Student Debt Bubble to Spark U.S. Economic Collapse?
After much deliberation, the Fed has finally raised rates. Having nearly brought about a U.S. economic collapse, some believe the rate hike has come too late—the commodities sector seems like it’s in a perpetual decline, the housing market is inflated, the corporate sector is facing layoffs, federal debt is skyrocketing, and the stock market is in a fragile state. Nonetheless, one issue could spark a U.S. economic collapse in 2016 is student debt.
Student loans have touched all-time highs this year—over a whopping $1.0 trillion and growing. The recent interest rate hike has further tightened the economy. Certainly, neither wages nor the employment rate will be going up anytime soon, which means indebted students are graduating with degrees only to face unemployment or underemployment. Either way, they are unable to pay back their debt.
To put this crisis into better perspective, take the Wall Street Journal’s report on Fed data, according to which more than half the students at 347 for-profit U.S. colleges and schools have failed to pay a single penny even after seven years. (Source: “Student Debt Payback Lags,” The Wall Street Journal, September 13, 2015.)
These profit-seeking institutions have further worsened the problem by allowing their degrees to become devalued. Virtually anyone can take up a hefty loan to get enrolled in a degree program. With more and more holders of the same degree out there, the value of the degree has decreased. In effect, students are paying more to buy an asset that’s losing value. The result? Joblessness!
As for students who land a job, part of their wages go to paying back the debt, thus decreasing their disposable income that could be set aside for consumption. Of course, lower consumption translates into lower overall economic activity, lower corporate profits, and ultimately more joblessness for the next graduating class.
In fact, the problem of student debt is a vicious cycle. A study by the Federal Reserve reveals that student loans and school tuitions have become congruent. (Source: “Credit Supply and the Rise in College Tuition: Evidence from the Expansion in Federal Student Aid Programs,” New York Fed, July 2015.)
What’s happening now is that institutions are raising tuitions because they know students have debt financing at their disposal. The higher tuitions translate into higher demand for student loans. The higher credit supply then becomes a reason for institutions to further raise tuitions and the cycle continues.
Now, the recent hike in interest rates may not affect students who have already taken up loans, but it certainly spells trouble for future students. Interest rates on future private student loans that are variable will certainly go up. Public student loans, on the other hand, are fixed, but depend on 10-year Treasury notes. So ultimately, those too will be going up, even if by a small margin.
We wouldn’t be wrong to assume that should the Fed go for more rate hikes, they’ll bring the student debt bubble to the point where it will only explode; and when it does, it will take down the consumer market with it, tipping the scale for a trickle-down effect to follow that will cause a major dent in the U.S. economy, if not an economic collapse in 2016. Watch out!