Last week, economists from the New York Federal Reserve gave an update to the press on the current student loan crisis in America.
The presentation was chock-full of useful data. Let's analyze what the Fed had to say and find out if student loans will be the next bubble to burst or if the trends indicate that disaster has been averted.
Rising debt with fewer active borrowers
The best place to start when breaking down this debt market is to look at the total debt being borrowed.
For students in America today, aggregate student loans have been increasing steadily for years. With every passing semester, more and more money is borrowed to pay for tuition, books, housing, and other student living expenses.
As seen in the graph below, provided by the New York Fed, student loan balances have increased even as other forms of consumer debt have declined. Student loans, it seems, were immune to the so-called "great deleveraging" that followed the financial crisis.
The Fed attributes this steady growth primarily to an increase in older borrowers. In 2004, 25% of student loans were made to borrowers aged 40 or above. By 2014, that demographic held 35% of outstanding student debt. Over that same period, outstanding debt to borrowers over age 60 increased 850%.
Interestingly, the total number of active borrowers is on the decline. Active borrowers are students who are taking out new debt each semester. Active borrowers peaked in 2010 at about 12 million students. Today that number is down to about 9 million active borrowers.
Think about that for a moment: Total debt outstanding is rising, yet the number of borrowers is decreasing. What gives?
This is the part where the data gets ugly
Two immediate possibilities come to mind. First, the average loan per active borrower could be increasing. Secondly, existing borrowers could be defaulting and driving higher debt outstanding in aggregate due to lower repayment rates.
Unfortunately, the Fed says default rates are the primary driver of these diverging figures.
Before talking default rates, let's address rising tuition rates, as that is most commonly pointed to as the cause of the student loan crisis in America today. According to the Fed, tuition hikes are significant but not as critical as slow repayment. Since 2010, a lower percentage of students are taking out student loans to fund their education. That decrease, in terms of the macro picture, has offset the continuing rise in tuition costs.
However, nothing is offsetting the spiking default rates.
From 2003 to 2012, the number of borrowers who defaulted every year increased from about 500,000 to 1.2 million. Since then that number has declined, but those borrowers who fell behind during the Great Recession have struggled to catch up. That slow repayment means these borrowers are pushing the aggregate debt outstanding higher despite the decline in new active borrowers.
Don't panic -- yet
Digging a bit deeper into the data actually shows that even though this is a serious problem, the student loan market is looking better than it has in years.
The Fed discovered that underlying these problematic trends, there's a similarity among the majority of struggling borrowers: Students who have taken out student loans in the last few years, it turns out, are not defaulting at nearly the rate of those who borrowed during the financial crisis and Great Recession.
Analyzing default rates by year, the Fed shows that more recent borrowers are defaulting in line with the historical trends of their income groups. In other words, loans default every year, and that default rate is generally predictable based on a borrower's income. During the recession, however, default rates spiked across all income demographics. Today, the historical default rates trends are back in place.
The problems we still observe in the student loan market are not due to a continued crisis, but rather the continued struggles of those borrowers who first fell behind during the recession.
The overall default rates tell the story. Default rates increased from 2.4% in 2004 to 3.6% in 2012. That rate has declined since then though to 3.1% as of 2014. The Fed expects that number to continue to fall to historical levels as the economy continues to improve.
The bubble isn't bursting
What does this tell us about the market and a possible bubble? In my view, this points to a debt market on the mend.
The number of active borrowers is down, and among today's student borrowers, repayment rates are in line with historical norms. The elevated default rates and continued rising balances seem to point to those borrowers who took out student loans during the financial crisis and continue to struggle to catch up on their debt payments from years ago.
Could there be larger, more systemic problems in the U.S. education system? Maybe. Rapidly rising tuition costs could change the dynamic dramatically in the years to come. But based on this data from the Fed today, investors can feel confident that the student debt crisis won't roil the markets anytime soon.