Something sinister has been brewing in the shadows of a thriving U.S. economy. With a stock market breaking all-time highs on an almost daily basis (until recently), few want to stop the party by bringing up what is an increasing problem: student debt. Currently at a record 1.4 trillion USD, student debt has become the largest component of (non-housing) U.S. household debt and amounts to more than twice the country’s budget deficit of 2017. The worrying part, however, is not the levels of debt but rather an increasing failure to repay student loans amid rising interest rates and tuition fees.
The 1.4 trillion-dollar worry…
Taking on student loans to finance tertiary education is common practice in the U.S, with 70% of graduates still working to pay back their loan. Student loans can be obtained either from the government –through federal loans– or from private institutions. While federal loans charge lower interest, they are often insufficient to cover the cost of private universities in the U.S. This leads many students who do not have a scholarship or grant to take out additional private loans to fund their education, but at a higher cost. Millennials are the most common borrowers: of the 44 million people who currently have student loans in the U.S., 17 million are under the age of 30. These pay an average of 351 USD per month on their loan, claiming a painful amount of their monthly pay-checks if they have begun working.
Growth of student debt and default
Despite this, the level of student debt level has been steadily increasing. Over the past ten years, this has grown at an annualized rate of over 10% to a record high of 1.4 trillion USD, whereas the 810 million USD of credit card debt is just below its pre-crisis high of 2008. More importantly, serious delinquencies –when a borrower fails to make a payment for over 90 days –have risen for student loans since the financial crisis, whereas those of all other household-debt components have fallen significantly. According to data from the New York Federal Reserve, delinquency rates for student loans amount to 11.2% as of third-quarter 2017, whereas those of Credit Cards and Mortgages are 7.5% and 1.5%, respectively. In total, there is over 152 billion USD of student debt which is seriously delinquent, more than double that of credit card debt.
Is it going to get any better?
It is unlikely that student debt levels or defaults are going to decrease any time soon. Quite the contrary; as a degree becomes more expected in the labour market, students feel pressured to take out loans in order to attend increasingly expensive universities. Since 1980, the average price of tuition has increased by more than four times the rate of inflation. This is particularly the case with private universities, whose tuition fees have increased from an average of 16,000 USD in 1997 to 41,000 in 2017. Interest rates on both federal and private loans, currently standing at respective fixed-rates of 4.45% and 9.66% on average, can also be expected to increase as the Federal Reserve tightens its monetary policy to control inflation in a growing U.S. economy. This, in turn, places more pressure on graduates to find a well-paying job to repay their loans.
Should we be worried?
Private student loans can be packaged together to form derivatives called Student Loan Asset-Backed Securities (SLABS), allowing investors to benefit from regular coupon payments on the underlying loans. These SLABS are frighteningly similar to the Collateralized Debt Obligation (CDO) derivatives which played a major role in causing the 2008 financial crisis. Unlike CDOs, however, there is no tangible collateral to SLABS, such as a house, making many believe they are even more dangerous. For the time being, private loans constitute approximately 150 billion USD of total student debt, which limits the effect of their default to those investors who purchased SLABS and private lenders. While the size of the SLABS market is still small relative to that of the CDO market prior to the crisis, mass default of student loans, both private and federal, could have severe implications for the U.S economy –particularly if student loans continue to grow.
Written by Jasper Thouin