Probably the best way to identify a bubble is when its chart goes parabolic. That's why I'm using a lot of charts in this diary.
There are several bubbles in today's economy. For instance, government debt (which is too large and overpriced), but those bubbles could go on for many more years before bursting.
Student loans, OTOH, are in real trouble and can't continue like this for long.
For those of you familiar with the charts behind the subprime housing boom and bust, I would like to present two charts that should remind you of 2007.
These two charts alone should concern you. The thing is, even these charts don't tell the entire story.
The Department of Education just started reporting on student loans three years after graduation.
Two years after leaving school, students default on their federal loans at a rate of 9.1 percent, up from 8.8 percent at last count. That figure jumps to 13.4 percent at the three-year mark, the report shows.At 13.4% default rate that comes to $120 Billion of government loans not being paid.
And yet this is still not the worst news. For instance, consider how much the default rate jumped between the 2 and 3 year marks. That should give you a hint.
Does this mean that the prospects for student loan delinquencies are similar to those for the household debt in general, and thus no special attention is warranted?
Unfortunately, this is not the case—some special accounting used for student loans, not applicable to other types of consumer debt, makes it likely that the delinquency rates for student loans are understated. In the case of federally backed loans, which represent a majority of total lending, repayment is deferred until the student graduates from school and can then be pushed back by another six-month grace period. How do these student loans in deferment or grace periods show up on credit reports and contribute to the delinquency statistics? Given that no payment is necessary until graduation, these deferred student loans are not included in the past due balance but they are included in the total balance from which the delinquency rate is derived. This may help explain the low proportion (12.6 percent) of borrowers with past due student loans among those under thirty years old, compared with 16.9 percent among those between the ages of thirty and thirty-nine, since many of the younger borrowers are still in school and don’t yet have to make any payments.
From this exercise, we find that as many as 47 percent of student loan borrowers appear to be in deferral or forbearance periods, and thus did not have to make payments as of third-quarter 2011.
We then recalculate the proportion of borrowers with a past due balance excluding this group of borrowers. We find that 27 percent of the borrowers have past due balances, while the adjusted proportion of outstanding student loan balances that is delinquent is 21 percent—much higher than the unadjusted rates of 14.4 percent and 10 percent, respectively
In other words, the student loan default rate is rapidly approaching subprime housing market circa 2007 levels.
So what makes this a bubble?
As Dr. Davies explains, the best way to understand the bubble is to “consider the recent housing bubble” of 2008 and draw comparisons. We see many similar policies being used: artificially low interest rates, tax incentives for taking on larger amounts of debt, and the government imposing itself as a direct lending agent to students.
So to summarize the situation: the government has artificially inflated a huge market for an intangible product called “education,” price is accelerating upward, and the debt-holders are generally low-income young people with no way to evade repayment if things go bad.
At the current rate of student loans, the total federal student loan market should hit $1.3 Trillion in just over a year. $1.3 Trillion is a significant number when you put it into context.
Look at the size of the subprime housing market in 2007.
The difference being is that unlike the subprime housing bust, much of this defaulted debt will go on the public balance sheet, not to Wall Street banks.
Consider just how big the student loan program is to the Federal Government, as shown by the latest flow of funds report.
I remember trying to discourage a college-educated friend of mine not to buy a house in 2005. She was worried about being "forever priced out of the market". She also told me not to worry because "housing prices always go up".
I tried to tell her that if something always went up in price then no one would ever invest in anything else. She didn't listen.
The student loan bubble is similar in many ways. The price of higher education has been going up faster than inflation for decades now. The return on investment is falling because of this, yet prices are rising ever more rapidly.
Meanwhile wages for entry-level jobs are falling. The gap is being filled by ever larger amounts of debt.
Simple math says that this can't continue for long.
So what happens when it bursts? It's hard to be certain, but you bet on a couple things happening.
1) a number of banks will take hits and there will be pressure to bail them out
2) the student loan program will be slashed. This will likely...
3) cause several colleges to close (for-profit colleges will get hit first)
Which leaves two issues that are much harder to predict.
How will this effect the students? It's a political decision, so it could go any direction. Do we bail out a bunch of college educated kids? Do we leave an entire generation of our most promising youth to struggle with debts their entire lives? Do we reform a system badly in need of reform, or just slash it?
And how will this effect the future of higher education? Will we return to a society in which only the rich can afford it?