less (median) was $57,600 in 2012. These increases were higher for social sciences and humanities degrees compared to professional degrees such as MBAs or medical degrees, which yield greater long-term returns. For example, a master’s in education rose 66% to $50,879 and a master of arts rose 54% to $58,539 (see graph).

Screen Shot 2014-03-26 at 1.31.02 AM

Debt has generally been concentrated among a minority of students. “In the 2012-13 academic year, graduate students accounted for about 1 in 6 student-loan recipients but between 30% and 40% of student debt extended by the federal government”. Recently, the Obama administration has been taking steps to reduce student-debt and investigate the for-profit schools with exceptionally high rates of students defaulting on loans. There has been a strong correlation between high student debt and rising costs at for-profit and graduate schools. Featured in this article is a study by Jason Delisle. He comments, “”Graduate schools have essentially found a way to capture more of someone’s future income and future spending than what would probably occur if we had some sort of underwriting standards and loan limits.” If the amount of debt held by students at for-profit and graduate schools were excluded, the nation’s student debt situation wouldn’t seem so alarming.

A large factor of what is driving this debt is that many households lost savings and other assets during the recession- thus making it more likely for students to borrow. To make the situation worse, schools raised prices because of cuts in state aid. Also, a greater number of students are pursuing advanced degrees than in previous generations because of the pressure to adapt to the modern economy. In addition, there was a law in 2006 passed which removed the cap on how much graduate student may borrow from the federal government. Before the change, the cap (excluding med students) was $138,500. Now, students may borrow up to the “cost of attendance”.

I believe that the recent student-loan situation is a blessing and a curse. It is a blessing in that lifting caps on loans incentivizes undergraduates to pursue higher education. It is a curse in that the debt burden has been continually growing over time, even through the recent recession. However, there is an upside to the situation. Cited in the WSJ link- people with graduate degrees degrees default on their loans at lower rates than those with lower education. They are also more likely to earn higher salaries and are less likely to be unemployed. The incentive is definitely still there, but the reality worsens for the students who are not able to find a job after grad school.

In recent news, student-debt forgiveness plans have been becoming more and more popular. These are federal programs that forgive some student debt after making payments on the loan for a certain amount of time. However, these plans encourage colleges to push tuition even higher. Enrollment in these plans has surged nearly 40% in only 6 months, which has left about 1.3 million Americans owing around $72 billion. Although this aid opens the possibility of highly subsidized or even free graduate degrees, it is at the expense of the taxpayers. The plan enacted by President Obama requires borrower to pay 10% a year of discretionary income in monthly installments. After 10 years of payments, the balance for a worker in the public sector or a nonprofit is forgiven. Debt for those working in the private sector is forgiven after 20 years of payments. The aim of the program is to have no one paying on their student debt for their entire working life. Just recently, the Obama administration proposed to cap the debt forgiveness at $57,500 per student. As there is currently no limit on the debt, I believe this cap was put into place because the government is starting to realize that it is becoming more and more costly to maintain.

There are many drawbacks to the program. As we have learned throughout our economics classes- this brings up the issue of moral hazard. Promising to forgive these debts may incentivize borrowers and schools to become less disciplined about costs. Specifically, colleges will start to charge more and students will borrow more. I believe that the program is very well-intentioned, however I do not see it extending very far into the future without facing some major revisions. Under the current program, it is likely that schools will increase the cost of tuition, while forgiven debt to borrowers places a burden on taxpayers. I believe that a harmony in the program needs to be reached where students do not end up paying loans during their entire working life- while also there is no incentive for colleges to inflate costs. The program definitely needs to be capped because even though the debt is “forgiven”, these costs do not simply disappear into thin air. Graduate school professors still need to receive the correct amount of compensation for their services. So the cost itself still remains, but the taxpayers are the ones who actually see it. In sum, the program itself is very well-intentioned, but just needs to be refined.

Revised: How to Deflate the Education Bubble

In the last 15 years, outstanding student debt in the United States has grown from $240 billion to an astonishing $1.2 trillion, driven largely by rapidly accelerating tuition rates.  During the same time period, average wages have only grown a mere 10%, making student debt an increasingly uncomfortable topic.  In fact, JP Morgan deemed the student loan market so overladen with risk that in October of 2013, the firm stopped issuing any additional student loans.

Based on these signs, I agree with a recent Huffington Post article that relates the higher education bubble to the housing bubble America experienced in 2008.  The loose lending standards (low down payments), securitization of mortgages (MBS), and high levels of speculation (overwhelming belief that the housings values will continue to rise) that contributed to 2008 bubble burst all have parallels in the higher education market.  Many students pay no downpayment and have poor (if any) credit history.  Student loans are being packaged and resold as student loan asset backed securities (SLABS) to hedge lender risk.  And despite the 44% undermployment rate of young college graduates, most Americans continue to believe that a college education is an ideal (if not necessary) investment.  All these factors suggest another bubble is about to burst, and in an attempt to offer a partial solution, this post will focus on the speculation involved in the higher education market.

However before considering a solution, it is important to first understand the route cause of asset bubbles.  In A Random Walk Down Wall Street, Burton Malkiel makes the cause of asset bubbles very clear in his explanation of the tulip-bulb craze that plagued Holland in the early 1600s.  After the mosaic virus created striped tulips in the late 1500s, Dutch citizens desperately wanted the most unique tulips in their gardens, and they were willing to pay a handsome premium for them.  As more and more people bid up the price of tulip bulbs, more and more believed these bulbs were a smart investment.  Indeed, by the 1620’s people were selling their jewels, furniture, and even land to buy tulips!  Nevertheless, no bubble can grow forever, and in February 1637, Dutch public opinion changed.  The price of bulbs fell more than 20-fold that month, and despite the government’s best attempt to prevent a sell-off, the bulb bubble burst, leaving an abundance of disappointed and bankrupt investors.

The Tulip-Bulb craze perfectly illustrates the result of what Malkiel refers to as “Castle-in-the-Air” investment theory.  Under this theory, an investment’s value is based on public opinion, and decisions to buy and sell are based on random guesses about changes in public opinion.  When public opinion changes, bubbles can burst and investors can suffer huge losses.  In my opinion, the “Castle-in-the-Air” investment theory applies perfectly to college education (tuition costs are rising despite the fact that tuition benefits, ie: employment and wages, are falling).

I’d argue, and I think Malkiel would agree, that a switch in investment theory could reduce the risk of asset bubbles.  In addition to “Castle-in-the-Air” theory, Malkiel also explains  the “Firm-Foundation” theory, which is an investment strategy based on the intrinsic value of investments.  When the price of an investment is less than its intrinsic value, you should buy; when the price is more than intrinsic value, you should sell.  Because this form of investing is based on data and not public opinion, it is arguably less susceptible to speculative attack.  Indeed, Malkiel points out that firm-foundation investing is how Warren Buffet made his fortune.

It therefore seems that to reduce the risk of a student loan bubble, we need to switch investment in higher education from a “Castle-in-the-Air” model to a “Firm-Foundation” Model.  But how?  I believe the answer lies in a recent Wall Street Journal article.  In “Colleges Are Tested by Push to Prove Graduates’ Career Success,” author Melissa Korn points out a trend in prospective students requesting information on graduates’ salaries.  Given that college is an investment (that should generate a real return after an initial payment), this request seems extremely logical!  Why would anybody spend $200,000 on out-of-state tuition at UM without assurance (or at least data supporting) a sizable income stream after graduation?

If firms are required to release GAAP-audited financial statements to give prospective investors a prediction of future cash flows, I believe universities should have to do the same.  While there is currently significant push back from universities to release this data, I think that reporting graduate salaries based on school, major, GPA, etc. is an essential step in changing college education from a “Castle-in-the-Air” investment to a “Firm-Foundation” investment.  (The implications of this are consequential indeed, as it would likely force the cost of well-paying majors like business and engineering higher than the cost of low-paying majors like anthropology and agriculture.  That said, this is a consequence that is completely in line and appropriate given a “Firm-Foundation” investing environment, and it is one that I am comfortable with.).  Personally, I believe if we can successfully alter the way students choose to invest in college education (by reducing speculation), we can effectively reduce the risk involved in student loans and prevent student debt from repeating the Dutch Tulip Crisis and pushing America back into recession.

 

A Sharp Growth in Grad Students Debt

According to Wall Street Journal, the surge in student-loan debt in recent years has been caused by borrowing for graduate schools. Since the law in 2006 removed a limit on how much graduate students may borrow from the federal government, each graduate student’s loan could easily reach six figures because of the higher tuition, textbook, transportation and living expenses. While undergraduates still have a borrowing cap of about 57,500 dollars, one in four graduate student borrowers owed at least 99,614 dollars in 2012. There are several factors that could drive the surge in loans for graduate students.

First of all, more and more student decide to go to graduate schools to enhance their skillsets and better prepare for jobs. The lackluster performance of job markets providing much less positions for college students after financial crisis has been acting as a stimulus for they to work harder in order to be more competitive. A growing number of them would consider going to graduate schools. Even some current employees or those became unemployed during the crisis choose to go to graduate program and wait for better working opportunities. A large proportion of them also borrow money from federal government to finance themselves. With huge amount of loans policy makers are concerned about the potential defaults of these graduate students. The nation’s student debt would be a serious problem if we don’t consider those on for-profit and graduate schools. “If you factor those two thins out, things don’t look very bad,” said Mr. Delisle, a former Republican congressional aide.

Moreover, the cost of higher education is higher than before. The tuition and living expense at public university rose 5.4% on average. Many universities had a drastic increase in their tuitions.  For example, California State University San Marcos increased its cost by 31%, which created the highest record. The soar in the costs of higher education combined with the effect of a general decrease in family income made more students choose to borrow money for their further study in graduate schools.

The huge amount of loans also causes negative effects on graduate students. Since many students have a loan of about more than 100,000 dollars, it would be a big burden for them even after they land a job. The news also covers a story of John Berg who amassed more than 150,000 in student loans for his master degree and doctorate. Although he found a job with the Department of Veterans Affairs as a psychologist, he found 1,000 monthly payment is the biggest obstruction that prevents him from buying a house.

Therefore, we can see the surge in loans for graduate students was caused by the slow job growth and the increasing cost of higher education. It might cause a heavy burden on the borrowers, but in the short term more and more students would go to graduate schools in order to find a job after graduation.

Rising Grad School Debt

Much of student-loan debt has recently been driven disproportionately by grad students. In what is now not the strongest economy, it is growing harder and harder to resolve these debt burdens. The typical debt load of a student leaving master’s, medical, or doctoral programs jumped 43% between 2004 and 2012. The point at which half of borrowers owed more and the other half owed less (median) was $57,600 in 2012. These increases were higher for social sciences and humanities degrees compared to professional degrees such as MBAs or medical degrees, which yield greater long-term returns. For example, a master’s in education rose 66% to $50,879 and a master of arts rose 54% to $58,539 (see graph).

Screen Shot 2014-03-26 at 1.31.02 AM

Debt has generally been concentrated among a minority of students. “In the 2012-13 academic year, graduate students accounted for about 1 in 6 student-loan recipients but between 30% and 40% of student debt extended by the federal government”. Recently, the Obama administration has been taking steps to reduce student-debt and investigate the for-profit schools with exceptionally high rates of students defaulting on loans. There has been a strong correlation between high student debt and rising costs at for-profit and graduate schools. Featured in this article is a study by Jason Delisle. He comments, “”Graduate schools have essentially found a way to capture more of someone’s future income and future spending than what would probably occur if we had some sort of underwriting standards and loan limits.” If the amount of debt held by students at for-profit and graduate schools were excluded, the nation’s student debt situation wouldn’t seem so alarming.

A large factor of what is driving this debt is that many households lost savings and other assets during the recession- thus making it more likely for students to borrow. To make the situation worse, schools raised prices because of cuts in state aid. Also, a greater number of students are pursuing advanced degrees than in previous generations because of the pressure to adapt to the modern economy. In addition, there was a law in 2006 passed which removed the cap on how much graduate student may borrow from the federal government. Before the change, the cap (excluding med students) was $138,500. Now, students may borrow up to the “cost of attendance”.

I believe that the recent student-loan situation is a blessing and a curse. It is a blessing in that lifting caps on loans incentivizes undergraduates to pursue higher education. It is a curse in that the debt burden has been continually growing over time, even through the recent recession. However, there is an upside to the situation. Cited in the WSJ link- people with graduate degrees degrees default on their loans at lower rates than those with lower education. They are also more likely to earn higher salaries and are less likely to be unemployed. The incentive is definitely still there, but the reality worsens for the students who are not able to find a job after grad school.

How to Deflate the Education Bubble

In the last 10 years, outstanding student debt in the United States has grown from $240 billion to an astonishing $1.2 trillion today, driven in part by rapidly accelerating tuition rates.  At the same time, labor demand has stagnated, keeping many graduates from paying down this debt.  In fact, JP Morgan deemed the student loan market so overladen with risk that in October of 2013, the firm stopped issuing any additional student loans.  To me, the student loan market is eerily similar to the housing market before the Great Recession – there are too many bad investments and not enough good ones.  And as was the case in 2008, my fear is that the student loan market is about to crash.

Before examining a solution to the student loan issue, it is important for us to first understand the route cause of asset bubbles.  In A Random Walk Down Wall Street, Burton Malkiel makes the cause of asset bubbles very clear in his explanation of the tulip-bulb craze that plagued Holland in the early 1600s.  After the mosaic virus created “bizarres” (ie: striped tulips) in the late 1500s, Dutch citizens desperately wanted the most unique tulips in their gardens, and they were willing to pay a handsome premium for “bizarre” bulbs.  As more and more people started bidding up the price of  bulbs, hoping they would yield unique flowers, more and more people saw tulip bulbs as a smart investment.  Indeed, by the 1620’s people were selling their jewels, furniture, and even land to buy tulips!  Nevertheless, no bubble can grow forever, and in February 1637, Dutch public opinion changed.  The price of bulbs fell more than 20-fold that month, and despite the government’s best attempt to prevent a sell-off, the bulb bubble burst, leaving an abundance of disappointed and bankrupt investors (Part 1 – Section 3 – “The Tulip-Bulb Craze”)

The Tulip-Bulb craze perfectly illustrates the result of what Malkiel refers to as “Castle-in-the-Air” investment theory.  Under this theory, an investment’s value is based on public opinion, and decisions to buy and sell are based on random guesses about changes in public opinion.  When public opinion changes, bubbles can burst and investors can suffer huge losses.  In my opinion, the “Castle-in-the-Air” investment theory applies perfectly to college education; many people attend college because public opinion dictates it is the “smart” thing to do.  But as I point out in “Why College Graduates are Useless,” data does not confirm this opinion, as many students cannot find jobs, even after investing thousands of dollars in student loans and higher education.  It thus seems that it is simply a matter of time before the student loan market goes the way of Dutch tulips and crashes.

I’d argue, and I think Malkiel would agree, that a switch in investment theory could reduce the risk of asset bubbles.  In addition to “Castle-in-the-Air” theory, Malkiel also explains “Firm-Foundation” theory, which is an investment strategy based on the intrinsic value of one’s investments.  When the price of the investment is less than its intrinsic value, you should buy.  When price is more than intrinsic value, you should sell.  Because this form of investing is based on data and not public opinion, it is arguably less susceptible to speculative attack.  Indeed, Malkiel points out that firm-foundation investing is how Warren Buffet made his fortune.

It therefore seems that to deflate the risk of a student loan bubble, we need to switch investment in higher education from a “Castle-in-the-Air” model to a “Firm-Foundation” Model.  But how?  I believe the answer lies in a recent Wall Street Journal article.  In “Colleges Are Tested by Push to Prove Graduates’ Career Success,” author Melissa Korn points out a trend in prospective students requesting information on graduates’ salaries.  Given that college is an investment (that should generate a real return after an initial payment), this request seems extremely logical!  Indeed, why would anybody spend $200,000 on out-of-state tuition at UM without assurance (or at least data supporting) a sizeable income stream after graduation?

If firms are required to release GAAP-audited financial statements to aid prospective investors, I believe universities should have to do the same.  While there is currently significant push back from universities to release this data, I think that reporting graduate salaries based on school, major, GPA, etc. is an essential step in changing college education from a “Castle-in-the-Air” investment to a “Firm-Foundation” investment (the implications of this are consequential indeed, as it would likely force the cost of high-paying majors like business and engineering higher than the cost of low-paying majors like anthropology and agriculture.  That said, this is a consequence that I am comfortable with).  Personally, I believe if we can successfully alter the way that students choose to invest in college education, we can effectively reduce the risk involved in student loans and prevent student debt from repeating the Dutch Tulip Crisis and pushing America back into recession.

 

It’s time for the U.S. to invest in itself

As tuition at the University of Michigan has continued to increase on an annual basis (3.2% more for out-of-state students this year), the financial burden on its students has grown heavier and heavier. Of course, with a national 2% inflation target, the price to attend college is expected to increase across the board each year. Yet since 2011, the availability of student loans has decreased, and when offered, at a much higher interest rate. On Monday, there was finally some good news for students as more private lenders are once again targeting collegiate loans.

For many students, the federal government is willing to provide some loans to students at a discounted rate. Often, however, these loans only cover a portion of tuition and living expenses, forcing students to look elsewhere for the rest of their funding. But while students have been leaning on more loans, lenders have disappeared since 2008. As the economy worsened, risk increased for college lending as students struggled to find employment out of college, even with their Bachelor’s degrees. As the economy returns to natural output, these lenders are finally starting to come back.

While this is good news for students, parents, and private lenders, the government should be taking note. Already having lost the worldwide advantage of having the most holders of Bachelor’s Degrees, the U.S. continues to lose ground in this category. President Obama added returning the U.S. to the top of global college attainment to his long to-do list in 2009, and now is the time to act. With more confidence that students will find employment and pay back their loans, there is more incentive than ever to help high-achievers afford college.

The laundry list of reasons why it is important to continue putting Americans through college far exceeds 800 words, but two key statistics are that Bachelor’s degrees bring higher salaries and a much lower risk of losing a job. By offering low rates on college lending, the U.S. is effectively investing in itself by creating highly skilled workers who can compete on a global scale. In addition, by offering more subsidized loans rather than unsubsidized loans (more information about the difference can be found here), college students aren’t overburdened with accruing interest while attending college.

Having more private lenders for college loans will certainly lower interest rates and encourage more middle class students to attend more costly, and often prestigious, universities. However, the news that these loans have decreasing default rates should motivate the U.S. government to ensure that all highly-performing students have the financial opportunity to attend college. The first step is to offer greater amounts of federal loans at subsidized rates – ideally postponing interest payments until the completion of college. By doing so, the U.S. can close the growing gap in young adult’s education level that has widened over the past decade and create a more skilled workforce. Simply put, its time for the United States to invest in itself.

Student Debt Hurting the Economy

Ever since it became relevant, most economists have seemed to believe that student-loan debt plays an insignificant role in the economy. However, the immense growth in student-loan debt in recent years indicates that its effect will soon demand attention, as it puts a damper on the US economy. An article in the Wall Street Journal (Student-Loan Debt Slows Recovery)  indicates that average debt has increased 25% in the past four years. Today, the average student-loan debt is $29,400. However, many of us know that attending a university like the University of Michigan can leave us with a debt of over $100,000 (even as much as $200,000).

The Federal Reserve Bank of New York reports that Americans have accumulated $1 trillion in student debt. Compared to the $10 trillion in mortgage debt, this may seem insignificant. But the biggest impact this is having on graduates is on their inability to accumulate credit, get loans, buy a car/house, get married, etc. Just when graduates are expected to go out into the real world and shape their lives, they are faced with these credit concerns which inhibit their potential.

Increasingly, graduates are choosing to default on their loans. According to the New York Fed, at the end of the quarter 12% of student debt was delinquent, compared to 7.6% four years ago. “The Fed defines delinquent as debt that hasn’t had a payment in at least 90 days.” More and more, graduates are deciding to simply stop paying their loans- presumably because they are not financial capable, not because they don’t want to.

On its road to recovery, the US needs the boost in consumption, which student-loan debt is hindering. A Bloomberg article, Fed Student-Loan Focus Shows Recognition of Growth Risk, reports that the Fed is noticing the restriction that student-loan debt is placing on car and house sales. More importantly, the article suggests that Fed is recognizing the overall negative impact of student loans on the economy.

So what can be done about this? I do not suggest that people not go to college. Nor do I suggest that graduates keep defaulting on their debt (it is only making their situation worse). Instead, I think the US should follow the wise example of most of the developed world, where college is much more affordable. Western Europe houses many of the world’s top universities, and their tuition is nowhere near top American universities’. Many universities charge a much more reasonable tuition based on household income, something the United States should also consider. I believe some things should not be capitalized on, and education is one of them. Not only would students benefit from lower tuition costs, but the economy would be alleviated from the huge burden it currently faces.

Student Debt Strikes Again – The Next Big Bubble

In a previous post, “Why College Graduates are Useless,” I discussed how high levels of student debt prevent graduates from actively participating in the economy, which in turn depresses economic growth.  In this post, I’d like to expand on that post and identify how student debt not only causes graduates to depress economic growth, but universities and creditors as well.

It is important to understand that high tuition not only hurts students, but universities too (seems ironic, right?).  As tuition at universities continues to grow, more and more students are opting for cheaper education alternatives.  Many students now attend community college or pursue associates degrees, and this trend is having a huge impact on four-year universities.  The Wall Street Journal recently found that over 25% of colleges have seen at least a 10% drop in enrollment.

This 10% decline in tuition revenue is forcing colleges to make significant faculty cuts, as universities can no longer afford to cover their overhead costs.  A study by the Goldwater Institute, a libertarian think-tank, found that at UM, there is 53% more administrative staff than there is faculty. This high level of administrative staff causes overhead costs to balloon.  Thus as tuition revenue declines, many universities are struggling to remain solvent, leading to reductions in credit ratings and lay-offs of faculty members.  Certainly, these lay-offs are not good for the economy.  Rather than fueling the economy by providing high-end, high-wage employment opportunities, universities are fueling unemployment.

Creditors are also suffering from high levels of student debt.  In the US, student loans now top $1 trillion dollars, and 81% of these loans command interest rates of 8% or higher. From a creditor’s perspective, this would be an extremely attractive situation if these were all low-risk loans.  Unfortunately for creditors, this is not the case.  As discussed in my previous blog post, “Employment is on the rise, but is it the employment we want?”, college graduates are mostly taking low-end, low-wage jobs.  Accordingly, many are at risk of default as they lack the liquidity to pay off high-interest student loans.  Defaulting on loans is never a good thing, and as the 2008 financial crisis demonstrated, defaults can have huge impacts on the greater economy.  My fear is that student-loan-backed-securities (if they exist) will become the new mortgage-backed-securities, and that widespread default will push this country back into recession.

Ultimately, there is some serious room for improvement within the higher education system.  If education is not affordable, nobody wins.  High levels of student debt hinder graduates’ ability to get involved in the economy.  High tuition costs are reducing college enrollment and forcing universities to make layoffs and fuel unemployment.  There is obviously a problem, but how do we fix it?

Personally, I believe that growth in high-end, high-wage jobs would help quite a bit.  If graduates can find high paying careers out of college, they will be less stifled by student debt, and the risk of default on student loans will decrease.  That said, fueling growth in high-end, high-wage jobs is not easy.  Another possible solution would be to restructure universities.  If universities could reduce the amount of overhead used (ie: reduce fixed costs), tuition would not need to be so high.  Accordingly, there would be less of a need for student loans in the first place, and the lower cost of investment will boost the ROI of a college education.

What ideas do you have for addressing the problem of student debt?