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Student Debt Is A Drag, Not A Bubble

a black mortarboard graduation cap resting on a wood table against a dark background.

In some corners of the media, it has become popular to characterize educational debt as a bubble. This makes for a catchy headline, but unfortunately it’s a misleading turn of phrase.

Student loan debt more than doubled over the past decade, according to Federal Reserve data. Average debt per borrower has also grown, even as average wages remained stagnant. Americans collectively owe nearly $1.5 trillion, placing educational debt second only to mortgages as a source of total consumer debt.

There are reasons to be alarmed by the way educational costs have outpaced inflation. But some observers have started to compare student loan debt to mortgages not only in size, but in suggesting that the so-called student loan bubble will pop in a way analogous to how the housing market collapsed between 2007 and 2009. However, this comparison doesn’t hold up under scrutiny. Student loans and mortgages differ in some fundamental ways.

Because of the way student loan debt is structured, lenders – including the federal government – can essentially wait as long as it takes to secure repayment. In a mortgage, the home is collateral, and banks can foreclose as soon as the borrower misses payments. Student loans, on the other hand, use the student’s future earning potential as collateral. As long as the borrower can theoretically earn wages in the future, the lender can still expect repayment.

Forbes columnist Robert Farrington described this difference as the mechanism that allows for a “pop.” Securing debt with concrete collateral, such as mortgages and car loans, allows lenders to seize the collateral all at once and then sell it, even at a loss. The debt bubble then pops in a relatively quick, if often economically painful, event. Student loan debt simply does not work this way. As long as borrowers still have earning potential, lenders have no incentive to write off the debt.

In addition, mortgages are more frequently securitized (that is, pooled with other assets and sold to investors as a bundle). Student loan-backed securities do exist, but the market for them is substantially smaller than for mortgage-backed securities. Most student loans, instead, remain in the hands of loan issuers. The biggest issuer, by far, is the government, which backs more than 90 percent of outstanding education debt. When homeowners defaulted in large numbers and banks began to go bankrupt in 2008, the chain reaction threatened to bring down the United States’ underlying financial infrastructure. Regardless of whether student loan debt and related defaults continue to increase or level off, the systemic threat simply cannot rise to the same level.

This is not to say that student loan debt is not a problem for the U.S. economy, or for individual Americans. Large student loan balances have a self-evident negative impact on borrowers. While some of the people carrying six-figure loan balances, such as law or medical students, are able to repay their loans over time because of their high earning potential, many of the people struggling began with smaller initial balances but earned degrees that do not open as many professional doors. Economists and education advocates have argued that for-profit colleges, especially, use exaggerated promises of graduates’ job prospects to lure borrowers to take on debt while awarding degrees that do their bearers little good – or sometimes harm, in the case of schools with especially poor reputations – in the job market. Students who drop out are left with debt and no degree at all.

Even for those of us who do not face the challenges of personally paying off massive balances, the overall crisis will hurt in other ways. Loan forgiveness programs are often tied to specific milestones that can take years to achieve, dragging repayment out over many years, or sometimes decades. This means a substantial fraction of young workers may struggle to save for retirement, emergency funds, house down payments or other financial goals until they are in their mid-to-late 30s or beyond. Young adults often just can’t afford to pursue financial milestones as soon as earlier generations could. And borrowers who have struggled to keep up with payments face all of the challenges created by a subpar credit score. Young adults with significant student loan debt are also less likely to pursue entrepreneurial ambitions.

Beyond the drag they create on gross domestic product and consumer consumption, student loans directly affect taxpayers, since the government guarantees the majority of these loans. Government programs that artificially lower borrowers’ repayment amount, such as income-based repayment plans, pass along inflated tuition costs to taxpayers, which is a drag on the economy at large. And if defaults continue to rise over time, it could create a growing financial burden for the federal government.

Without action, this trend is likely to get worse. Colleges and universities have little incentive to lower tuition in an environment where, legally and culturally, students are encouraged to take as many loans as they need to go to the school they want. At Palisades Hudson, we have discussed the hazards of this attitude for years, but just because the mindset of “college at any price” is dangerous doesn’t mean it is rare. Despite the costs, demand for education remains strong. Enrollment in post-secondary education programs has risen right along with tuition. This means that many schools still have many more applicants than they need to fill classes, even if few of those students end up paying full price after scholarships, work study and other financial aid. Given that the collateral is a borrower’s future wages, lenders are usually happy to make up the difference.

The severity of the student loan debt crisis has led to a variety of proposed solutions. Some employers offer to help employees pay off student loans as a benefit. Politicians on both sides of the aisle have suggested forgiving more, or all, of the current outstanding loans owed directly to the government. Some lawmakers now advocate making public college tuition free to in-state residents, extending the state’s responsibility for education past grade 12. More moderate voices would like to concentrate on lowering college costs, if not all the way to zero, and on improving graduation rates to make sure that few if any students are stuck with serious debt and no degree to show for it. Making it harder to borrow for college is an understandably unpopular solution, but it could serve as a realistic check on colleges raising prices without consequences, year after year.

Reasonable people can disagree on the best way forward, but what seems clear is that we need to act. Student loan debt is a concern that the United States needs to address, not because it could trigger an economic crisis, but because it could act as a drag on our economy for years to come.

Managing Vice President Paul Jacobs, of our Atlanta office, is among the authors of our firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. He wrote Chapter 12, "Retirement Plans"; Chapter 15, "Investment Approaches And Philosophy"; and Chapter 19, "A Second Act: Starting A New Venture." He also contributed to the firm’s book The High Achiever’s Guide To Wealth.

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