Student Loans: the next debt crisis?

By Paul Ockelmann.

A recent article in the Atlantic caught my eye with its bold headline: The Debt Crisis at American Colleges. The two main points of the article are that college in general is overpriced and that there is a possibility of student loans becoming the next subprime bubble to burst. In this post, I take a closer look at both of those claims.

The Price of College
Living in Germany for the past five months has brought me in contact with many college students. I was shocked to hear that for the most part, a college education is free in Germany. Some programs in Berlin do charge the whopping sum of 600 euros per semester, but that includes a metro pass that is worth more than the 600 euro fee. For comparison, here are the tuition rates for the top five national, public, and liberal arts colleges in the United States for the 2010-11 school year (public school tuition is an average of in-state and out-of-state tuition):

Amherst:  $40,862
Columbia: $43,304
Harvard: $38,416
Michigan: $24,282
Middlebury: $52,500
Stanford: $39,201
Swarthmore: $39,600
UC Berkeley: $22,308
UCLA: $22,221
UNC: $15,973
UPenn: $40,514
Virginia: $22,101
Wellesley: $39,666
Williams: $41,434
Yale: $ 38,300

The cost of college in the United States has risen drastically in the past thirty years, with the average tuition of these 15 schools $34,712. The most common justification for these rising costs has something to do with the rising cost of living along with higher prices. The graph below starts with the average cost of attending a 4-year college in 1980 (tuition only). The green line tracks how much tuition would rise if it paralleled inflation. The red line shows the actual tuition costs for 4-year colleges today:

Tuition data from National Center for Education Statistics. Inflation on 1980 tuition
calculated using the Bureau of Labor and Statistics’ CPI Inflation Calculator.

Of the 4.8x increase in college tuition from 1980 to 2008, only 33% is a result of inflation. It is clear that college tuition has far outpaced the rising prices cited as the primary reason for higher tuition. Combined with the troublesome fact that parents are paying less and less for their children’s college (from the Atlantic: “last year, a typical family with college-age children spent $3,102 on dining out, but only $2,055 on education”), the ever-increasing cost of college has forced more students to seek out loans.

The Basics of Student Loans
The total amount of student loan debt in the United States is staggering, approaching $1 trillion and having passed total credit card debt in America around a year ago. For many college students, loans are the only option for them to attend college. Over 65% of students at four-year colleges graduated in 2007-08 with some debt, with the average student loan debt for seniors $23,186. While this does not seem like an overwhelming amount of debt to pay off over 10 or 30 years, the recent financial crisis has made it harder to find a job out of college. Student loans come due largely at a time when one is making the lowest salary of his or her career. The 2013 MBA class at Wharton will graduate as one of the most debt-ridden classes in history, with the average MBA graduating with $124,000 in debt. To comfortably pay down this loan, “a graduate would need an annual gross salary of $176,560,” far more than the median starting salary of a Wharton MBA at $110,000. On top of the large size of student debt on graduation is the student loan law in the United States. Student loans are not ‘dischargeable,’ meaning that declaring bankruptcy does not stop payments from being due. As long as you are earning income and have an unpaid student loan, you are legally obliged to pay it off.

Is a Debt Crisis Imminent?
Although loans pose an obvious burden on those directly out of college, it isn’t immediately obvious that a debt crisis is imminent, as suggested by the Atlantic. The magazine argues that the student debt market has obvious parallels with the housing market in that loan agreements are hard to understand and the assumption is made that future earnings (or future house prices) will inevitably rise. Yet loan issuers have little fear of nonpayment because of the way student loans are structured. Payments are often deferred, but it is typical for collection agencies to garnish money from sources such as unemployment checks and even Social Security payments. Add on default charges and compound interest and it can be impossible to ever get rid of the burden of student loans. Instead of a debt crisis, the most likely future seems to be high interest rates on student loans and an increase in deferred payments. The economic consequences are high for the economy, as high loan burdens could dampen future consumer spending among the fresh out of college generation and prevent future economic growth (For a more thorough analysis, I suggest Alan Nasser’s The Student Loan Debt Bubble).

Concluding Thoughts
College tuition is rising at an incredible rate, forcing more and more students to seek out loans. These loans can burden students for decades after they graduate. With continued high unemployment, the number of deferred loan payments will increase. This increase will not mirror the housing market, because there is no way to default on student loan payments. The long-term economic consequence of rapidly increasing defaults would be a slowdown in consumer spending and consumption, as disposable income is locked down in paying collection agencies and interest accrued on loans. Even a gradual increase in deferred payments could reduce consumption enough to prevent a complete economic recovery in the United States.

Paul is a member of AIDemocracy’s “student super-committee”, examining the current debt debate. He is a student at Stanford University, and a regular blogger on his own site Policy Outlook.