How Bad Is the Student Loan Bubble?
While the macroeconomic indicators are still looking good - the unemployment rate is currently sitting at 3.7% - the recent rate hike has rung a bell for all of us and gave chills to all the investors: It is time to slow down the economy. However, with the recent rising interest, what we should be really concerning is the debt bubbles that are about to pop.
Looking at the household debts alone, the total US mortgage outstanding is $15.8T and followed up by a $1.5T worth of student loan in the second-largest category. Given that the tuition has risen at rates much faster than living cost, these borrowers have to get their tuition from both government fund and private financers. And they are more than happy to lend out money as the government promotes education as a human capital investment and an extremely low interest rate to boost the economy. As a result, according to Federal Reserve, there are now 44M student borrowers, who on average bear over $37,000 loan post-graduation. However, given the declining value of a college degree and tightening labor market, these student borrowers actually struggle to find high-paying jobs that allow them to repay debts and afford quality life. Though one million people default their student loans annually, the number is expected to rise as economy might potentially start to slow down.
But defaulting student loans is more complicated. Like mortgage loan, these students debts are securitized and traded between the financial institutions as student loan asset-back securities market (SLABS). The ripple effect of residential mortgage-back securities that triggered in the financial crisis back in 2008 gave us a lecture - but unlike the mortgage, these student borrowers have nothing to back up their loan and thus these securities are actually much riskier than mortgage securities. Once the bubble burst, the US economy could enter recession again and that might even be worse than the situations in 2008. Many economists, including former US Treasury Secretary Henry Paulson, have warned the potential crashes of the financial system. Though regulators have prevented these loans to be discharged in times of bankruptcy, people who default their student loans usually have terrible credit records and unmatched skill sets for jobs and therefore unable to repay in any way. In the end, it is the economy with less consumption from these borrowers that suffers.
Rising interest rates have already increased cost for people to borrow to satisfy their living needs and repay debts. Even some state governments have started student loans, the help is limited. While the rising rate trend goes on and continually gives pressure to the households and investors, what we can do is to reflect on the education policies and financial system stability: Are all colleges worth the price? Are these securities even worth the risk?
Sources:
https://www.bna.com/looming-collapse-student-n73014473186 https://www.investopedia.com/advisor-network/articles/why-student-loan-debt-might-be-next-financial-crisis/ http://www.investmentwatchblog.com/the-real-debt-bubble-that-will-destroy-america/ https://www.businessinsider.com/fed-interest-rate-path-possible-recession-end-of-2019-2018-6 https://www.forbes.com/sites/jessecolombo/2018/09/27/how-interest-rate-hikes-will-trigger-the-next-financial-crisis/#7ea2ef1e6717 https://www.forbes.com/sites/zackfriedman/2017/02/21/student-loan-debt-statistics-2017/#50ad0f275dab https://www.federalreserve.gov/publications/2018-economic-well-being-of-us-households-in-2017-student-loans.htm https://www.express.co.uk/news/world/990653/US-financial-crisis-news-economic-crisis-2008-recession-us-economy-news-trump-trade-war
