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  (NYSE: FICO  ) -- 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  (NASDAQ: SLM  ) 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  (NYSE: NNI  ) and Citigroup's  (NYSE: C  )  Citibank, with $25 billion, and Wells Fargo  (NYSE: WFC  ) , 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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  • Report this Comment On January 30, 2013, at 4:41 PM, TEBuddy wrote:

    OMG, so the only option you will present as reasonable is to just bail out more irresponsible people? Just let the cycle of bad descisions having no consequences continue. This is absurd, I am getting sick of all of the breaks people with debt are getting. Let these people go live in poverty, teach them a lesson, so that the next generation of people hopefully arent deadbeats, like this nation has become. Thank You democrats for fostering a deadbeat nation.

  • Report this Comment On January 30, 2013, at 4:55 PM, TMFHelloNewman wrote:

    @TEBuddy

    Definitely not the only options, but the ones that seem the most likely that I could fit within a reasonable word count. And, please note, I did include letting those with debt keep it.

    Reform of the system that caused this situation is slowly underway, it seems. The for-profit colleges are under more regulation, and more universities and organizations are opening up classes for free through the internet. College enrollment and tuition is actually expected to decrease in 2013.

  • Report this Comment On January 31, 2013, at 12:05 PM, winston12 wrote:

    Deadbeats? I pay out 3000 a month in student loan payments. 2400 of that to a private sl company. Thats almost 90% of my income. I need to file for bankruptcy but cant due to a shady backroom deal by congress in 2005. This country can either return this consumer debt back to bankruptcy eligibility (like ppl who buy big screen tvs and fancy cars, jets, boats, or businesses and cant make their payments) or many of us are going to leave and take our degrees with us to other countries to start over, much like our forefathers. Otherwise your economy will never recover since lucky ppl like me who got good jobs cant buy homes, cars, furniture, and the rest of you will will feel the effects of us not spending when you are laid off due to lack of sales.

  • Report this Comment On February 04, 2013, at 6:18 PM, KathrynTok wrote:

    What makes you automatically believe these are all deadbeats? Couldn't they just be regular folks like you and me, lawyers, doctors, airline pilots with 6 digits in student loan debt that they are desperately trying to repay? Regardless, I think the first point that even if you have no loans it's effecting you was lost on TEBuddy. Sure, let them live in poverty. Let millions of them live in poverty. Surely, that's good for the neighborhood, good for the economy, good for everyone, NOT! To have a healthy economy we need people who are saving and buying, not living day to day paying debt incurred decades ago. Sending $1,500/mo to pay student loans for next 30 years is not the same as buying an airline ticket to visit folks in Minnesota. The debt is just debt. The ticket to Minessota translates into jobs. If you work for an airline, you want people buying airline tickets not living in poverty paying down their student loans until their grave. It's just an example, but the point is that as a person who earns money by other people's choices and activities, you want lots of activity and choices that increase business for you or the company you work for. You don't want poverty all around you and nobody able or willing to pay for your services or wares. I believe this point was lost on TEBuddy. Instead I sense desperation and anger of I'm being screwed so everyone should be screwed. Let them live in poverty, until it's your mother, your sister, your best friend, your neighbor.

  • Report this Comment On February 04, 2013, at 6:45 PM, Jofbow wrote:

    Thanks KT for that voice of reason. Unfortunately, what many have misunderstood about the student loan debacle, is that their legislators hold much of the responsibility for the lending crisis. They have given legislative power to lenders, they have validated policies of a dysfunctional, archaic Dept. of Education, which Ron Paul felt should be abolished, and they took away banking stop gaps like Glass-STeagall so the Oligarch Robber Barons could collaborate with no transparency or accountability with the College Admissions Depts., some of which are being brought law suits against by Gov.,, such as Cuomo of New York, for predatory practices and lack of transparency regarding lending practices. This is a National Security Issue, as stated by Condolezza Rice, and this is a serious economic ball and chain around the necks of our citizens.. loan or no loan. If young people are strangled by this debt, and those who are reskilling and retooling if they lost their jobs have far too much debt.. sometimes find no jobs or are underemployed, it adds a greater burden on the economy, and hurts small businesses because Americans have less disposable income. Americans need to come together, stop falling for the "splitting" that is being thrust upon the Nation by the two parties, both fighting for power and control for their money changers and powerful interest groups. This is what happened here folks. The Congress sold us out to the Oligarchs.. and our educational system has fallen prey to the Oligarch lenders.. and thanks to removal of consumer protections, courtesy of YOUR legislators or the past 25 years, this is where we are... an Educational Bureaucracy paying College Presidents more money than the President. If Americans don't see that this is a predatory, raping and pillaging of the American system, without Liberty and Justice for All.. and against the rights and equal justice for all that our founding fathers held dear. It is going to take Americans, pulling together, We The People, working together to rid the nation of dysfunctional politicians in both parties, and restore the responsible laws that protect the General Welfare. Unless you understand what IBR is, what HR 4170 is, what the new legislation for bankruptcy reimplementation legislation is about, what Glass-Steagal did and how it was removed, and which Presidents removed the consumer protections...then you don't know how this raping and pillaging in the system ensued, and you should take the time to find out. Because, if the corrupt legislative dysfunction doesn't get you directly and you don't have a student loan, it will get you another way.....because it already has. Just look at your paychecks starting Jan. 1rst. Put the blame where it belongs, not on the people who were duped with nontransparent regressive policies, but on your congressional leaders who have forgotten they work for We The People.

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