In the ashes of the 2007, housing bubble is born the next investing bubble. In this slow economy, the American youth and recently unemployed finding themselves competing for fewer jobs against a more competitive workforce have been enrolling in college by the droves. With tuition costs rising faster than income and inflation, students from low-income families are increasingly acquiring student loans with the prospects of obtaining a high paying job in the future to repay the debt. Just as with the subprime mortgage debacle, where banks pushed low income consumers to take out teaser rate mortgages for houses that they could not truly afford when the rate resets after five years, the financial industry is now doing a similar scheme by conceiving students to take on more debt than they could likely payback. It seems that not only did the industry not learn anything from the last bubble, but also they could barely even be bothered to change the rules of the game that nearly devastated the economy in 2007.
While student loans are financially similar to mortgages, they are politically different because student loans are often more protected as they encourage the creation of an educated workforce. As with all loans, there is a risk that students who have taken out these loans will default because their education gambit did not pay off with the acquisition of a better paying job to pay back the principal. However, this is completely dependent on the projected growth of the economy and job market. If this booming population of college graduates return to the job market to find that it just as bare as when they left, it is likely that they will default on their obligations. Large amounts of defaults could burden the state-run student loan giant Sally Mae, just as large amounts of defaults caused the mortgage giants Fannie and Freddie Mac in 2007. This could then send the same ripples through the banking and investment industry in a repeat of the economic crash.
What happened in the housing crisis was that people began to default on loans at a higher rate then was statistically projected because the banks were lending to high-risk/low-income wage earners. Sallie Mae is not the only distributer of student loans, there are private student loans available through Citi-Group that offer loans upwards of $40,000, and often come with fewer restrictions on a person’s credit score and liquid assets. One of the reasons the private industry likes student loans is that borrowers cannot declare bankruptcy on the debt. The private industry is well aware of the risk that students may default on these loans at higher rate than normal just as in the mortgage market. There is a vehicle to move this risk from the lender onto other institutions; these finical instruments called derivatives of credit default swaps and act like insurance on the initial investment. It was through the web of interchanging hands from banks to investment firms and hedge funds that nearly tanked the entire global finical system in 2007.
It is also possible that the bubble is not just beginning to grow but about to burst. As Sallie Mae has already reported a loss in its derivative market this quarter, and a report from the Department of Education reported that student loan defaults rose from 7% to 8% this year, as well other reports suggest that there is an even higher delinquency rate this year comparatively. The debts incurred by borrowers are also up a full 5% from last year reports the New York Times. On the political front, there have been lenient government sponsored repayment options for students, one program started in 2009 and another enacted recently by the Obama Administration. Although these programs help borrowers in the short run, they could be creating incentives for future borrowers to continue to take on more debt than they can possible pay back in the future and therefore continue to feed the bubble rather than allowing it to run its course.
Of course, currently this bubble is in the boom cycle and is providing the necessary growth that the markets and economy needs to prosper and not all booms lead to as devastating a bust as the 2007 crash. From where I am sitting this bubble looks and smells all too similar to the last bubble, the negative externalities of which are still being felt. I fear that it may prove to be a forlorn hope that Wall Street learned its lesson and is now playing a conservative game to lessen the economic impact of large-scale defaults on student loans.
The Economist Nope, Just Debt
NY Times College Graduates’ Debt Burden Grew, Yet Again, in 2010
Bloomberg Sallie Mae 4th Quarter Derivative Loses
NYTimes Student Loan Default Rates Rise Sharply in Past Year
NYTimes Another Debt Crisis Looms
What the fuck is a Derivative?