The 1.2 Trillion dollar student loans debt bomb is hampering growth because recent graduates entering the job market are unlikely to start a business, buy houses or take on additional debt. What is most disheartening for many is that the debt load discourages graduates from marrying and having children until they feel more financially secure.
They could have quite a wait because 71% of bachelor degree recipients will graduate with student loans, compared with less than half two decades ago. The issue is exacerbated for advanced degrees graduates entering the workforce as their debt skyrockets to a whopping 200% of their incomes.
There seems no indication this trend will decrease or that students will reduce borrowing in the near future. In public 4 year schools, tuition and fees have increased an incredible 225% from 1984-5 to 2014-15. Bloated administrative costs, unionized and tenured faculty, and long-rooted cronyism between government and the academic world ensure increases in tuition. With the lackluster economy neither parents nor students have increased their wealth, making increased student aid a certainty.
Student loan debt is especially burdensome because it cannot be discharged in bankruptcy, unlike almost all other debt. Congress made student loans non-dischargeable in the Bankruptcy Abuse Prevention & Consumer Protection Act of 2005. Student loan debt can and often does follow the borrower all the way to old age. The government can even levy social security benefits to force repayment of the debt.
Student loan defaults harm the economy in a second way. Because the federal government guarantees the vast majority of student loans, Uncle Sam will be liable for defaults. What the government spends on paying defaulted student loans, it can’t spend on improving the economy by repairing infrastructure, creating jobs, etc. Since the government doesn’t have the money to pay off student loans, it will borrow money, thus increasing the national debt.
When the government borrows money, the taxpayer ends up footing the bill. When taxes go up, consumers have less to spend, and the economy shrinks.
The third way student loan defaults can seriously damage the economy is if a large number of them default, causing a panic in the bond and derivative market where these loans are securitized. Student loans are bundled into securities called “SLABS” (student loan asset backed securities). Sound familiar? Mortgage loan securitization catastrophe of 2008, anyone? Obviously, a panic in financial markets will harm the economy.
Forbes discounts this risk by arguing among other things that the size of student loan debt is much less than the mortgage debt was. However, if there was a critical mass of defaults, it would likely trigger a contagion into share prices of companies related to the student loan market. And in the current fragile and volatile state of financial markets, what if a student loan default crisis occurred around same time as a default in corporate junk or the emerging market debt? A few financial experts have been wary of defaults of corporate junk debt and lower quality emerging market debt.
In the current weak job market, where the majority of jobs created are low-paying, it will certainly lead to more defaults. This is a vicious cycle that is very hard to break, and the resulting economic harm could easily be the final nail in the coffin of the very vulnerable U.S. financial markets.
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