Ever since the Consumer Financial Protection Bureau declared that student debt had crossed the $1 Trillion mark, there has been an endless stream of
headlines declaring this the next big crisis in the US. With the US and many other countries still reeling from the 2008 crisis this has many people asking if this is the next mortgage crisis.
Here are 5 reasons why its not even close:
1.The size of the market is much, much smaller.
The below chart from the NY Fed gives a breakdown of the more than $11 Trillion in debt owed by individuals. The red portion of the line represents student loans (8% of the total), the yellow part of the line represents mortgage debt (72% of the total).
2. The Private loan market is an even smaller percentage of that.
Somewhere around 85% of Student loans are backed directly by the US Government. This means that in addition to student loans being a small percentage of overall consumer debt, only a small percentage of that is held by non government financial institutions. (learn more about agency bonds)
3. False assumptions are not feeding the crisis.
There were two primary assumptions that fed the mortgage crisis:
- Since there had never been a sustained period in history where housing prices had not risen, the financial models used to price mortgage debt assumed that housing prices would continue to rise in the future. As we now know, not only did housing prices stop rising, they fell substantially.
- Since the loans were backed up by a hard asset it was assumed that when borrowers defaulted, a fairly large amount of the money would be able to be recouped by foreclosing on the property. As we now know this is a fine assumption unless large groups of people get foreclosed upon at the same time, which is exactly what happened.
Neither of these dynamics are present in the student loan market.
4. You can’t get out of your student loans by declaring bankruptcy.
It is next to impossible to get out of paying your student loans. Thanks to a law passed in 1998 by the same government that is giving out all the student loans, you can’t discharge your federal student loans in bankruptcy. The only exception to this rule is if you can prove “undue hardship” which, according to most bankruptcy experts, is next to impossible*.
For private student loans? As of 2005 the same rules apply, no discharge in bankruptcy.
*There are programs available for people who cannot pay their student loans which do not get you out of the loan, but can reduce or delay payments.
5. People see this one coming.
While the mortgage crisis caught many by surprise the student loan crisis is and has been well covered in the media. With this in mind if there is any sort of “blow up” in the student loan market it is unlikely to catch many by surprise.
Does this mean investors have nothing to worry about?
What’s happening with student loans is not the same as the mortgage crisis, there are still reasons to worry. According to a recent NY Times article the balance of federal student loans has grown by more than 60 percent in the last five years. While the increase in student loans has helped many people go to college that would not have been able to otherwise, it has also allowed universities to increase tuition fees dramatically. From 2001 to 2011, tuition and fees at state schools increased 72 percent, and tuition costs are now rising faster than any other major category of expenses, including healthcare.
While this is certainly a crisis for anyone looking wanting a higher education, it’s also a problem for investors. If the level of student debt continues to grow at its current rate, it could become a significant economic drag, as the younger generations delay purchases that would have otherwise fed economic growth.
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