Student Debt Bomb – Far From Nuclear

Student debt problems have received considerable attention of late. The general media has focused on individual hardships and broken dreams. The financial media has focused on how much will likely go unpaid, often referring to the potential for loss as a “bomb.” By noting that student debt is second only to mortgage debt as a line item of household liabilities, much of this financial discussion sensationalizes the problem by drawing an implicit parallel to the mortgage debt trouble that seemed to have Wall Street on the brink of collapse in 2008-09. The reality, though far from happy, is less dangerous. Prospective student debt failures are neither large enough nor widespread enough to threaten anything near those troubles of six-plus years ago.

According to the U.S. Treasury, student debt in the United States has indeed exploded, growing more than 300 percent during past nine years. It presently stands at about $1.2 trillion. That is not a small figure. A careful parcing of consumer credit categories does indeed make student debt second only to mortgages in the list of household liabilities. The reports indicate that default rates already approach 20 percent. Debt forgiveness rules promoted by the Obama White House, “forbearance” in Washington’s way of speaking, will mean that an estimated additional $125 billion or 10 percent of this outstanding amount will also never get repaid, bringing the total expected loss to some $365 billion.

Large as this number looks, it needs perspective to gauge potential financial impact. According to the Federal Reserve (Fed), all forms of non-mortgage credit in the household sector amounted to $9.4 trillion at the end of the third quarter, the most recent period for which data are available. Mortgage debt outstanding amounts to $13.4 trillion. Potential losses on student loans, then, would amount to 12.8 percent of all non-mortgage consumer credit, 9.0 percent of mortgage debt outstanding, and 8.5 percent of total household liabilities. That is a significant portion of the total, to be sure, but well short of the sort of stuff that could bring down financial markets. Put another way, this student debt figure amounts to a mere 1.5 percent of the estimated of $81.3 trillion in household net worth and 1.2 percent of the estimated of $95.4 trillion in total household assets.

What makes this prospective loss still more manageable is that the federal government holds the bulk of it. In 2010, the federal government took over the student loan business, ceased offering subsidies to private lenders, and lodged the bulk of the outstanding debt with the Education Department, where it remains. Today only some 16-17 percent of outstanding student debt lies in private hands, and that portion is dwindling as these debts are repaid or written off. Any mass failure, then, will fall almost entirely on the taxpayer. And in this context it matters not whether the debt is forgiven or in default, it amounts to a failure to repay either way. Though this is hardly good news for the taxpayer, it certainly fails to constitute a financial game changer for the private sector. Nor is the amount overpowering in the context of the federal budget. The potential loss amounts to a mere 10.0 percent of the $3.7 trillion in total annual federal outlays estimated for 2014 and 14.0 percent of the $2.6 trillion total annual flow of spending for what Washington refers to as “human resources,” mostly entitlement programs.

None of this discussion aims to label prospective student debt losses a welcome event. The individual distress involved is, of course, incalculable. Only slightly more yielding to quantification is the contribution the whole program has made to the inflation of college costs over past years and prospectively. But as the cause of another financial disaster, the matter can only be described as exaggerated.

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