Will Student Debt be the Next Bubble to Burst?

By: Amber Wetzel

Everyone remembers when the subprime mortgage bubble burst and sent the economy into a tail spin.  Although there are differing opinions on whether or not we have seen the beginning of the end of these dark days, there remains a dark cloud hovering in the background, gaining more and more attention.  The upcoming election has shone a spotlight on issues associated with the ever-rising student debt, and some are now saying it is time to take a closer look, to determine if the student debt bubble will soon burst.

“Over the last five years, student debt has literally exploded,” economist Bernard Weinstein said.  (http://dfw.cbslocal.com/2012/10/29/calculating-the-real-student-cost-for-a-college-degree/).  The Consumer Financial Protection Bureau (CFPB) reports the outstanding student debt total has now passed the one trillion dollar mark.  The CFPB reports that 150 billion dollars of this total is wrapped up in private loans.  Part of the answer to the debt explosion is the 21% increase in student enrollment and the ever-increasing rise of tuition.  In 2008, the private student loan market increased to over twenty bullion dollars, a 300% increase from 2001.  Weinstein noted the significance of trillions of dollars of student loan debt to the collateral of the loan: a student’s earning potential.  The “persistent unemployment” of college graduates is making it hard for students to repay these debts.

This summer, Congress voted to extend, for one year, the 3.4% interest rate on federally subsidized student loans.  The bill, which would only extend the lower interest rate until July 1, 2013, prevented the interest rates from increased to 6.8%.  Interest rates used to be 6.8%, until 2007, however, there is no certainty there will be a bipartisan compromise in order to keep the loans low come next July.  The uncertain future of federal interest rates is just one factor that could impact the future of the student loan bubble.

Another problem arising from student debt is the lack of escape.  As the amount of debt and number of debt holders increase, so does the number of people who default on their loan.  Being in “default” is the term given when a person misses payments for 270 days or more.  It is estimated there are currently five million federal loans and 50,000 private loans in default, or approximately sixty-seven billion dollars in default.  In 2011, the number of loan payments that are three months late rose 14.6%. Loan holders have even started turning to private debt collectors. However, student loans remain the only type of consumer debt that is not protected by bankruptcy laws; Congress outlawed bankruptcy for student loans in 1977.

There are quite a few similarities between the problems of subprime mortgages and the student loans.  Getting a degree, having a good job and owning a home are central to the “American Dream.”  But too often good intentions can create bad results.  This is how the mortgage crisis started.  Now, there are too many people with degrees for too few jobs.  And, as with the subprime mortgages, the scrutiny level is not where it needs to be.  As more “for profit” four year and professional schools crop up, the number of people eligible to earn a degree increases.  “For-profit universities are basically letting anyone into these loan programs,” says Ken Lin. (http://www.thefiscaltimes.com/Articles/2012/10/25/5-Ways-the-Student-Loan-Bubble-Mirrors-the-Housing-Crisis.aspx#page1), founder and CEO of CreditKarma.com, an education website that allows consumers to receive a credit score report and view available financing options based upon their situation.

There are two other important similarities between the mortgage industry and student loans.  First, the government is the guarantee for most loans in both industries: Fannie Mae and Freddie Mac for mortgages and the Department of Education for student loans. Second, the bureaucratic “run-around” that many people experience when trying to learn of their options or resolve a problem.  The CFPB reports that many complaints from student loan holders are similar to mortgage borrowers, specifically: “’misplaced’ payments, delayed error resolution, inability to contact the appropriate person in times of hardship, inability to take advantage of low interest rates due to a lack of refinance options, and inability to secure modified payments plans during the difficult labor market.”(http://www.thefiscaltimes.com/Articles/2012/10/25/5-Ways-the-Student-Loan-Bubble-Mirrors-the-Housing-Crisis.aspx#page2).

The CFPB has recently asked Congress to consider allowing private student loan holders to file for bankruptcy.  The current Congress had a difficult time reaching an agreeable solution to cover the roughly six billion dollar bill that comes with the one year extension for lower interest rates.  With an increasing national debt, a presidential election, and likely more late payments, one must wonder: what will happen next July when the interest rate is set to increase?  If the low interest rate is extended, what concessions will students have to make in exchange? In order to reach an agreement on this year’s low interest rates, graduate and professional students’ access to federally subsidized loans was revoked, and the annual household income eligible to receive the highest amount of federal aid has been raised by 9,000 dollars.

It is no doubt students are paying more for their education; tuition prices continue to rise and the cost of financing an education is a high-risk investment.  With the similarities of subprime mortgage debt, many question what will happen if the student loan bubble bursts next? Student loans are not packaged into securities the way mortgages are, however, if tuition continues to rise while job openings and starting salaries decrease, even more loan payments may be late or unpaid.  Private lenders are beginning to feel anxious, as more and more students enroll in college just to come out in markets that are already over-saturated.

Schools and students alike need to consider what to do about this growing problem.  Most people think the solution is not to open up more schools, but that is exactly what is happening in Indiana.  Indiana Tech is planning on opening the fifth law school in Indiana, where it will compete against top schools like Notre Dame and Indiana University at Bloomington.  As more students enter colleges to pursue fields that are oversaturated, the outlook for high salary jobs is slim.

While this is not the best the situation, it is still not enough to create a crisis just yet.  There are many other variables that will help to tip these scales.  The unemployment rate is slowly dropping, and there is talk the economy has stopped declining and may actually be on the rise.  The job market is a key factor, because a student’s ability to make loan payments depends on income post-graduation.  Another important factor is for profit schools that are trying to open in a market that is not stable enough to be the foundation of new institutions.  Students need to be diligent about finding scholarships and making smart money choices.  Schools need to make this process easier for students, and try to ensure diplomas do not start to lose value.

Sources:

http://dfw.cbslocal.com/2012/10/29/calculating-the-real-student-cost-for-a-college-degree/

http://www.thefiscaltimes.com/Articles/2012/07/26/11-Things-You-Didnt-Know-About-Student-Loans.aspx#page1

http://money.cnn.com/2012/06/29/pf/college/student-loans/index.htm

http://www.thefiscaltimes.com/Articles/2012/10/25/5-Ways-the-Student-Loan-Bubble-Mirrors-the-Housing-Crisis.aspx#page1 

http://www.businessinsider.com/new-indi

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