A Scary Report From the Federal Reserve Bank: More Than Half of a Recent Cohort of Student-Loan Borrowers Did Not Reduce Their Debt by One Penny Over Five Years

Steve Rhode commented recently on a Federal Reserve Bank report published last July. As Mr. Rhode pointed out, the Feds reported that home ownership among young people declined by 8 percent over an 8-year period (2007 to 2015);  and the Feds concluded that a substantial reason for this decline is rising levels of student-loan debt.

The Fed report also observed that more young Americans are living with their parents than in previous years. In 2004, about one third of 23-25-year-olds lived with their parents. In 2015, 45 percent of people in this age bracket were living with mom and dad--a big increase.

These are alarming statistics, but the Fed's report also included information that is even scarier. More than half of student-loan borrowers in the 2009 cohort of borrowers had not paid down their student loans by even one penny five years after beginning repayment.

According to the Fed report, 59 percent of the 2009 cohort who owed $5,000 or less had not reduced their debt by even a dollar by 2014.  Well over half of people with very modest levels of student debt were delinquent on their loans, in default, or had failed to reduce their original loan balance by even a fractional amount.

Among people who owed between $50,000 and $100,000, 57 percent had not cut their student-loan debt by even a penny over five years. Among people owing $100,000 or more, 54 percent had made no progress on their loans during that time period.

The Fed report was commenting on a single cohort: people who took out student loans in 2009. But the repayment rates for more recent cohorts must be at least as bad. The Department of Education has been encouraging distressed borrowers to enter 20- and 25-year repayment plans, which lowers monthly payments. But in almost every case, the lower payments are not large enough to cover accruing interest, so most of the 6 million people in long-term, income-drive repayment plans are seeing their loan balances grow larger with each passing month.

And here's another scary tidbit of information. The Government Accountability Office reported in 2016 that half the people in income-driven repayment plans have been kicked out because they aren't abiding by the plans' eligibility rules.

In short, a perfect storm is brewing on the nation's economic horizon. Student loans are forcing more and more young people to postpone buying a house and to live with their parents.  Millions of people are making no progress at all toward paying off their student loans.

We can quantify some of the harm caused by the student-loan crisis, but other harms are difficult to measure. How many people have given up trying to get ahead because their student-debt grows larger with each passing month? How many have become cynical, despondent, or angry? How many of those masked antifa anarchists have student loans?

Steve Rhode put his finger on the only solution to the student-loan catastrophe. "Unless we tackle the growing problem of excessive student loan debt and allow those with unmanageable student loan debt to a fresh start in bankruptcy,"Mr. Rhode wrote, "the economic future of the days ahead is going to be less than it could have been."

Exactly. The only path out of this economic quagmire is through the federal bankruptcy courts.

The student-loan crisis is brewing into a perfect storm.

References


Zachary Bleemer, et al. Echoes of Rising Tuition in Students' Borrowing, Educational Attainment, and Homeownership in Post-Recession America. Federal Reserve Bank of New York Staff Report No. 820, July 2017.

Steve Rhode. Student Loan Debt Hurts Economy, Consumers, and Retirement Savings. Personal Finance Syndication Network, September 207.

US. Government Accounting Office. Federal Student Loans: Education Needs to Improve Its Income-Driven Repayment Plan Budget Estimates. Washington, DC: U.S. Government Accounting Office, November, 2016.

The Student-Loan Bubble: Will the rising level of student-loan indebtedness lead to a national economic catastrophe?

This is the way the world ends

Not with a bang but a whimper.

T.S. Eliot                       

The Hollow Men            

In recent years, I have heard speculation that the federal student-loan program is similar to the real estate bubble that developed in the early years of this century and which ultimately led to the national financial meltdown of 2008.  Does the student loan program have the potential for running our economy into the ditch?

I once discounted this notion. After all, the home-mortgage crisis involved a lot more money than the federal student-loan program.  It is true that Americans now owe about $1.3 trillion in student loans, which is not chicken feed. But compared to the national debt--about $19 trillion--the student-loan program doesn't seem like a big deal. After all, the government's quantitative easing program involved the creation of $1 trillion a year when it was in full swing.

But I'm beginning to think differently about the student-loan crisis based on these considerations:

Enormous growth in student-loan debt. First of all, total student-loan indebtedness has grown enormously over the past 10 years. According to a recent report by the Federal Reserve Bank of New York, total outstanding indebtedness grew from  around $400 billion in 2007 to more than $1.2 trillion in 2015. In other words, total indebtedness tripled in less than 10 years.

Indeed, as has been widely reported, student loans now comprise the second largest category of consumer debt, surpassed only by home mortgages.  Student -loan indebtedness is now larger than both automobile loans and credit card debt.

More student-loan debtors.  Second, the total amount of student-loan borrowers keeps growing--43 million people now have outstanding student loans. That's almost 18 percent of the nation's adult population.

High loan default rates. Third, student-loan default rates are distressingly high. Although the U.S. Department of Education reported recently that three-year default rates are dropping, the drop is deceptive. Three-year default rates are dropping because the Department of Education and the college industry are encouraging students to obtain economic-hardship deferments or other form of forbearance that excuse former students from making monthly loan payments. But the fact remains that a high percentage of borrowers in the repayment phase of their loans aren't making payments,

In fact, as the Brookings Institute reported, 5-year default rates are 28 percent.  In the for-profit sector, the five-year default rates is an eye-popping 47 percent! Given the catastrophic consequences of default, it is astonishing that almost half the people who attend for-profit colleges eventually default on their loans.

Discounted tuition rates. Finally, private colleges are discounting their tuition rates more and more, an indication that American families simply refuse to pay the sticker price for a college education.  According to an article in Inside Higher Ed, private colleges are now discounting tuition for freshman students by an average of 48 percent!

Obviously, the federal government can't go on forever lending ever larger quantities of money and expecting students to passively take out larger and larger loans for the privilege of going to college.

So yes, there is a student-loan bubble; and the bubble is going to burst. When? I don't know, but I think we will see growing turmoil in the for-profit-college industry and the private-college sector. Within five years, we will see a significant number of non-elite private colleges bite the dust. And we will see increasing pressure on the for-profit colleges.

But when the bubble bursts, I don't think we will witness a spectacular meltdown in the economy that we saw in 2008. To borrow a phrase from T. S. Eliot, the federal student loan program is not going to explode with a bang, but with a whimper.  And the people who will be whimpering most are the millions of people--probably 20 million--who simply cannot pay back their student loans and who cannot discharge them in bankruptcy.

In my opinion, everyone in the higher education industry should be praying for more compassionate bankruptcy judges who are willing to discharge billions of dollars in student-loan debt and give millions of distressed borrowers a fresh start. If distressed student-loan borrowers don't obtain some form of tangible relief, we are going to see a shrinking middle class and a class of lifetime student-loan debtors who have been pushed to the sidelines of the national economy by student loan debt from which they cannot shake free.  In other words, as I have said before, we are hurdling hell-bent toward a sharecropper economy.

References

Jesse Bricker, Meta Brown, Simona Hannon, and Karen Pence. How Much Debt Is Out There? FEDS Notes, August 7, 2015. Accessible at http://www.federalreserve.gov/econresdata/notes/feds-notes/2015/how-much-student-debt-is-out-there-20150807.html

Kelly Woodhouse. (2015, November 25). Discount Much? Inside Higher Ed. Accessible at: https://www.insidehighered.com/news/2015/11/25/what-it-might-mean-when-colleges-discount-rate-tops-60-percent?utm_source=Inside+Higher+Ed&utm_campaign=389f6fe14e-DNU20151125&utm_medium=email&utm_term=0_1fcbc04421-389f6fe14e-198565653

Adam Looney & Constantine Yannelis, A crisis in student loans? How changes in the characteristics of borrowers and in the institutions they attended contributed to rising default rates. Washington, DC: Brookings Institution (2015). Accessible at: http://www.brookings.edu/about/projects/bpea/papers/2015/looney-yannelis-student-loan-defaults

Karyne Williams. Federal Reserve Bank of New York Takes On Student Debt Crisis in New Blog Series. Generation Progress, February 27, 2015. Accessible at http://genprogress.org/voices/2015/02/27/35083/federal-reserve-bank-of-new-york-takes-on-student-debt-crisis-in-new-blog-series/

According to the Federal Reserve Bank of New York, one third of student-loan borrowers in repayment during 2012 were delinquent!

According to the Department of Education's most recent report, 13.7 percent of student-loan debtors in the most recent cohort of borrowers defaulted on their loans within three years of beginning the repayment period.  That's not a good number, but DOE tells us that the student-loan default rate actually went down a bit from the previous year, when the three-year default rate was 14.7 percent.

The DOE's report on student-loan default rates is mildly intersting, but the Federal Reserve Bank of New York drilled down a little deeper into the data; and its findings are alarming.  In a report issued last  April,  FRBNY concluded that about 17 percent of the nation's 39 million student-loan borrowers were in default in 2012. Interestingly, people in the 30 to 49 year-old age bracket had the highest delinquency rates--higher than either younger borrowers or older borrowers.

 Moreover, as the Federal Reserve Bank pointed out, this percentage figure is based on a denominator that includes borrowers who are not in the repayment phase of their loans. Some are still in school, some have deferments, and some are participating in income-based repayment plans.

Among borrowers in the repayment phase (which constitute a smaller denominator), almost one third are in delinquency. This figure should alarm everyone in the higher education community.

Furthermore, the percentage of borrowers transitioning into delinquency on a quarterly basis is going up. The FRBNY report found that 6 percent of non-delinquent borrowers transitioned into delinquency in 2005. "By 2012, that rate had increased to 9 percent." Thus, there has been "an increasing trend of borrowers becoming newly delinquent over time"(Brown, et al., 2014, p. 12).

So what's the bottom line? In 2012, almost a third of student-loan borrowers who are in the repayment phase on their loans are delinquent on their monthly payments.  And that doesn't include millions of people who have economic-hardship deferments that excuse them from making payments. And when we add in all those people in income-based repayment plans who are making monthly payments that are so low that their loan balances are not going down, we can see that the percentage of people who are not paying off their student loans is quite high.

In short , the evidence is all around us. The federal student loan program is in real trouble.

References

Meta Brown, Andrew Haughwout, Donghoon Lee, Joelle Scally, and Wilbert van der Klaauw. Measuring Student Debt and Its Performance. Federal Reserve Bank of New York, April 2014. Accessible at: http://www.newyorkfed.org/research/staff_reports/sr668.pdf