Submitted by Mark Hanna
Courtesy of MarketMontage. View original post here.
As we’ve been speaking about for quite a few years, student loans are the next great bubble… in fact the broader university system is the next great bubble. Tuition has been increasing at far greater rates than healthcare costs the past two decades, and both are well ahead of income growth. (the first chart below is a few years old but you get the picture) Hence the need to subsidize/borrow to the moon to keep the systems going. Much as I spoke of the student loan bubble well before it was fashionable I will now be early on the “student debt forgiveness” action I expect coming.
I fully expect the federal government to (in due time) to absolve America’s students of large portions of their debt sometime in the 
coming decade or two, as the numbers continue to go in very wrong directions. To facilitate this, the government has taken over the vast majority of student loan servicing, just as it has done in the mortgage market. So when you own the loans, it is much easier to give say a 40% haircut to their values someday down the road. The government is already at step 1 of this by absolving all student debt in 20 years as long as you pay a minimum – 10% of income. This of course creates an incentive to borrow huge sums since you need only pay a relatively small portion and can walk away from it all in 2 decades – quite perverse actually. It is also a massive taxpayer subsidy to the university system. Also if you work for certain parts of government the “stimulus plan” of 2009 created a path to walk away from all student debt after 10 years.
Along these lines the one area of debt that has exploded the past few years as people hunker down on their credit cards and mortgages is student debt. In fact we highlighted a story showing student debt has passed credit card debt in this country. Part of this is of course the bad job market, but part of this is the (even lower) rates offered by government on student debt. But at some point one leaves school and has to begin paying those loans. The chart to the right (below) is amazing in its consistency – essentially a 45 degree angle, starting from a relatively low base just over $200B – this has grown by a factor of 4(!) in a decade.
A good portion of this newly minted loans have already gone bad, and as this WSJ story points out as a whole student loans now have surpassed credit card debt in delinquencies. I expect this to accelerate in the years ahead as “ability to repay”, especially for the young and out of work, doesn’t really seem to be much of an issue when offering tens of thousands of loans. This lack of worrying about “ability to repay” should bring back memories of just half a decade ago in the mortgage market. Last, I am reading many more stories in the past 12 months of parents taking on the burden of these loans on behalf of their kids, and now emptying their 401ks and savings to service them. This is going to have implications for the economy that are incredibly broad and deep.
- U.S. student-loan debt rose by $42 billion, or 4.6%, to $956 billion in the third quarter, the Federal Reserve Bank of New York said Tuesday. Overall household borrowing fell during that period.
- Payments on 11% of student-loan balances were 90 or more days behind at the end of September, up from 8.9% at the end of June, a rate that now exceeds that for credit cards. Delinquency rates for all other consumer-debt categories fell or were flat.
- Nearly all student loans—93% of them last year—are made directly by the government, which asks little or nothing about borrowers’ ability to repay, or about what sort of education they intend to pursue.
- “Is there any way the federal government could possibly come out to the good?” Sen.Bob Corker (R., Tenn.) asked at a Senate Banking Committee hearing in July on student loans, noting that the government demands no collateral and has no underwriting requirements. “What we’re really doing is piling up debt down the road the same students are going to have to pay off.”
- Unlike most other types of consumer credit, student debt is extremely difficult to discharge in bankruptcy. After falling behind on payments, a borrower typically finds it harder to obtain other types of consumer loans, or can only do so at higher interest rates.
- Moody’s economist Cristian deRitis earlier this year warned of the prospect of a wave of future student-loan defaults that could have a “crippling effect on the ability of many households to access credit in the future.”
- So-called Stafford loans account for more than three-fourths of federal student loans. They impose no credit standards and are capped at a total of $57,500 for undergraduates. Some of the money can be used to cover living expenses. For loans to parents and some graduate students, which have no upper limits, the government weeds out borrowers with an “adverse credit history,” such as a bankruptcy filing in the previous five years.
- Student lending grew rapidly in the 2000s, as did other consumer borrowing. The bulk of the loans were made by private lenders and guaranteed by the federal government. In 2010, in a money-saving effort pushed by Mr. Obama, Congress cut out the private middlemen and had the federal government start making loans directly.
- Since the end of 2007, just before the financial crisis hit, total student debt has grown by more than 56%, adjusted for inflation, the new Fed data show. During that time, overall household debt—including mortgages, student loans, auto loans and credit cards—fell by 18%, to $11.31 trillion as of Sept. 30. (surely a good portion of that is explained my massive mortgage defaults however)
- Earlier this year, New York Fed researchers said that their reported delinquency figures understate the problem because many borrowers are not yet required to make payments, either because they are still in school or have been granted a postponement. The unemployed, for example, can defer payments for a limited period.
- In an effort to reduce defaults, the Education Department has tightened standards for loans to parents and grad students, prohibited federal lending to schools if more than a certain percentage of its graduates default over several years, and allowed borrowers to postpone payments during periods of “hardship.” The administration also has finalized rules that enable certain borrowers to have their remaining debt forgiven after 20 years, provided that they make monthly payments at 10% of discretionary income—down from the previous standard of 15%.
- Loans to students attending for-profit schools have been especially prone to problems. Such students account for 12% of total undergraduate college enrollment and 22% of Stafford loan funds, according to the College Board. Among those whose federal loans came due in the year ended Sept. 30, 2009, 23% defaulted—meaning they went a year without making a payment—within three years, Education Department figures show. That compares with a 13% default rate among students at all institutions.
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