A Degree in Debt: Student Loans and the Economy
Manning & Napier
October 15, 2013
Recent times have drawn concerns about student loan debt and rising delinquencies. Anecdotes of unfortunate individuals struggling financially to cope with massive student loans raise fears of broader risks to the US economy and financial markets.
Phrases like “soaring debt” instantly revive events of the past, such as last decade’s sub-prime mortgage meltdown, which inflicted tremendous collateral damage on the broader financial markets bringing the real economy to a standstill. Many still in “recovery-mode” view the student loan situation as another potential catalyst for a financial crisis.
While it is true that nearly $1 trillion of student loan debt outstanding exists today across approximately 39 million borrowers, our assessment of the potential overall impact is that it is more likely a modest headwind to growth, versus a larger threat to financial markets or the broader economy.
In our view, the risk of a true financial crisis stemming from a surge in student loan defaults is very unlikely, due to several factors:
- The vast majority of student loans outstanding (approximately 85%) are either directly issued by the U.S. government (i.e., the Direct Loan program) or guaranteed through the Federal Family Education Loan Program (FFELP).
- Approximately 15% of outstanding student loan debt is provided by private lenders. Private lenders tend to be more selective than public programs when approving loans than and often require co-signers. As a result, the private loan delinquency rate is currently less than half of the national rate.
- In addition, Financial Obligations Ratios (FOR) for renters and homeowners excluding mortgages (i.e., consumer borrowing), show that in aggregate, consumer financial burdens remain below historical averages.
While this is good news, at the same time, recent college graduates may be facing the prospect of higher debt balances, coupled with weaker employment prospects, especially those in the 20-24 year old age group. Although this group historically has had a higher unemployment rate than those over 25, the reality is that since the Great Recession, this gap has widened even further.
Echo-boomers (mid-teens to early thirties) currently make up about a quarter of the population, and are entering the stage in their lives where they should be purchasing cars and first homes. According to the National Association of Realtors, first time home buyers made up just 28 percent of the housing market in August, well below their long-term 40 percent average. One third of college graduates plan to live at home with their parents post-graduation, according to a recent Accenture survey.
These factors may curb growth at the margin, as consumers must divert their income used for other purchases, and evaluate how student debt will adversely impact both current and future consumption and savings plans. While the debt situation generally appears manageable from a macroeconomic perspective, we will need to monitor further for greater economic headwinds as they present themselves. Overall, the current student debt situation is another contributing factor that supports our ongoing slow growth thesis for the U.S. economy.
(c) Manning & Napier