Lombardi: Stock Market Commentary & Forecasts, Financial & Economic Analysis Since 1986

The Student Loan Ticking Bomb; Why It’s Such a Big Problem

Wednesday, February 6th, 2013
By for Profit Confidential

The Student Loan Ticking BombThe threat of another credit rating downgrade for the U.S. national debt is increasing. But it’s not just due to the government’s inability to control its deficit; it’s about items not considered in budget talks. Student debt, for example, which has become increasingly guaranteed by the government, currently stands near $1.0 trillion.

And consumer debt is increasing, too. In third quarter 2012, non-real estate household debt in the U.S. economy increased 2.3% to $2.7 trillion, of which $42.0 billion was student loan debt. (Source: Federal Reserve Bank of New York, November 27, 2012.)

The percentage of student debt delinquent for 90 days or more is 11%. This delinquency rate is much higher than other credit products, such as credit cards, home equity line of credits, mortgages, and auto loans. Student debt default is skyrocketing.

A study by Fair Isaac Corporation, a credit score provider, found that about 26 million Americans had two or more student loans on their credit report in October of 2012. That’s up from 12 million in 2005, a rise of 116%.

How does this all relate to the U.S. national debt getting its credit rating cut again?

The federal government has been playing an active role in the student debt market. It makes 93% of all the student loans in the U.S. economy. (Source: Wall Street Journal, January 30, 2013.)

Now, imagine what happens to U.S. national debt if the delinquency rates on student debt keep rising as those who borrowed are unable to pay?

U.S. national debt has surpassed $16.4 trillion, and the government continues to post yearly deficits. I continue to ask: what happens when our creditors come to the realization that paying for expenses by printing paper money can only go on for so long? And what will that do to the value of the greenback and interest rates?

The truth of the matter is that there are no jobs in this country. As I wrote last Friday, the official U.S. unemployment rate actually rose in January from December, and the majority of jobs being created are in low-paying sectors, like retail and service (restaurants). If the jobs market is a bad one, how can we not have rising defaults on student debt? At the same time, college tuitions have increased significantly.

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Why is this important to my readers?

While the government tries to get its annual deficit under $1.0 trillion, and makes promises that it will, other factors outside of its current regular bills are not being considered. Should the government start writing off some of its student debt guarantees? Sure it should. Will interest rates rise as inflation comes into play over the next couple of years, because there are too many dollars in circulation? Sure they will rise.

Add in the “unexpected” costs of higher interest rates, rising student debt defaults, and other “unforeseen” factors, and hundreds of millions of dollars could easily be added to the annual government deficit.

My point in all this?

It will be years before the Federal Reserve can turn off the money spout. Long-term, I believe this will be a big problem for consumers because of the inflation after-effects of such a large increase in the money supply. Inflation cometh; followed by higher interest rates.

Michael’s Personal Notes:

The Federal Reserve has increased its balance sheet significantly through quantitative easing, but I still continue to question its effectiveness. Quantitative easing hasn’t done much for the U.S. economy except: 1) make the banks richer; and 2) rally the stock market, which is good for Wall Street. Quantitative easing has not helped the working poor in this country; nor has it helped the great majority of our citizens.

We need to look at other nations that have already implemented quantitative easing and that have failed at it, such as Japan or the United Kingdom.

Similar to the Federal Reserve, the central bank of Japan has promised to print an unlimited amount of Japanese yen to boost its economic growth and to promote export. Unfortunately, the effects of this are unseen in the economy. As a matter of fact, things have just turned the other way. The trade gap for the Japanese economy for 2012 was $78.27 billion, and exports have been falling for seven consecutive months. (Source: Reuters, January 24, 2013.) Meanwhile, the Japanese yen has fallen in value against other major currencies in the global economy.

Likewise, the Bank of England took the route of quantitative easing. The result? The U.K.’s economy contracted in the fourth quarter of 2012. The central bank of England introduced quantitative easing in March 2009 to boost economic growth, and since then, the Bank of England has printed 375 billion pounds worth of paper currency it exchanged for government debt. (Source: Bank of England web site, last accessed February 4, 2013.)

When I see these nations struggling to spur economic growth through printing paper money, I become more skeptical about further quantitative easing by the Federal Reserve. We are becoming similar to these countries. Our dollar has declined in value against other world currencies, and our economy contracted in the fourth quarter of 2012.

The economic conditions for consumers in the U.S. economy are very poor. Bottom line: they don’t have excess money to spend, and they are worried about their financial future. Quantitative easing isn’t helping them, as they continue to suffer.

I stand by my belief that if quantitative easing didn’t work for countries like Japan and the United Kingdom, chances of it working here anytime soon are very slim to none. Don’t get fixated on the performance of the stock market, dear reader; it is running on hopes.

Where the Market Stands; Where It’s Headed:

For the stock market, we are at the top or very close to it.

What He Said:

“You’ve been reading my articles over the past few months and have seen how negative I’ve become on the U.S. economy. Particularly, I believe it’s the ramifications of the faltering housing sector that are being underestimated by economists. A recession doesn’t take much to happen. It’s disappointing more hasn’t been written on the popular financial sites and in the newspapers about the real threat of a recession happening in 2007. I want my readers to be fully aware of my economic opinion: I wouldn’t be surprised to see the U.S. economy in a recession sometime in 2007. In fact, I expect it.” Michael Lombardi in Profit Confidential, November 13, 2006. Michael was one of the first to predict a U.S. recession, long before Wall Street analysts and economists even thought it a possibility.

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Michael Lombardi - Economist, Financial AdvisorMichael bought his first stock when he was 17 years old. He quickly saw $2,000 of savings from summer jobs turn into $1,000. Determined not to lose money again on a stock, Michael started researching the market intensely, reading every book he could find on the topic and taking every course he could afford. It didn’t take long for Michael to start making money with stocks, and that led Michael to launch a newsletter on the stock market. Some of the stock recommendations in Michael's various financial newsletters have posted gains in excess of 500%! Michael has authored and published over one thousand articles on investment and money management. Michael became an active investor in real estate, art, precious metals and various businesses. Readers of the daily Profit Confidential e-letter are offered the benefit of the expertise Michael has gained in these sectors. Michael believes in successful stock picking as an important wealth accumulation tool. Married with two children, Michael received his Chartered Financial Planner designation from the Financial Planners Standards Council of Canada and his MBA from the Graduate Business School, Heriot-Watt University, Edinburgh, Scotland. Follow Michael and the latest from Profit Confidential on Twitter or Add Michael Lombardi to your Google+ circles