A Vicious Cycle Fuels The Massive Student Loan Bubble

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by: Lionfin Capital


A vicious cycle of government-backed loans fuels the massive student loan bubble.

Student loan debt is a drag on economic growth.

Too many young people go to college.

The student loan bubble resembles the recent housing market bubble.

A Vicious Cycle & Its Impact On Growth

The student loan bubble begins with the government. Loans offered to students are guaranteed by the federal government. Colleges can then charge higher tuition rates if the government intends to back its own loans. The effect of government-backed subsidies and loans is staggering inflation. As seen in the image below, college tuition prices have easily outpaced benchmark inflation.

In fact, college tuition prices have outpaced inflation every year since 1981. Secondly, college tuition increases at an average of 6% greater than benchmark inflation. One method of reducing prices would be to increase the supply of students, thereby lowing tuition costs. However, colleges choose to solve the problem by raising prices and will likely continue to do so. The effects of higher tuition costs are starting to impact the financial stability of students. Two-thirds of college students are in debt and the average graduate owes $25K. In total, student debt exceeds $1T. As a result of mounting debt, the student loan default rate is growing quickly. From 2003-2010, the student loan default rate more than doubled from 4.5% to 9.1%! To compound problems, student loans from the federal government are non-dischargeable. With non-dischargeable loans students cannot declare bankruptcy and rid themselves of student loan debt. Instead, students are only allowed to purchase essential items for survival as the federal government aggressively garnishes the wages of those in debt. An increasing number of consumers that can only purchase essentials serve as a drag on the U.S. economy.

Too Many Young People Go To College & Similarities To The Housing Market Bubble

It's hard to argue with the statistics that indicate too many high school seniors go to college. For one, the U.S. has the highest dropout rate in the industrialized world. If the federal government didn't guarantee student loans then fewer students would go to college. With fewer students attending traditional higher education, the runaway inflation of college tuition prices would be under control. A second effect of fewer students obtaining traditional higher education degrees would be the decrease of structural unemployment. Too many decent, well-paying vocational jobs go unfilled in the U.S. In other industrialized nations such as Germany, some students choose to attend job training programs offered by companies that are happy to hire dedicated, well-trained high school graduates. It's healthier to both the individual and the broader economy to be a vocational worker with a $44,000 salary and no college debt than an unemployed humanities major with a frightening amount of student loan debt. In fact, half of humanities students obtain jobs that don't require a college degree.

That being said, a simple comparison of salaries indicates that it is unquestionably better to have a college degree than solely a high school degree. The issue is not higher education, it's too many students pursuing higher education with a huge, government-backed loan. Similarly, too many people became "homeowners" and as household debt soared, the housing market bubble increased. Homeownership is a good thing, but becomes a problem when too many pursue it. Likewise, a college education is a good thing, but not when those who don't need it pursue it. In both cases, the root cause lies with the federal government and its inflation fueling loans and subsidies. Just as the federal government encouraged home ownership in the years leading up to the housing market bubble, the federal government is actively pushing some students to obtain a potentially unneeded major. Even worse, as college tuitions rise, public pressure increases to increase loans and subsidies to college students! Politicians, responding to the wishes of the people then increase loans and subsidies. And in increasing government loans and subsidies, those in government only add fuel to a rapidly growing bubble that threatens to puncture growth.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.