Student debt. It’s been increasing at radical paces, and the rising cost of tuition only seems to make things worse. College degrees become more out of reach for the middle and lower class members of the country, so the government steps in to help. Loans become more accessible, and more people go to college.
You may have heard that the student debt bubble is approaching. You may even be paying some student debt yourself. How serious is this problem?
The Debt Cycle
Student loans have been around for many decades, but the huge expansion of nationwide borrowing is more recent. In 1995, the combined higher education debt for the whole country was a little under $100 billion. By 2010, that number hadn’t changed much, mostly following the pace of inflation to reach a total just over $100 billion.
Today, the estimated total is around $1.2 trillion. In 5 and a half years, the debt total rose by an order of magnitude! How did we let this happen?
Changes in student lending regulations are the first major factor. As loan limits have increased in the past decade, more recent rulings have removed bankruptcy as a way to escape unpayable loans.
While a defaulted car or mortgage payment still has consumer protection in place, this is not true for student loans. This makes them much more appealing to lenders, as they are backed by government regulation and can lend to inexperienced borrowing groups at fairly reckless paces.
The second big issue ties into increasing tuition. In 2011, the country hit a milestone where public universities were paying bills more by tuition than by state funding.
This trend started in the mid ‘90s, but it accelerated dramatically since 2010. This has made attending college much more expensive, and loan amounts have had to increase to accommodate that.
The Risks
It has been reported that in 2016 alone, as many as 40 percent of college graduates are not making payments on their loans. This is exactly what could lead to a bubble collapse. When enough borrowers default, there is no longer enough money running in the system to absorb the losses.
Major banks risk going bankrupt in these scenarios and we risk another major bailout like in 2008 or losing a chunk of the financial sector. Neither is a good thing for the economy. How likely is the student bubble to burst? A comparison with the housing bubble can make it easier to predict.
The financial collapse in 2007 was largely attributed to reckless lending. Reduced regulation made it easier for people to get loans on houses they couldn’t really afford.
They were able to overcome this financially because the value of the homes appreciated faster than the loans accrued interest, and profits were made. Eventually this cycle reached a tipping point, where people had to borrow too much for the next home, and the defaults started tumbling.
When we compare the college debt bubble, we can notice two important differences. First, even with the outrageous inflation of tuition costs, these loans are much smaller than a mortgage, which means each individual default hurts major banks much less.
The second thing to note is how different an investment education really is. No one can sell their education for a profit only to turn around and take another student loan.
Instead, educational investments see their returns over long-term wage increases. This slows the overall cycle and puts theoretical limits on student loans in general.
What Is Going to Happen?
With a better picture of the situation, you can see that as big as the student loan bubble is, and as fast as it has grown, it is still much smaller and more stable than the housing bubble that caused the Great Recession.
This doesn’t mean that there is nothing to worry about, but it suggests that the risks aren’t as severe. Instead of bursting, the college bubble is more likely to slowly lose air when one of a few key conditions are met.
There are a few ways to alleviate the debt pressure, and any of them would significantly lower the cost of higher education as an effect. The easiest solution is to make loans harder to get and revert back to philanthropic subsidies. Several universities have already started implementing “no loan” policies to make this happen.
On the other side, improved techniques and technologies should be able to cut costs substantially. Lowering the cost of education reduces the loan totals and tuition prices inevitably fall even lower as a result.
Whatever ends up happening first, the loan bubble will shrink. When it does, some banks may suffer, but none will collapse. The “burst” may slow economic growth, but it doesn’t present anything resembling the catastrophe of 2007.
Regards,
Ethan Warrick
Editor
Wealth Authority
