When Student Loans Go Bad, We’re All on the Hook

There’s not going to be a bailout for the next financial crisis because the federal government already owns the bad debt. 40% of federal student loans are given to parents and students with subprime credit scores, and 11% of the Parent Plus loans are already delinquent (no payments made for over a year). We’ve racked up over $1,200,000,000,000 in student loan debt — quadrupled since the year 2000 — and the government is not showing signs of slowing down.

What does this mean?

National debt isn’t necessarily a bad thing, but debt without a secure backing is. The problem with this student loan debt is that it’s going to people without consideration of their degree or their ability to pay those loans back. These loans can’t be wiped out in bankruptcy, and the debt can sometimes be passed down to children, so even as more loans are given, the interest on the currently issued ones continues to grow.

The government extends this bad debt to students and parents because the value of a college education is perceived to be higher than it actually is. This is a classic economic bubble: the asset (college) is valued more highly than its payoff (increased salary over a graduate’s lifetime), so capital is over-extended to buy the asset. We’ve seen this pattern for literally hundreds of years and somehow we haven’t found a way to avoid it.

What happens to bubbles?

They burst. Eventually.

The longer they’re allowed to grow, the worse the collapse is. This student loan bubble is helping churn out graduates with massive amounts of debt who are underemployed or going to jobs soon to be replaced by robots. The effect of lots of people with debt is crippling to the whole economy — not just the borrowers. People with lots of debt don’t buy homes, invest for retirement, or make purchases. They are more stressed, less healthy, and perform worse at their jobs. It’s serious stuff.

Usually the government will attempt to minimize the effect of a bubble by buying bad debt or “bailing out” the bad lender (see the 2008 financial crisis). The reason that the student loan bubble is especially worrying is that the government owns this bad debt today, and it’s already weighing on the economy. When this bubble bursts it’s hard to say what will happen. It’s still not as large (in total debt) as the mortgage bubble, but this bubble will exhibit its worst effects on lower-middle class graduates who had no other way to pay for college.

What can we do about it?

Two things need to happen:

  1. Colleges must provide value equal to their cost. Colleges need to train workers for jobs that actually exist, and they need to come to terms with the fact that they’re overpriced. Some of this is happening. Trade schools are making a comeback in the form of software development “bootcamps,” and more liberal arts colleges are starting data and computer science programs.
  2. The federal government needs to find a better way to fund college for disadvantaged applicants. Loans allow students from diverse economic backgrounds the opportunity to go to college. We have to continue doing that, but it can’t happen by extending more credit to subprime borrowers. Grants, scholarships, need-based aid, and regulations that push colleges to admit students from diverse backgrounds are all better options. In addition, the government needs to hold colleges accountable for their growing costs.

Until college costs come into line with their value, this bubble will continue to grow, and eventually we’re all going to pay for it.