How Student Loans Could Ruin the Economy


If you have student debt, sending in those monthly payments might be a pain. But even if you don't have any student debt, it's becoming clearer that the student debt issue will become a problem for you and the economy at large. Why?

The amount of debt and delinquency rates keeps growing, and without major policy changes, it will keep weighing down growth.

Joining the crowd
When the recession hit, we could look at growing enrollment rates in higher education to comfort ourselves that even if the economy wasn't looking bright, there would be plenty of bright people in the future to lift it out of its funk. Unfortunately, a lot of these students who took on debt have had trouble repaying it. Now these financial obligations hold back their spending and might require higher intervention.

A new report from the Fair Isaac Corporation -- the same company that developed the ubiquitous credit score -- sums up the situation in several graphics after analyzing data from 10 million credit files. From the 81% of us who don't have student debt to the nearly 1% of us who hold more than $100,000 in student debt, this issue needs further examination.

The opposite of deleveraging
In March of last year, the average student debt balance was found to be $23,300 by the Federal Reserve Bank of New York. In October, average debt for the class of 2011 was reported at $26,500 by the Institute for College Access and Success. Now, FICO reports that the average student debt is $27,250:

Source: FICO, "Is Growing Student Loan Debt Impacting Credit Risk?" Jan. 2013.

While consumers learned lessons from overextending their credit during the recession and average credit card and auto debt fell, average student-loan debt increased 58% since 2005. Deleveraging and shedding excess debt is an important step in getting the economy right-side-up, but student loans are working against this. As former students pay back loans, they have less money to spend on new houses, iPhones, and business ventures.

Fewer are paying on time
And those missed iPhone sales are assuming that student debt holders are even paying off their loans. The delinquency rate for student loans as reported by the Department of Education in September was 13.4% for the 2009 cohort and a whopping 22.4% at for-profit institutions. The FICO study found even scarier figures for loans between 2010 and 2012:

Source: FICO, "Is Growing Student Loan Debt Impacting Credit Risk?" Jan. 2013.

More than 25% of student loans became delinquent. With the entire student-debt market near or already above $1 trillion, depending on the source, that's a lot of potential losses. Taking even a conservative figure of 10% of those loans being discharged, that's $100 billion in losses. But for whom?

Who gets the rotten apple?
Mostly, the federal government. Since July 2010, under the Student Aid and Fiscal Responsibility Act, private companies like Sallie Mae have not handed out any new Federal Family Education Loan Program loans, which the federal government insured against default. But companies do offer private education loans, which Sallie Mae estimates paid for 4% of undergraduate costs in 2011 and 2012. In 2011, Sallie Mae itself originated $2.7 billion in private education loans, and, given the risks associated with student loans, 91% of these had a cosigner.

While companies can't originate any new FFELP loans, they do still service them. The largest holders in 2011 besides Sallie Mae, which holds $115 billion, were Nelnet and Citigroup's Citibank, with $25 billion, and Wells Fargo , with $18 billion. Only Nelnet's holdings increased from 2010, while the other companies reduced their holdings by at least 10%.

What is $100 billion to the federal government? Take a look at the automatic cuts our government fought so hard over, only to delay decisions for a few months. If a new agreement is not put into place, defense cuts in 2013 will be $42.7 billion. Both domestic and defense cuts after 2013 will be $54.7 billion per year. Absorbing losses from bad student loans would be the subject of a major argument in Congress.

Why student debt is special
And if losses aren't discharged by the government, there is little freedom for student debt holders. Student debt has a special status and can't easily be discharged through bankruptcy. The government can garnish wages and hold onto tax refunds. And the Department of Education hires collections agencies and pays them up to 20% of the collection amount recovered.

The choices now seem to be either let the government absorb the losses or keep the ball and chain of student debt lashed to the country's economic growth. Both seem tough to swallow.

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