Student Loans and the Next Crisis
These are boom times for student debt. Now 10 percent of all household debt, it has nearly doubled in the past five years. That growth comes entirely from new lending by the federal government.
Recent federal efforts to shut down for-profit colleges, a major source of demand for student loans, may not be enough. The federal takeover of the student-loan industry in 2010 was a shock to the supply of student loans, just like the boom in private securitization was to residential mortgages during the 2000s. We have seen this movie before. If the government is to prevent either another debt-driven economic downturn or large write-offs at the taxpayer's expense, the supply of student loans must pull back.
This will be difficult, and not only because students are a sympathetic bunch. The more meaningful obstacle will be government itself. If the Fed is to regulate the supply of student loans -- which, since the financial crisis, is responsible for such regulation -- it will have to knock on the Department of Education's door. And the Department of Education doesn't think of itself as a source of macroeconomic risk, even though it should.
The worry is that government does this sort of self-regulation badly. Think of Fannie Mae and Freddie Mac, which enjoyed government backing in the boom and then imploded in the bust. A more apt analogy may be the many developing countries where the state and state-run institutions are a large and direct source of credit and not merely of loan guarantees, as were Fannie and Freddie.
Without careful thought to the design of institutions, state-run lending has a tendency toward unpleasant endings. Inattentive to risk, the government starts a credit boom. It then fails to rein it in, because prudence never attracts a political constituency. When the bust comes, government faces an unattractive choice: It can forgive debts at great cost to taxpayers, or it can leave the borrowers saddled and plunge the economy deeper into distress.
Why are student loans a danger? More than a third of young families now have student debt and carry a median balance of $17,000, according to the 2013 Survey of Consumer Finances, up from a fifth of households with a median balance of $10,000. Those with bachelor's degrees pay 6.5 percent of their annual income in student-debt service. Student loans surpassed auto loans as a source of debt in 2010, but it remains less than mortgages. And delinquency rates are up. If the level of student debt does not make it major risk today, its explosive growth guarantees it will be in a few years.
The good news, say the defenders of the student-loan boom, is that government does not face any credit risk. They are correct in that student loans are not dischargeable in bankruptcy but wrong in a more substantive sense. If student-loan defaults were to soar, they would be the first ones calling for government to forgive the loans so that the economy avoids a recession. So the option of collecting on federally-owned student debt via the tax system -- the final recourse that the government has -- may not be a viable one if the debt boom continues.
A stronger defense is that young people are swapping student debt for other forms of debt, such as auto loans and mortgages. In fact, more detailed data from the Survey of Consumer Finances show that debt burdens for young households are down since 2010. Those with student debts also tend to be pretty well off -- for the most part, they have college degrees -- and so maybe they can handle it. Yet much of the decline in home and auto loans is cyclical. It's not clear whether the growth in student loans will look so much like a "swap" when these other forms of borrowing return.
Better to get the institutions right, then, when we can. To its credit, the Obama administration has worked hard to establish rules that prevent the government from financing educations at institutions that don't improve their students' job prospects. Yet these rules are "microprudential," in the regulatory terminology that has so far been limited to banks. Student lending is fast becoming a macroprudential concern.