The Crisis in Student Loan Debt

I've written before about a possible bubble in American higher education, but this article deals with a new twist on that idea, namely, a bubble in student loan debt, which is strangely similar to the subprime mortgage and housing debt (sponsored by "Sallie Mae" rather than "Fannie Mae").

The extraordinary growth of student debt paralleled the bubble years, from the beginnings of the dot.com bubble in the mid-1990s to the bursting of the housing bubble. From 1994 to 2008, average debt levels for graduating seniors more than doubled to $23,200, according to The Student Loan Project, a nonprofit research and policy organization. More than 10 percent of those completing their bachelor’s degree are now saddled with over $40,000 in debt.

Are student loans as financially problematic as the junk mortgage securities still held by the biggest banks? That depends on how those loans were rated and the ability of the borrower to repay.

In the build-up to the housing crisis, the major ratings agencies used by the biggest banks gave high ratings to mortgage-backed securities that were in fact toxic. A similar pattern is evident in student loans.

The health of student loans is officially assessed by the “cohort-default rate,” a supposedly reliable predictor of the likelihood that borrowers will default. But the cohort-default rate only measures the rate of defaults during the first two years of repayment. Defaults that occur after two years are not tracked by the Department of Education for institutional financial aid eligibility. Nor do government loans require credit checks or other types of regard for whether a student will be able to repay the loans.

There is about $830 billion in total outstanding federal and private student-loan debt. Only 40% of that debt is actively being repaid. The rest is in default, or in deferment (when a student requests temporary postponement of payment because of economic hardship), which means payments and interest are halted, or in forbearance. Interest on government loans is suspended during deferment, but continues to accrue on private loans.

As tuitions increase, loan amounts increase; private loan interest rates have reached highs of 20%. Add that to a deeply troubled economy and dismal job market, and we have the full trappings of a major bubble. As it goes with contemporary bubbles, when the loans go into default, taxpayers will be forced to pick up the tab, since just about all loans to date are backed by the federal government.

Of course the usual suspects are among the top private lenders: Citigroup, Wells Fargo and JP Morgan-Chase.