The risk of student loan debt

The ever-growing student loan debt is turning into a long term burden on the US economy. The American economy is tied to consumer spending, and the addition of this long term debt to consumers’ balance sheets diminishes total disposable income. This could delay (maybe for decades) and possibly keep young people out of the housing market. Unlike other consumer debt that has bankruptcy as a way to escape, student loans do not have that option.

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Student loans are a problem. But the Millennials have a number of harsher economic issues to deal with that their predecessors did not have. Rising student debt may prove to be one of the more painful aftershocks of the Great Recession, especially if left unaddressed.

The growing student loan burden carried by millions of Americans threatens to undermine the housing recovery’s momentum by discouraging, or even blocking, a generation of potential buyers from purchasing their first homes. Tightening loan standards have taken the amount of entry level buyers (homes in the $150K to $330K range), and reduced them dramatically. Think about that; older Americans started building our assets by qualifying for and purchasing an entry level home. The student loan issue of the last few years has the ability to put a huge roadblock in entry level buyer’s ability to build up their assets.

First-time buyers, the bedrock of the housing market, are unable to step up to fill the void. Historically, they have accounted for nearly a third of home purchases in the past. Now they make up less than 7% of the market, well below the historical norm. The trend has alarmed some housing experts, who suspect that student loan debt is partly to blame. That debt has tripled from a decade earlier, to more than $1 trillion, while wages for young college graduates have dropped.

The fear is that many young adults can no longer save for a down payment or qualify for a mortgage, impeding the housing market and the overall economy, which relies heavily on the housing sector for growth. Student debt trumps all other consumer debt. It’s going to have an extraordinary dampening effect on young peoples’ ability to borrow for a home, and that’s going to impact the housing market and the economy at large.

These days, federal student loans — the largest part of the market — are essentially made by the colleges, using government money. There is no underwriting criteria and few limits on how much any student can borrow. The limits that do exist apply to so-called dependent undergraduate students, who are at least partly supported by their parents. Graduate students can borrow what they want, and parents of dependent undergraduates can take out their own student loans after the student has maxed out.

Obviously, there is no way to apply conventional loan underwriting standards to students who, by definition, are not at the moment earning enough money to repay their loans. But the program is subject to abuse by colleges whose primary — if not only — goal is to get their hands on the money.

The Department of Education has been trying to come up with a rule to exclude programs that have a clear history of not producing people who can earn enough to repay their loans: a “gainful employment” rule. This is largely targeted at programs that do not lead to conventional degrees — largely the training programs pushed by for-profit private schools, the kind that do a lot of advertising

The Department’s first effort was rejected by a federal judge after the Association of Private Sector Colleges and Universities sued. The Department has now submitted a second rule to the Office of Management and Budget, but the details are not yet public. The Department did that after a panel it appointed, including representatives of various types of colleges and students, could not reach agreement.

It might make sense for the Department to instead, or in addition, design a “skin in the game” rule for the colleges. If a college’s former students turn out to default frequently, the college could be required to pay a substantial penalty. That could mean colleges would have good reasons not to promote programs that did nothing to help their students.

On the other hand, colleges whose alumni were particularly good at repaying loans might receive some kind of financial reward, perhaps in the form of a grant that could be used for scholarships. I personally feel that any place of higher learning that has a high number of defaults needs to be cut out of the program. Who are they serving?

Any such proposal would prompt protests that such a rule would keep needy students from receiving the aid they need to get ahead. But all too often now, student loans are not a pathway to the middle class but a burden that keep young people from having any real chance of success. Particularly if the ability to get a job based on their education and training is not available.

More needs to be done to regulate the companies that service the student loans. There are uncanny resemblances between issues faced by student loan borrowers and struggling homeowners.

At one time, student loans were a clear way to provide economic opportunity to people who might not have the ability or opportunity to attend college any other way. And the economic effect of lack of degree is apparent when looking at level of unemployment by education degree. In the US, those without a high school degree are over 25% unemployment, while those with a 2 year trade or 4 year college degree is below 4%. So the need for education is obvious.

The question is what has changed? Why has student debt and its consequences mushroomed since 2009? The recession caused many to question their experience and ability to become employed again. Many for-profit schools aggressively pursued the ability to attract those unemployed by offering guaranteed federal loan programs tied to their educational offerings with little to no job placement after training. As in all educational pursuits, the ability to attain a job after graduation is the graduate’s responsibility. And if they did not complete the training they were still on the hook for the loan.

A positive way of looking at this problem is this consumer debt (student loans) is the largest asset on Uncle Sam’s balance sheet, bigger than U.S. Official Reserve Assets, total outstanding mortgages or taxes receivable. The negative is the dampening effect on consumer home buying.

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The rapid growth in student debt will continue to be an ongoing topic. The stunning chart on the first page illustrates the rapid growth in federal loans to students since the onset of the Great Recession. This chart is based on data from the Financial Accounts Table, which shows the Federal Government’s assets and liabilities. The loan balance has risen and astonishing 531 percent over the last 6 years, most of which dates from after the recession. The below referenced chart only includes federal loans to students. Private loans make up an even larger amount.

So back to the original question. Yes, the current student loan situation has and will continue to be a larger burden than ever before on home buyers.

The positive is that if you live, or are employed in Texas, where over 40+% of all jobs in the nation have been created in the last 5+ years, and own a home in Texas, you are better off than your friends in other states.

Great article, Mark. I had no idea about this wild increase in student loans. Thanks for casting some light on this issue.

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