A Different Kind of Bubble: Does Student Debt Threaten the US Economy?

It has been almost a decade since the 2008 financial crisis, but investment professionals remain concerned about unchecked market bubbles that could burst and trigger fresh economic shocks.

The rapid growth of student loan debt in the United States, which some have compared to the pre-crisis growth of subprime lending activity, has been a particular cause for concern. Reports suggest that the total amount of student loans outstanding in the United States exceeds $1 trillion.

An analysis based on data from the US Department of Education found that the class of 2015, the most recent class of happy graduates, is the most indebted in US history. They will graduate with “a total of about $56 billion in public and private loans,” and the average student who borrowed money will be more than $35,000 in debt — about $15,000 more than just one decade ago.

However, a recent study from the Urban Institute suggests that the debt load is manageable on an individual level. Holders of undergraduate degrees, who tend to borrow less, may be able to meet their loan payments if they successfully find employment at the standard starting wage. Gail MarksJarvis of the Chicago Tribune highlighted the findings from the Urban Institute’s study, noting that student loan borrowing has declined during the past three years, and “the massive borrowing at the $50,000 level occurs primarily among students seeking graduate degrees.”

There are no exotic derivatives or complex securitized products tied to student loans that could trigger a sudden, unexpected collapse in financial markets. However, the size of the total debt outstanding means that debtors changing their repayment behaviors could still have profound economic consequences.

The mere idea of debtors altering their behavior certainly has a dramatic effect on news outlets. An opinion piece published in the New York Times, in which Lee Siegel recommended that indebted students consider defaulting on their loans, was quickly met with an avalanche of criticism:

• “Paying Student Loans Is Hard. Do It Anyway.” (Bloomberg)
• “A New York Times Op-Ed Says You Should Default on Student Loans. That’s a Terrible Idea.” (Vox)
• “The New York Times Should Apologize for the Awful Op-Ed It Just Ran on Student Loans” (Slate)
• “A Guy Wrote a New York Times Op-Ed Suggesting You Default on Your Student Loans — Why That’s the Worst Idea Ever” (Business Insider)
• “Times Op-Ed Goes All In on Student Debt Silliness” (Forbes)

But the biggest economic impact of student debt may not be directly connected to either voluntary or involuntary default. Amir Sufi, a professor of finance at the University of Chicago, is concerned about its effects on other spending activity. In an interview with MarketWatch, he stated that “there is increasing amounts of evidence that student loan debt is holding back auto spending, home ownership, and general economic activity.” He points to the overall “drag [this magnitude of debt] has on the economy, especially when it comes to the household spending behavior of younger Americans.”

Sufi is well placed to examine parallels between subprime lending before the global financial crisis and outstanding student loans today. He is co-author, with Atif Mian, of House of Debt, which former US Treasury secretary Lawrence Summers described as potentially “the most important book to come out of the 2008 financial crisis and subsequent Great Recession.” Sufi and Mian have found that a sharp reduction in consumer spending after the housing market crash was the reason why its effects were felt more broadly than the 2000 bursting of the dot-com bubble. Ultimately, the reduced consumer spending resulting from excessive student loan debt could likewise have serious consequences.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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