Student Loan Defaults Could Drag Down the Economy

The number of people defaulting on their student loans has risen for the fifth year in a row, according to a September press release from the Department of Education. The rate of people who defaulted within two years of their loans entering repayment went up to 9.1% for 2010, from 8.8 in 2009. That number was a relatively reasonable 4.5% in 2003.

Graduates in 2010 (the latest year available) had the highest average student debt ever, according to the Institute for College Access and Success. And if that’s not bad enough, they also had the highest unemployment rate for new grads in recent history, at 9.1% (this number, while high, was still lower than the national rate at the time). With ever-increasing debt burdens and a still feeble job market, of course people are defaulting on their gigantic loans.

"Most students in the Class of 2010 started college before the recent economic downturn, but the economy soured while they were still in school, widening the gap between rising college costs and what students and their parents could afford," said another ICAS report.

The last time this many Americans had massive debt they couldn’t handle, the housing market collapsed, dragging down the rest of the economy with it, first locally and then internationally.

Not that long ago, millions of Americans took out mortgages they couldn’t afford, from lenders who knew they couldn’t afford them. The lenders then bundled these risky debts (sub-prime mortgages), and sold them to other lenders for more than they were worth — debt that won’t be repaid has no value at all. Other lenders saw the quick bucks being made, and did the same thing. Then, when, as could have been expected, the borrowers defaulted on their mortgages, it sent a ripple through the entire economy that we’re still feeling the reverberations of now.

Now, Americans are taking out student loans that they can’t afford, from lenders who know they can’t afford them. Those lenders are re-selling the debt to other lenders, and, as student loan debt increases at a far higher rate than the unemployment rate decreases, more and more of these loans are going unpaid.

So, is student loan debt the next big bubble?

The National Association of Consumer Bankruptcy Attorneys thinks it is, according to the February 2012 report, ominously titled “The Student Loan ‘Debt Bomb’: America’s Next Mortgage-Style Economic Crisis?”

“With student loan debt now topping U.S. credit card debt and few or no options available for distressed borrowers,” the press release for the report says, “America faces the very real possibility of another major economic threat on a par with the devastating home mortgage crisis.”

Like with the mortgage crisis, it’s not just the “distressed borrowers” who hurt financially when the debt burden becomes too much to bear. More than 37 million Americans, or about 15%, have outstanding student loan debt, which not only hurts them personally but also keeps them from contributing to the economy, which so desperately needs resuscitation.

Student loan debt was in the spotlight briefly in the spring, when Congress was gearing up to decide whether or not to let federal loan interest rates go up. But now that the election is just around the corner, the focus has shifted to that insane circus. Meanwhile, student debt is quietly leading us all ever closer to the edge of a financial cliff.

There have been a few political steps toward student loan forgiveness, which should really be done as soon as possible so that it’s a preventative measure and not a precarious rescue mission, but, as with so many other things, partisan bickering is standing in the way of progress.

While President Obama made speeches to students on the campaign trail about how they don’t take on debt because they like it, but because it’s a necessary investment in their future, other politicians and economists painted the idea of student loan forgiveness as a socialist handout.

“This is a bunch of kids who don’t want to pay their loans back,” wrote Justin Wolfers, a blogger for Freakonomics.com. He argued that forgiving student loans would set a bad precedent, that nobody would ever think they had to pay for an education again if the slate is wiped clean this time — even though the proposed Student Loan Forgiveness Act still requires students to pay back some of their loans.

Hopefully, when this election is over and President Obama is able to refocus on issues, student loan forgiveness will make the list of important things to handle right away. Forgiveness, along with major overhauls to the way universities are run – there’s absolutely no reason for the cost of education to continually rise at the rate it has been – is absolutely necessary if the economy is ever going to recover. In fact, it’s absurd to think that economic recovery is possible if the next generation of should-be job creators and innovators have to choose between spending years paying off unreasonable debts and ruining their credit by defaulting.