Will Student Defaults on Loans Bring Down the U.S. Economy?

Dawn of the debt

In tales of the economic miasma of the early 21st century (none but the great and powerful Krugman dare speak the D-word), the Debt-Ridden Student has become a stock character. She or he has graduated from college or is about to, saddled with mammoth loans accrued in order to pay rising tuition—and arrives in the work world only to find that the high-paying jobs that were supposed to repay all that debt have vanished along with Lehman Brothers.

In recent months, though, a new worry has emerged: In addition to destroying their own lives, are today's debt-ridden college graduates going to trash the economy as well?

It's the meme that will not die, reappearing with every study reporting new levels of student indebtedness. (Over $1 trillion! More than Americans' cumulative credit-card debt!) Mincing few words, William Brewer, chair of the National Association of Consumer Bankruptcy Attorneys, told The Washington Post last month, "This could very well be the next debt bomb for the U.S. economy."

Doomsayers warn growing student debt could lead to, well, doom.
Doomsayers warn growing student debt could lead to, well, doom.
Brewer: College loans could be “the next debt bomb.”
Brewer: College loans could be “the next debt bomb.”

Brewer minces only slightly more words in a conversation with the Voice. "My concern is same song, second verse," he says, noting that bankruptcy lawyers were among the first to raise red flags about the mortgage crisis. "We're seeing a tremendous amount of defaults." He points to a Federal Reserve Bank of New York study released last month that showed that 15 percent of Americans with credit reports have student debt, and more than a quarter of those are behind in their payments. While he acknowledges that student debt's "tentacles into the economy are not the same," Brewer foresees a "chilling effect" on such things as new-car purchases and the housing market, as graduates deep in debt are unable to qualify for mortgages.

Hogwash, responds Center for Economic and Policy Research co-director Dean Baker. "The numbers are just totally different," says Baker, who has some cred of his own when it comes to mortgage-bubble gloomcasting, having warned of an eventual housing crash as early as 2002. "We're talking about something on the order of a trillion dollars in student-loan debt. The housing-market peak was over $20 trillion."

What about indebted students reducing their spending as a result? "It's a damper, no doubt about it," Baker says. "That list of big purchases—first car, new house—those are things that undoubtedly many people will have to put off." As for the overall economy, though, he notes that the rule of thumb is that people spend 4 to 5 percent of their wealth each year. Even if you double that under the assumption that young people burn through their money like energy drinks, that's still only $80 billion a year. "That's a little over half of 1 percent of the GDP. It's not trivial, but it's not anything that's going to put us into a recession."

Still, that's not likely to be much comfort if you're one of those holding a share of that trillion dollars in debt—especially if you came of age in the last decade, when student debt was falling to historic lows. That all changed starting a few years ago, to the point where in the class of 2010, two-thirds of students graduated with some outstanding loans, according to the California-based Project on Student Debt. Average debt load per student: $25,250.

That number is rising an average of 5 percent a year, with no signs of slowing down, says Lauren Asher, president of the Institute for College Access and Success, which runs the Project on Student Debt. "Student debt has become a fact of life for more and more Americans and for the majority of college graduates," she says. "That was not always the case."

While rising tuition has gotten the most press, Asher blames a number of factors: "With the down economy, you have this painful convergence of less money in state coffers, less money in family bank accounts, more need and demand for education, and more eligibility for aid." The upshot, she says, is increased costs when students can least afford them.

As a result, loan-default rates are rising as well, in some cases, dramatically so. The number of students who default within two years of leaving school—"the tip of the tip of the iceberg of student distress," Asher says—has risen from a low of 4.5 percent in 2003 to 8.8 percent in 2009, the most recent graduating class for which numbers are available. And a study by the Institute for Higher Education Policy further found that for every student debtor in default, two more have already fallen behind in their payments.

A look at the New York City default numbers shows wide variation from campus to campus. Where most colleges, including NYU, Columbia, and CUNY, sport default rates in the low single digits, two schools—ASA in Downtown Brooklyn and Manhattan's Apex Tech—managed to send more than 1,000 indebted students out into the world (with or without degrees—the numbers don't distinguish) in 2010, more than 20 percent of whom have already defaulted.

ASA and Apex Tech are both private for-profit schools, and Asher says that this is par for the course for the growing industry: Nationwide, students at for-profits are more than twice as likely to default on their loans as those at public schools and three times as likely as students at private nonprofits, according to Department of Education data. (Not all for-profits are created equal, though: For-profit Monroe College in the Bronx managed to cut its default rate from more than 10 percent to just 5.6 percent in the most recent report.)

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