The Student Loan Crisis is WORSE than the 2008 Housing Crisis: The Return of "The Big Short"

As everyone knows, the housing market collapsed in 2008, triggering a major economic crisis in the United States. The nation descended into recession, and the national economy is still recovering from this catastrophe.

Steve Rhode and others have described a student loan "bubble," and I share these commentators' view that the federal student loan program as it functions now is unsustainable.  Approximately 42 million borrowers collectively owe $1.4 trillion in student-loan debt, and families are beginning to experience sticker shock. Enrollments are declining at the for-profit schools, and nonprofit liberal arts colleges are desperately scrambling to maintain their enrollments.

Many people may think the student-loan crisis--no matter how bad it is--is just a small tremor compared to the 2008 housing crisis, which was an earthquake.

But in fact, the student loan crisis has produced more casualties in terms of human suffering than the housing collapse ten years ago.

Earlier this week, Alan White of Credit Slip, an online news source on economic matters, commented on a housing-data report released recently by the Urban Institute. Based on the Urban Institute's data, White assessed the total damage from the subprime housing crisis. From 2007 to 2016, 6.7 million homes went into foreclosure and another 2 million homes were lost through short sales or deeds-in lieu of foreclosure. Thus the total number of homeowners who lost their homes in the subprime housing debacle is about 8.7 million. If we assume a majority of those homes were owned by married couples, then the total number of individuals who were injured in the housing crisis is about 16 million.

That's a lot of people, but the casualty list from the student loan crisis is larger. 

As the New York Times reported in 2015, about 10 million student borrowers have defaulted on their loans or have loans in delinquency. Almost 6 million debtors are now in income-driven repayment programs (IDRs), and those people are locked into repayment plans that last from 20 to 25 years. A majority of those people are making payments so low they are not servicing accruing interest, which means their student loans balances are growing larger (negatively amortizing) with each passing month.

So we're talking about 16 million people who defaulted, have delinquent loans, or who are in IDRs. And millions more have student loans in forbearance or deferment, which means they are not making payments on their loans but are not counted as defaulters. For most of those people, interest is accruing, which means their student loan balances are growing. The Consumer Financial Protection Bureau reported a total of about 9 million people in deferment or forbearance in its 2013 report titled A Closer Look at the Trillion. 

All these numbers are fluid. Some delinquent student-loan borrowers will bring their loans current, and some defaulters will rehabilitate their loans. And some people will move from deferment status to some form of IDR.

But it is safe to say--indeed conservative to say--that about 20 million Americans have outstanding student loans they can't pay back. That's 4 million more people that were injured by the housing crisis. It's The Big Short all over again.

Alan and Catherine Murray, who received a partial discharge of their student loans in a Kansas bankruptcy court last year, are the poster children for this calamity. They borrowed $77,000 to finance their studies, and both obtained a bachelor's degree and a master's degree. They paid back $54,000--about 70 percent of what they borrowed. 

But the Murrays experienced hard times and put their loans into deferment for a few years while interest accrued at the rate of 9 percent. They now owe $311,000! Will they ever pay that back? No, they won't.

Yes, the federal loan program is in a bubble, and the suffering has already begun. The federal government is propping up this house of cards and disguising the real default rate. Congress doesn't have the courage to address the problem, and the Trump administration appears to be clueless

We must look to the federal bankruptcy courts for relief. The Murrays obtained a partial dischage of their their loans from a Kansas bankruptcy judge last year, but their case is now on appeal.  

Stay tuned for further developments.

The Big Short

References

Rohit Chopra. A closer look at the trillion. Consumer Financial Protection Bureau, August 5, 2013.

Editorial, "Why Student Debtors Go Unrescued." New York Times, October 7, 2015, A 26.

Murray v. Educational Credit Management Corporation, Case No. 14-22253, ADV. No. 15-6099, 2016 Banrk. LEXIS 4229 (Bankr. D. Kansas, December 8, 2016).

Steve Rhode. The Student Bubble That Many Don't Want To See. Get Out Of Debt Guy, July 15, 2016.

Jill Schlesinger. Looking for the next bubble. Chicago Tribune, August 24, 2016.

Alan White, Foreclosure Crisis Update. Credit Slip, April 5, 2017.

The Student Loan Bubble: Eerily Similar to the Home Mortgage Crisis

A few months ago, Steve Rhode posted a thought-provoking blog titled "The Student Loan Bubble That Many Don't Want to See."  He argued that student-loan indebtedness is in a bubble that will soon burst, creating two huge problems:

First, when the student-loan market collapses, postsecondary education will be out of reach for most people,  which will "put a drag on the overall economy as fewer and fewer people will be able to pay for tuition that outpaces inflation."

Second, a sharp contraction in federal student-loan revenue along with a shrinking student base will force many colleges to cut tuition, putting them under enormous financial stress. Rhode predicts that "[m]any schools, public and private, will fail."

Mr. Rhode sees a parallel between the the student loan program and the overheated housing market that led to a global financial crisis in 2008.  Just as financiers packaged home mortgages into mortgage-backed securities called ABS, the banks have bundled student loans into so-called SLABS, or student-loan asset backed securities.

The home-mortgage market went into free fall when investors woke up to the fact that the ratings services (Moody's, Fitch, etc.) had rated ABS as investment grade when in fact a lot of them were junk because they were packed with mortgages that were headed for default.

Now we see Moody's and Fitch downgrading SLABS based on the fact that student borrowers are not paying off their loans as investors expected. More than 5 million borrowers have signed up for income-driven repayment plans that lower monthly loan payments and stretch out the repayment period from 10 years to 20 or even 25 years. SLABS investors now don't know when or how much they are going to be paid on their investments.

Some policy commentators reject the notion that the student-loan market is in a bubble. In a book published last year, Beth Akers and Matthew M. Chingos wrote: "Student loans have a zero chance of becoming the next housing crisis because the market is too small and essentially functions as a government program rather than a market." Akers and Chingos point out that student debt represents only 10 percent of overall consumer debt while home mortgages accounts for 70 percent of household indebtedness.

Personally, I think Steve Rhode is right: Higher education is sustained by a student loan bubble that the nation's colleges and universities refuse to see. In fact, there are eerie similarities between the housing market before it crashed in 2008 and the current level of student-loan indebtedness.

First,  higher education at many colleges and universities is wildly overpriced, just as the housing market was overpriced in the early 2000s. This is particularly true in the for-profit sector and at private liberal arts colleges.

As as been widely reported, liberal arts colleges are now discounting tuition for freshman students by almost 50 percent--a clear sign that their posted tuition prices are too high. And for-profit colleges are seeing enrollment declines. University of Phoenix, for example, has seen its enrollments drop by about half over the past 5 years.

Second, the monitoring agencies for both markets failed to do their jobs. As illustrated in the movie The Big Short, the financial ratings agencies rated mortgage backed securities as investment grade when in fact those bundled mortgages included a lot of  subprime mortgages.

Likewise, the Department of Education reports three-year default rates for student loans that vastly understates how many student borrowers are failing to pay back their loans. DOE recently reported that about 10 percent of the most recent cohort of student borrowers defaulted within three years. But the five-year default rate is 28 percent; and the five-year default rate for a recent cohort of students who attended for-profit schools is a shocking 47 percent.

And of course the government's vigorous effort to get distressed student borrowers into income-driven repayment plans also helps hide the true default rate. A high percentage of people who enter IDRs are making loan payments so low that they will never pay off their loans.

In short, Steve Rhode's analysis is correct.  A rising level of student-loan debt has created a bubble; and the bubble is going to burst. Colleges raised tuition prices far above the nation's inflation rate, knowing that students would simply take out larger student loans to pay their tuition bills. Millions of Americans paid too much for their postsecondary education and can't pay back their loans.

So far, the Department of Education has hidden the magnitude of this crisis, but the game will soon be up. Colleges are closing at an accelerating rate, stock prices for publicly traded for-profit colleges are down, and long-term default rates are shockingly high.

It is true, as Akers and Chingos pointed out, that the student-loan market is not nearly as large as the home-mortgage market when it crashed in 2008. But Akers and Chingos fail to acknowledge the enormous human cost that has been imposed on millions of Americans who took out student loans in the hope of getting an education that would lead to a better life.

Instead, all many Americans got by taking out student loans is an enormous debt load that they can't pay off or discharge in bankruptcy. Eight million Americans have defaulted on their student loans; 5.6 million are in income-driven repayment plans that stretch their payment obligations out for as long as 25 years, and millions more are playing for time by putting their loans in forbearance or deferment.

References

Beth Akers and Matthew Chingos. Game of Loans: The Rhetoric and Reality of Student Debt. (Princeton, NJ: Princeton University Press, 2016).

Anamaria Andriotis. Debt Relief for Students Snarls Market for Their Loans. Wall Street Journal, September 23, 2015.

Patrick Gillespie. University of Phoenix has lost half its students. CNN Money, March 25, 2015.

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).

Steve Rhode. The Student loan Bubble That Many Don't Want to See. Get Out of Debt Guy, July 15, 2016.

Amy Thielen. Declines at For-Profit Colleges Take a Big Toll on Their Stocks. The Street, May 8, 2015.

Kellie Woodhouse. Discounting Grows Again. Inside Higher Ed, August 25, 2015.