Federal Reserve Bank Report: Households with "negative wealth" tend to have high levels of student loan debt. Should we be surprised?

Households with more debt than assets are said to have "negative wealth." In other words, they owe more than they own. Or to put it more baldly, they're broke.

Researchers for the Federal Reserve Bank of New York published a report this week on negative wealth households, and some of  their findings are not surprising.

Researchers found that negative-wealth households "are younger, predominantly female, more likely to be minority, own homes at lower rates and have lower average annual incomes than households with nonnegative wealth" (quoting from Inside Higher Education). This is what we would expect.

What I found most interesting were the report's findings about the kind of debt that negative wealth households tend to have. Among households that have $47,000 to $52,000 in negative wealth, almost half of their total debt is student loans. Among households with lower levels of negative wealth--between $12,500 and $46,300--college loans made up 40 percent of total debt.

And here is the report's money quote:

Given the importance of student debt in explaining negative household wealth . . ., it is likely that the steady growth in student debt and borrowing combined with the slow rate of student loan repayment . . ., has materially contributed and will continue to contribute to negative household wealth and wealth inequality. 

Should we be worried by this report?

At least a couple of experts suggest that we should not be overly concerned. In an interview with Inside Higher Education, Robert Kelchen of Seton Hall University said that student loans are driving income inequality with just one group of students--those who take out student loans but never complete their degree.

Kelchen pointed out that a lot of households with negative wealth include borrowers "who took out student loan debt to pay for graduate school and professional degrees." Although this group may carry a lot of student-loan debt, it will eventually do well financially.

But of course Kelchen's observation is not completely accurate. Law school graduates, on average, leave law schools with $140,000 in debt; and they are entering a terrible job market. Paul Campos, a law professor at the University of Denver, flatly stated that most people who graduate from second- and third-tier law schools at the bottom or their law school class will be financially hurt by their law school experience. They will likely never obtain an income that justifies the debt they incurred to get their J.D. degrees.

Mark Kantrowitz, another expert quoted in Inside Higher Education, suggested that people who borrow money to get a college degree will be better off than people who don't go to college at all. "Would these individuals have been able to obtain a college education had they not borrowed?" Kantrowitz asked. "And where would their net worth be if they hadn't taken on this debt because they hadn't gone to college?"

Basically, Kantrowitz is repeating the mantra of the higher education community's insiders. Sure, they say, people borrow heavily to go to college. But they're still better off than people who don't go to college at all.

But that is not necessarily true. We know that 35 percent of the college-educated workforce is made up of people holding jobs that do not require a college education.  If those people borrowed a significant amount of money to get their degrees, they might very well have been better off had they skipped the college experience altogether.

And we also know that some people pay more for their college degrees than they are worth. Brenda Butler, who filed for bankruptcy recently, borrowed $14,000 to get a bachelor's degree in English from Chapman University in California, which she obtained in 1995. According to the bankruptcy court's opinion in her case, Butler never made much more than $30,000 a year, and she experienced some periods of unemployment when she was unable to make her loan payments. Twenty years after she graduated from college, Butler owed more than twice what she borrowed and was in bankruptcy.  I think we can safely say that Butler does not fit Kantrowitz's model.

In short, we should not dismiss this recent report from the Federal Reserve Bank of New York. The report confirms what we already knew intuitively, which is this: Student-loan indebtedness contributes to rising income inequality in the U.S. and it cripples some families from acquiring wealth.  And as the government shifts millions of college borrowers into 20- year, 25-year, and even 30-year repayment plans, the trend documented by the Federal Reserve Bank researchers is only going to accelerate.

References

Butler v. Educational Credit Management Corporation, Case No. 14-71585, Chapter 7, Adv. No. 14-07069 (Bankr. C.D. Ill. Jan. 27, 2016).

Andrew Kreighbaum. Federal Reserve analysis finds high student loan debt in housholds with most negative wealth. Inside Higher Education, August 3, 2016. Accessible at https://www.insidehighered.com/news/2016/08/03/federal-reserve-analysis-finds-high-student-loan-debt-households-most-negative?utm_source=Inside+Higher+Ed&utm_campaign=56be543194-DNU20160803&utm_medium=email&utm_term=0_1fcbc04421-56be543194-198564813

Olivier Armantier, Luis Armona, Giacomo De Giorgi, and Wilbert van der Klaauw. Which Households Have Negative Negative Wealth? Liberty Street Economics, August 1, 2016. Accessible at http://libertystreeteconomics.newyorkfed.org/2016/08/which-households-have-negative-wealth.html#.V6IRq3qxUwf

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