The Student Debt Bubble

by: Brad Alvarez

Look at the size of that bubble. That bubble is the size of one trillion dollars. A small number when you look at the overall total credit market debt owed in the U.S., which is $54 trillion, but the growth of the student debt is striking.

Luckily for the owners of this debt, which is a mix of both public and private, the ability for students to declare bankruptcy and avoid paying this debt is nearly non-existent, because bankruptcy law protects the lender in these cases. The reason is students are borrowing this money to get a good college education, so they can be forced to service this debt over their lifetime (and according to conventional wisdom, this education should increase the borrowers salary, making the debt servicing even easier). That’s why lenders don’t really care too much about the credit worthiness of the borrowers (most of them have no credit scores, or worthiness, at all). They’ll lend to nearly anyone, knowing that the debt can rarely be forgiven under current law.

Unfortunately, without strong structural fixes in our economy, this debt will hold down the graduates for years to come. It creates an unwanted psychological burden as well on the borrower, knowing that they have this $25,000 burden on themselves, which they’ll want to get rid of as soon as possible. All of this debt delays graduates from buying a home, marrying and having kids, buying cars, or any other big decision/purchase in their lives, because their number one priority is getting rid of this debt.

That $25,000 number is also the average. It combines the kids with no debt with the ones with debt, to find the mean. However, I would bet that the average graduate who had to take any loans at all is graduating with much more debt than $25,000, probably more up around the $60,000 range (that is arbitrary). And that is a scary number once you graduate, especially in today’s job market. This could create further inequality down the road, something that no one wants.

I would argue that the easiness of getting a loan is the main reason that college has become so expensive over the last 10 years. Of course the fact that state government support of higher education has fallen drastically has caused tuition to increase, but this can also be viewed as a demand issue. If state government's lowered support and that caused tuition enrollment to drop, I believe there would be a large backlash because no legislator wants to be responsible for lowering the ease of access to higher education. But if they see enrollment increase while slashing state support, then why not continue slashing? And that increase enrollment is due to the easily accessible college loans.

Since nearly anyone can get a loan, and the mass of amount of worker retooling that people need to get a better job, the demand for college is nearly limitless (try to name a public state university that enrollment fell at), allowing colleges (and state governments, because usually a state agency sets the tuition) to increase student tuition 10% a year. That is insane. No matter what colleges charge, one can get the loan to attend college for the year. That is a big problem. This even translates over to rent. The explosion of enrollment over the past 10 years has virtually dried up any excess supply in the rental department for college cities and towns, causing rent to skyrocket. I know that rent didn’t stop going up in Corvallis, which is where I go to school, even during the Great Recession. That drives up the cost of attendance even further, because students need somewhere to stay.

What angers me most are the fact that politicians caused this problem, (I would dare to say our elders who voted those politicians in and stood by as our deficits were driven through the roof and pension benefits became insanely generous, among other things) and the students and current high school kids are the ones that will be affected.

As a result, I see downward pressure on the economic potential of our economy in the long run growth due to my generation being stifled. Depending on how we respond to immigration (it’s not looking good), our long-term growth rate could be much less than during the 20th century, when it was 3.4%. I could easily see the average growth rate severely depressed to 2.0-2.5% during the 21st Century. That’s a 33% drop. That does not bode well for staples stocks such as Proctor & Gamble (NYSE:PG) or Pepsi (NYSE:PEP). I know a lot of people are very bullish on long term U.S. growth, but I wanted to show where the possible bears are.

Disclosure: I am long SDS, TLT.