Friday, May 16, 2014

Will College Debt pop like Housing in 2007?

By pop I assume you are talking about a sudden collapse in prices. Well as noted in my previous post, college debt is run by the Bank of Ed right now, and considering the ease at which one can obtain such a loan (usually the simple click of a mouse button) it is pretty clear that it’s a sub-prime market.

As such the Federal Government is engaging in a form of economic stimulation that will do nothing but cause inflation, at least where colleges are concerned. This could in part explain the reason why the prices of college keep going up the way they have in recent times. It is just pure inflation due to the free Federal dollars flowing into the system.

Unlike the housing market, the asset that results from a college loans is intangible in nature. In fact, I am uncertain you could truly assign a market value to a college degree like that of a house because by its nature it is non-transferrable to another person. As such there appears to be no way for the value of college degrees to recreate the conditions like housing where one could end up “under water” with the loan simply due to market trade conditions or to cause Wall Street to collapse unless these loans were repackaged into some sort of security instrument.

But according to Michael Wenisch writing in the Catholic Social Science Review, “With the exception of a handful of extremely wealthy universities, institutions of higher learning are for the most part substantially dependent on student tuitions, and thus also on student loans, in order to operate. Without the continuing growth of the student loan bubble, it is foreseeable that many colleges and universities will be forced to declare bankruptcy and cease operations over the next ten years.” (1)

And according to Andrew Ross writing in the New Labor Forum, the “transfer of fiscal responsibility from the state to the individual … has been steady for more than three decades, but the rate of transfer has quickened in recent years, driving up tuition costs in all sectors (they have risen by 500 percent since 1985), but in state universities in particular. Last year, overall state funding was cut by 7.6 percent, the largest decline in more than half a century.”(2)

So it is clear that without the student loans the higher education market could not maintain itself at its current pace, as such there are some who have looked at this market and believe that it could collapse simply by two things-

1. The sudden withdrawal of Federal funding of the loans.

2. The sudden withdrawal of students obtaining loans or attending college.

Either of these two conditions would cause the college market environment to experience a sudden contraction event, but unlike the housing boom this contraction event will not be so wide spread in economic effect. The flow of cash into the college market is simply too isolated from the rest of the economy to impact such things as Wall Street. As such a sudden collapse would only at best cause a smaller labor pool of college graduates doing nothing more than raising the wages for college level work which in effect would again attract more people back to college.

Personally I don’t think the 1st event is even possible because the Federal funding of college loans is a budget deficit offset (as in it is a negative budget element), so Congress really doesn’t have an incentive to stop the loaning while other spending continues. In fact, college loaning makes a great tool to balance the budget, or at least get closer to that goal. At least it is helping the States supporting colleges to make cut backs allowing them to balance their budgets based on Ross’ observations (2).

What is more likely to occur than either of the two conditions above is greater amounts of default on college loans which does nothing but raise the budget deficit. This point was noted in the Economy online section of BloombergBusinessweek by Caroline Salas Gage and Janet Lorin article entitled Student Loans, the Next Big Threat to the U.S. Economy? , in which they reported that in the 3rd Quarter of 2013 “student loans outstanding more than 90 days shot up 11.8 percent” (3). Further the New York, Kansas City, St. Louis and San Francisco Federal Reserve Banks (FRB) have been monitoring this situation as well (4).

Although recently the Board of Governors of the Federal Reserve System noted in a Feb. 19, 2014 posting of the FEDS Notes that there was a recent “deceleration in student loan debt” mostly attributed to “a flattening out in the volume of student loan originations and college enrollment, along with increasing repayment rates on existing loans”, but they did note “we also anticipate sizable originations of student loans in coming years, reflecting persistently elevated levels of college enrollment and further rises in the costs of higher education.”(5)

Even so since the Bank of Ed is basically running a sub-prime market which is in reality dependent upon wages to pay them back (just like the mortgage sub-prime market), if there is a collapse in college level work wages then there is a greater risk of default. This is the way that college loans can become “underwater” through the inability to obtain work paying enough wages to support the loan. This issue is basically a structural problem with labor market and job creation versus any cyclical nature that might be occurring.

The only way to prevent this collapse is to socially build into the system some form of guaranteed wages. Currently the only guaranteed wage is minimum wage, so obviously this needs to be raised to higher levels to support the current debt load, or at least re-created so as to guarantee wage amounts for college degreed individuals.

The only other idea is to allow re-financing of the loans to longer terms and thus lowering the impacts of the loans and ensure a lower default risk. This is what some U.S. Senators want to do currently base on a Yahoo Finance news report where they want to allow student loans to be refinanced to 3.86% (6).

In the end I don’t think the college debt load will pop like the housing deals, but I do think the amount of debt can cause problems for the Federal deficit should the conditions which are supporting the loaning suddenly change which in turn could cause greater national debt to occur causing less government spending, higher taxes, the potential raising of the minimum wage, and/or the encouragement of greater student debt for college with refinance options to deal with the situation.


(1) Wenisch, M. (2012). The Student Loan Crisis and the Future of Higher Education. Catholic Social Science Review, 17345-350.

(2) Ross, A. (2013). Mortgaging the Future: Student Debt in the Age of Austerity. New Labor Forum (Sage Publications Inc.), 22(1), 23-28. doi:10.1177/1095796012471638

(3) Gage, C. S. & Lorin, J. (2014) Student Loans, the Next Big Threat to the U.S. Economy? BloombergBusinessweek, Economy online section. Retrieved on 5/12/2014 from .

(4) Choi, Laura (2011). Student Debt and Default in the 12th District. Federal Reserve Bank of San Francisco, Community Development Research Brief. Retrieved on 5/12/14 from .

(4) Dai, Emily (2013). Student Loan Delinquencies Surge. Federal Reserve Bank of St. Louis, Inside the Vault, Spring 2013. Retrieved on 5/12/2014 from .

(4) Edmiston, K. D., Brooks, L., and Shelpelwich, S. (2012). Student Loans: Overview and Issues (Update). Revised 2013. Federal Reserve Bank of Kansas City, Research Working Papers. Retrieved on 5/12/14 from .

(4) Federal Reserve Bank of New York (2013). Student Debt by Age Group. Retrieved on 5/12/14 from .

(5) Hannon, S. and Mezza, A. (2014). A Few Thoughts on Recent Deceleration of Student Loan Debt. Board of Governors of the Federal Reserve System, FEDS Notes. Retrieved on 5/12/14 from .

(6) DiGangi, C. (2014). The New Proposal to Cut Student Loan Payments. Yahoo Finance: Retrieved on 5/12/14 from .

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