News & Analysis

Student Loans and the Cusp of the Next Great Recession

As people continue to fall behind on student loans, they become delinquent on other financial obligations, like auto and credit card debt, and delay important life milestones like marriage, children, and purchasing a house, which all creates a significant dampening effect on the American economy.
Student debt is holding back the rest of the economy and may be one of the primary causes of the next Great Recession. Cartoon: Milt Priggee

Whether the first domino to fall or a gravely exacerbating factor, student debt is primed to take center stage in the United States’ next financial crisis. Student debt accounts for the largest share of all total household debt and is worth nearly $1.5 trillion–that’s an amount equivalent to over 5% of the United States’ annual gross domestic product (GDP). The numbers are sobering: 31% of Americans are on the hook for student loans, 22% of college graduates with outstanding payments are struggling financially, and 15% of first-generation students are delinquent on their loans. As people continue to fall behind on student loans, they become delinquent on other financial obligations, like auto and credit card debt, and delay important life milestones like marriage, children, and purchasing a house, which all creates a significant dampening effect on the American economy.

As a student studying finance at Emory University, this author sees how prevalent the issue of student debt is, from how it affects the day to day lives of the students around him, to watching horrifying statistics on the state of student debt continue to pour in. For the vast majority of students, who are neither wealthy enough to afford the full cost of tuition, nor poor enough to receive sufficient quantities of financial aid, a college degree and student debt have become synonymous. Already high, the Great Recession had a profound effect on student debt levels as many millenials went back to school during the economic crash only to discover themselves paying higher tuition prices and left unable to find the expected well-paying jobs after graduation. As delinquency rates and the ratio of student loan debt to overall household debt continues to soar, it is expected that graduates will have even more difficulty paying their bills, which will have a devastating effect on other sectors of the economy, especially real estate and financial services.

The central and obvious reason for the student debt crisis is rising tuition at both public and private institutions. The average cost of attending college per year is just below $30,000, nearly double the $16,000 paid a decade ago. This price-tag is cost prohibitive for many students, because rising tuition means bigger loans. Before the Great Recession, The New York Federal Reserve reported that as a portion of household debt, student loans were well behind auto loans, credit card payments, and mortgages. Now, student debt is the fastest growing sector and has the highest rate of delinquency for any sector of household debt, and is the number two overall source of household debt, behind only home mortgages.

Part of the issue lies with how many individuals view higher education as required investment in human capital necessary for success in the modern workforce. This belief forces many people into a box, where they simultaneously believe that success without a college degree is impossible, and understand that the burden of paying back student loans is insurmountable. Those with a bachelor’s degree earn more than $24,000 per year more than those with just a high school diploma, meaning that many people who otherwise would not have pursued a college degree, like first-generation students, are now enrolling in pursuit of a brighter financial future. As expected, student debt is vastly disproportionate to the student’s parents’ education level, with first-generation students being two times more likely to be behind on loan payments than other students. 

Critics may say that because student debt is government-backed, that it is therefore risk-free, but they fail to recognize that the biggest problem isn’t the non-performance of student loans and associated burden on the American taxpayer, but, rather the trickle-down effect that overwhelming student loans will have on all other household debt. Soon, the burden of student debt will be so great that borrowers will begin defaulting on other loans, like mortgages or credit card payments. Student loans are already putting growing pressure on the housing market: each $1,000 increase in student debt correlates to a 1-2% drop in home ownership, which explains much of the massive gap in home ownership between generations. With the cost of college tuition more than doubling since 2000, the decline in homeownership and resulting delay in the building of personal equity will only continue to grow as more graduates opt to rent or live with their parents.

Critics are correct in that the next recession will not be caused by a dramatic collapse of the student debt market–92% of which is held by the US Department of Education–like what occurred with the housing market in 2008. The warning signs of the next recession should actually be easier for policymakers to identify because the extended timeline of delinquency and refinancing will provide more opportunities to evaluate the data and create a meaningful policy response, whether from the Congress, the Department of Education, or the Federal Reserve. 

Disturbingly, those focused on political solutions will note that the debate about improving access to higher education is similar to the rhetoric and policy tactics used to manipulate the housing market in the lead up to the Great Recession. The 1977 Community Reinvestment Act, with the noble goal of expanding home ownership, eased mortgage qualifications for low- and moderate-income neighborhoods by requesting the Federal Reserve and other financial institutions to assist with covering or making exceptions for their credit needs. The 1980s, however, were marked by the Savings and Loan crisis, a direct result of these relaxed policies. As this crisis was forgotten, the Federal Reserve passed the Recourse Rule in 2001, which gave highly-rated, privately issued mortgage-backed securities the same low-risk weight as government enterprise-issued securities from the likes of Fannie Mae and Freddie Mac.

A plot of the increasing amount of high-risk debt assets that institutions held in their portfolios before and during the Great Recession. Most student loans are held by the US government, but a growing number are being sold and packaged as financial instruments. Graphic: Chicago Federal Reserve

The Recourse Rule thus incentivized private lenders and banks to securitize mortgages and flood the market with securities formerly deemed extremely high-risk a few years earlier, which further fed into a housing asset bubble. It is ironic that the policymakers’ attempts to make housing more affordable and accessible resulted in housing bubbles and economic disasters on two separate occasions, it should come as no surprise that federal student loan programs may bring about a similar level of devastation.

As a college student, this author urges all legislators across the political spectrum to carefully analyze the data in forming their positions on the student debt crisis. Real, substantive change is needed or else the nation may find itself in another Great Recession. While this nation turn its attention to long-term investments like infrastructure, it cannot forget to invest in the next generation–this author’s generation–by addressing the impact of rising student debt. 

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