Student Loans: The $1.2 Trillion Time Bomb

How the Student Debt Crisis Endangers Everyone

Student Loans: The $1.2 Trillion Time Bomb
August 4, 2014

You’ve probably heard about the alarming increase in student loan debt over the past several years. According to the Consumer Finance Protection Bureau (CFPB), this debt recently surpassed $1.2 trillion. The Project on Student Debt from The Institute for College Access and Success (TICAS) notes that the average indebted graduate will have $26,600 in debt, with 10% owing more than $40,000.

If you don’t have children in college, why should you care? There are several good reasons.

  • Impact on the Overall Economy – To put this in perspective, the national debt is around $16.7 trillion, making student loans 6% of that overall value – the second largest type of consumer debt, lagging only mortgages. We are still recovering from the effects of the housing crash; are student loans headed down the same path?

    Even if we assume that is not the case, the overall effect of the debt is causing more of the recent graduates to delay the typical purchases. They cannot afford homes and are not able to save up enough to afford one in the future. Their savings and retirement funds are stretched, and they are likely to live off of higher credit card debt (or their parents, causing a drag on their retirement savings and purchasing ability).

    This causes a ripple effect throughout the economy. For example, people who are attempting to buy a larger home as they start a family will suffer from the lack of the usual potential buyers for their starter home. Either consumer spending decreases or collective credit reaches dangerous levels. With lower consumer demand, fewer jobs are created, thus making it even more likely that graduates will be underemployed and wages will be lower.

    A study from Demos estimated that student debt has a fourfold effect in wealth losses over the lifetimes of those with student debt. At the current $1.2 trillion, that amounts to $4.8 trillion in spending power removed – and that estimate does not even account for defaults. Demos estimated the average lifetime loss of the indebted at $208,000.

    In short, it takes longer for student’s debts to translate into wages that work their way back into the economy – if they ever get there at all.

  • Federal Backing – The vast majority of student debt is in federally backed student loans ($1 trillion of the current $1.2 trillion in debt) through the Department of Education, Sallie Mae, or similar vehicles. This is generally safer and preferable for students, because they can contain safeguards such as payback rates based on income, deferment and forbearance options, fixed interest rates, and other assistance to help avoid default.

    Unfortunately, the federal backing puts taxpayers on the hook for defaults. The alternative is private loans, which has less favorable terms and increases default risks (and typically, the overall amount paid back in interest).

Now do you care about student loan debt? Consider a few disturbing parallels to the subprime mortgage crisis: Overextension of debt with limited ability to repay, and the ultimate bailout backing of the taxpayer.

They are different in fundamental ways, of course – for example, the subprime mortgage crisis was a problem of misrepresenting risk to investors, while student debt is an investment that typically pays off, but is not guaranteed to. In either case, the result could be overall economic harm followed by taxpayer bailouts.

What do we do about it? Some argue that a degree of debt forgiveness is necessary – by that logic, we might as well get the bailout started before it gets worse. This could set a bad precedent for future bailouts and encourage risky behavior; at the very least, it can reduce consideration of whether a student’s debt load matches the future earning power that his or her degree should provide. Perhaps at least some public service should be required with the bailout?

Ultimately, the solution is to increase wages and the number of available jobs through economic growth, and lowering mismatches between degrees and available jobs. Better education of students regarding loan terms, consolidation options, and alternatives will help – as well as understanding the true earning power of their degree. But it is still up to students (and their parents) to make smart choices in the meantime.

Find out quickly at what rate you can refinance your student loan.

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