Who’s Going To Defuse The $1.3 Trillion Student Loan Bubble?

Lost in the madness of crowds and obscured by the euphoria accompanying the multitude of bubbles inflated by nearly a decade of accommodative monetary policy, are America’s twin trillion-dollar debt bubbles: auto loans and student loans.

Back in 2015, there was no shortage of commentary on the extent to which subprime auto lending and the massive student debt overhang were imperiling the financial system and erecting barriers to household formation, respectively.

Perhaps my take on this is colored by the fact that during 2015, I myself covered these topics extensively, so maybe the reporting hasn’t in fact dissipated or otherwise taken a backseat to more pressing matters such as Bitcoin, the Nasdaq, and the fact that since 2015, America has been careening down the path to authoritarianism.

Whatever the case, we shouldn’t lose sight of these two trillion-dollar bubbles because, well, because they are trillion-dollar bubbles and generally speaking, trillion-dollar bubbles do not just go gentle into that good night.

To be sure, neither of these bubbles pose the same systemic risk as the housing bubble and there is a vociferous debate about the extent to which the subprime auto issue has been blown out of proportion by those who have seen “The Big Short” eighteen too many times. Still, as Bloomberg noted early last month, “nearly 9.7% of subprime car loans made by non-bank lenders — including private-equity-backed firms catering to car dealers — became 90 or more days past due in the third quarter, the highest annualized rate in more than seven years.” Lending standards appear to be deteriorating and the usual suspects are of course front and center in the debate (e.g. Santander Consumer, American Credit Acceptance, etc.).

Meanwhile, the student debt situation is particularly worrisome, if not for the financial system, then for the economy, for the government and by extension, for taxpayers.

“The delinquency rates on student loans are much higher than for other types of consumer credit, as student loan programs have relatively looser underwriting, student loans are unsecured, and because non-performing student loans cannot be charged off even in bankruptcy,” Goldman writes, in a note dated Tuesday.

Have a look at the following chart which shows the rate at which student loans and mortgage loans transition into serious (90+ day) delinquency:

As Goldman notes, “the quarterly transition rate is 9.6% for student loans vs. 1.2% for mortgages.”

And have a look at everyone’s favorite (or “least favorite”, depending on your penchant for delighting in things that are sad) charts which depict how fast college tuition is rising compared to core inflation and GDP:

Here’s the thing: you can’t completely separate this from the central bank-inspired hunt for yield that’s part and parcel of the post-crisis policy response because that hunt for yield drives appetite for student loan ABS. Mercifully, the stock of securitized student loan paper has actually contracted since the crisis.

The good news for the financial sector is that out of the $190 billion in securitized student debt, $150 billion of it is guaranteed by the government. The majority of student debt not securitized is also guaranteed by the government and so, there’s limited risk for the financial system. I guess.

The bad news is that this massive burden of student debt has implications for all kinds of things, not the least of which is household formation (as mentioned above) and as Goldman goes on to note, “the substantial majority of student loan default risk is borne by the US Treasury.” So it’s borne by taxpayers.

Meanwhile, the Trump administration and House Republicans are working towards a revamp of the entire system. Needless to say, much of the proposal is controversial. As The Hill notes, “the House GOP bill to reauthorize the Higher Education Act would undo an Obama-era rule requiring career preparation programs at for-profit colleges actually prepare students to get jobs with incomes that allow them to pay off their student loans.”

And as the Journal details, the bill would “also end loan-forgiveness programs for public-service employees, who currently can make 10 years of payments and then have their remaining debt forgiven, tax-free.”

Education Secretary Betsy DeVos (one of the more controversial figures in an administration that’s defined by controversy), has already come under fire on a multitude of occasions this year. Back in October, AP reported that The Education Department was considering only partially forgiving federal loans for students defrauded by for-profit-colleges, a move we mocked in light of Trump himself having run a for-profit college that was compelled to pay out $25 million earlier this year for defrauding thousands of students.

Consider this from Politico:

For-profit colleges are winning their battle to dismantle Obama-era restrictions as Education Secretary Betsy DeVos rolls back regulations, grants reprieves to schools at risk of losing their federal funding and stocks her agency with industry insiders.

More than seven months into the Trump administration, DeVos has:

– Moved to gut two major Obama-era regulations reviled by the industry that would have cut off funding to low-performing programs and made it easier for defrauded students to wipe out their loans;

– Appointed a former for-profit college official, Julian Schmoke Jr., to lead the team charged with policing fraud in higher education – one of a slew of industry insiders installed in key positions. Schmoke is a former dean at DeVry University, whose parent company agreed last year to pay $100 million to resolve allegations the company misled students about their job and salary prospects;

– Stopped approving new student-fraud claims brought against for-profit schools. The Education Department has a backlog of more than 65,000 applications from students seeking to have their loans forgiven on the grounds they were defrauded, some of which date to the previous administration.

So while America’s student debt debacle is obviously an issue that predates the Trump administration, it’s not at all clear that this President and a GOP-controlled Congress are the ones for the job when it comes to defusing this ticking, $1.3 trillion time bomb.

Whatever the case, the bottom line is that this debt is never going to be repaid one way or another, so it’s difficult to understand how taxpayers aren’t going to end up on the hook.