Student Loans: Deregulation, Debt, and a Drag On The Economy

Mortar BoardPost secondary students, in Nevada and elsewhere, should have been on notice as of July 20, 2012 that the student loan “business” was showing some remarkable — and disturbing — similarities to the subprime mortgage patterns developed before the housing debacle.  Now that the interest rate for student loans is back up to 6.8% it’s time to revisit this territory.

In summary: “A large portion of the student loan boom that took place from 2005 to 2008 was financed by Asset-Backed Securities (ABS), and because more money could be made off such loans, lenders became more aggressive in their lending practices. Increased profits gave lenders “an incentive to increase loan volumes” with “less incentive to assure the creditworthiness of those loans.” [ThinkProgress]

If this reminder sounds eerily familar, it should.  On August 29, 2012 the Consumer Financial Protection Bureau — the agency the banking lobby loves to hate — issued its report on the student loan sector. (pdf)  There have been some improvements, but not necessarily in the eyes of the banking establishment:

(1)  Professional investors fed the boom in student loans backed by asset based securities from a $5 billion industry to a $20 billion giant from 2001 to 2008.  This amount has contracted back to about $6 billion as of last August.  This does represent an improvement because the aggressive marketing of the ABS/student loans created the potential for yet another bubble which would inevitably burst.  Left to their own devices and deregulation the banking lobby was pleased to expand their bubble from 2001 to 2008, and the contraction indicates they’ve pulled back from some of the more egregious practices.

(2) One indication that the bankers were all too anxious to take advantage of the deregulation of student loans appeared between 2005 and 2007 when the percentage of student loans made without financial aid office involvement or certification of need increased from about 18% to over 31%.

As of the CFPB report publication the banking sector has pulled back in this realm.  Underwriting and marketing practices have changed, and for the better.  For example, between 2008 and 2009 the percentage of co-signed student loans increased from 67% to 85%.  In 2011 approximately 90% of private loans were co-signed and 90% of the loans made to undergraduates required the certification of need.

If we allow for the veracity of the old saw, “Past performance is the best predictor of future performance, ” then it appears immediately evident that the past behavior of the financial sector during deregulation was at least borderline egregious.  Arguments that the Consumer Financial Protection Bureau constitutes an “onerous burden on financial institutions” falls flat when the student loan practices are compared before and after the institution of more oversight and publicity… not to mention the Mortgage Mess.

As the relative merits of traditional student loans and private student loans are debated it’s well to remember that there is a crucial difference between the two: “A key distinction between federal student loans and many PSLs is interest rate risk. Today all federal student loans have fixed rates. Most PSLs are variable-rate loans with risk-based pricing, where pricing varies from consumer to consumer based upon an assessment of the creditworthiness of the borrower.” [CFPB pdf]  This is key to understanding how  formerly  6.8% fixed rate loans can be transformed into  potential 8.5% loans in a variable rate scheme.

There are some powerful reasons for the Congress of the United States of America to move from its individual and collective duff and address the issues surrounding student loans.

(A) Student Loan Debt is a drag on the national economy.   The NY Federal Reserve provides the following chart —

Student Loan Debt 1The NY FED offers a couple of explanations regarding the deleveraging of younger consumers.

“The decline in participation in nonstudent debt markets by those with a history of educational debt may be driven by a number of factors. First, a weakening in the labor markets since 2007—near the peak of consumer debt—has likely lowered graduates’ expectations of their future income. The decline in participation in the housing and auto debt markets may be a result of graduates decreasing their consumption, and thus debt, levels in response to these lowered expectations.”

While lowered expectations may be at the heart of declining consumption, what’s lowering those goals?  The NY FED observes,

“Consumers with substantial student debt may not be able to meet the stricter debt to income (DTI) ratio standards that are now being applied by lenders. In addition, delinquency in repayment has become more prevalent among student borrowers. Lee finds that delinquent student borrowers are extremely unlikely to originate new mortgages.”

The rock now meets the really hard place.  Those who incurred student loan debt during the boom times for the financial sector are now saddled with debt levels which disqualify them from getting home mortgages or other forms of consumer credit.   The NY FED has charts for this —

Here’s the increase in student indebtedness —

Student Loan market increasesAnd  here’s what happens to mortgages and automobile loan markets —

Student Loan Debt Home MortgagesThere’s an explanation for  the changing relationship between ownership rates and student debt levels which is supplied in summary form by the NY FED analyst:

“However, this relationship changed dramatically during the recession. Homeownership rates fell across the board: thirty-year-olds with no history of student debt saw their homeownership rates decline by 5 percentage points. At the same time, homeownership rates among thirty-year-olds with a history of student debt fell by more than 10 percentage points. By 2012, the homeownership rate for student debtors was almost 2 percentage points lower than that of nonstudent debtors.  Now, for the first time in at least ten years, thirty-year-olds with no history of student loans are more likely to have home-secured debt than those with a history of student loans.”  (emphasis added)

Logical conclusion?  The higher the level of student debt the less likely a person is to buy a home — or a vehicle — of much of anything else.  (See also: Washington Post, April 17, 2013)

(B) Student loan debts are a constraint on future economic expansion.   Economic expansion in general requires savings.  As savers build up reserves the funds are not merely for their individual retirement or for household emergencies, the funds become part of the overall finances required to grow the U.S. economy.  And, Wells Fargo is worried … (now it’s worried?)

“Millennial Americans entered early adulthood in the wake of the Great Recession and know all too well the effects of a struggling economy. More than half (54%) of millennials say debt is their “biggest financial concern currently,” surpassing day-to-day expenses, according to a new Wells Fargo Retirement Survey (NYSE:WFC) focused on millennials’ attitudes toward savings and retirement. Forty-two percent of millennials say their debt is “overwhelming,” twice the rate of boomers who were also surveyed for comparison.”  [WellsFargo]

Those 42% who find the student loan indebtedness “overwhelming” are not only unlikely mortgage seekers and car buyers providing impetus for immediate economic growth, they are also less likely to be able to save for retirement, the education of their own children, or for household or medical emergencies in the future.

Wells Fargo analysis continues with the following observation:

“Paying off student loan debt is the top concern of millennials. More than half of millennials (64%) say they financed school through student loans as compared with only 29% of boomers who financed through loans. According to the Consumer Financial Protection Bureau, total student debt outstanding is over $1 trillion at the end of 2012. Other ways that millennials say they paid for school was through grants/scholarships (59%) and working while attending school (46%). About half of millennials (49%) say if they had $10,000, the “first thing” they’d do is pay down student loan or credit card debt.”

Notice the number of graduates who financed educational aspirations with student loans more than doubled between the Boomers and the Millennials?  And, notice that it’s not consumption or savings which would be done with that imaginary $10K bonus — it’s deleveraging.

While a person is deleveraging he or she is not developing new businesses.  If the priority is to repay old indebtedness, and this is combined with more stringent commercial lending standards, then we have a recipe for a decline in entrepreneurial activity.  After all, in order to form a new business a person needs to develop, market, and invest in products or services — not something that’s going to happen if funds are diverted for deleveraging. [CFPB May 8, 2013 pdf]

(C) Student loan indebtedness constricts economic growth in underdeveloped parts of the country.   Consider, for a moment, the impact of that “overwhelming” student debt on economic development in rural America.

An individual may wish to take a teaching job in a rural area, but when indebtedness combines with the lack of any public transportation in most rural areas, and the individual lacks the credit score necessary for a vehicle loan, we have a formula in which the prospective applicant to fill a position in a rural school district has to say “Thanks for the offer, but I can’t afford to take it.”  This situation not only leaves an educational position vacant — it also reduces by at least one the number of consumers in a given community.

Or, think of an individual seeking to pursue a career in a health related field?  Can a young physician afford to take a position in a small rural health clinic — much less consider opening a new practice — when his or her need to discharge student loans far surpasses the ability of the community to provide financial resources to do so?  Since most private student loans do not provide a “public service” reduction component, those with that type of loan burden are a further disincentive to take positions in rural areas.

Finally, we might consider the newly minted graduated in a technology based field of study.  The person might very well be able to advise and serve communities in need of more and better Internet access — However, if there is a serious shortage of rental property, as is the case in many rural areas, can the individual find affordable and adequate rental housing without having to address the issue of getting a mortgage for which he or she might well be ineligible?  [More at CFPB, May 2013 pdf]

In its avaricious quest for ever more profitable streams of gratifying revenues, the financial sector, churning out  those private student loans financed by asset based securities, did damage not only to the immediate overall economy and its consumers, but managed as well to hog tie our future capacity to expand our ‘real’ economy and placed already under-developed areas in even more constrained circumstances.

Given this sad state of economic affairs, it is extremely difficult to shed anything but crocodile tears for the wheelers and dealers on Wall Street when they whine about regulations and bemoan their reduced “opportunities.”  There’s no way to elutriate their sins or expiate their former behavior.


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