Much has been written in the popular press and within academic circles regarding the astonishing rise in Student loans over the past decade. Aggregate student loan balances stood at $639 Billion at the beginning of 2009. Over the past decade that number has more than doubled, standing at $1.442 trillion at the end of 2018. The dramatic increase in outstanding student debt prompts an obvious question: are student loans likely to be the source of the next economic crisis?
The answer is that it depends on how one defines a crisis. Our collective understanding of economic crises fundamentally changed as a result of the Great Recession of 2008-2009. While the word crisis means different things to different people, for every person that was conscious during the years 2008 and 2009, the word “financial crisis” is now associated with periods of dramatic unemployment, precipitous declines in housing values, volatility in financial markets, failing banks, and a large uptick in personal bankruptcies. The financial crisis could be described as violent, quick-hitting, and dramatic – like a hurricane or a tornado.
And yet the word "crisis" is also frequently used to describe slower moving phenomenon, like global warming. It is now readily accepted by science that global warming, to whatever degree, is real and will have consequences, and is a crisis. Yet one of the most salient features of global warming is the speed, or lack thereof, over which the consequences are and will continue to be felt. The point to be made is that we use the same term - “crisis” - to describe slow-moving phenomenon like global warming as we use to describe a quick-hitting phenomenon like a hurricane or tornado.
Student loans are currently a crisis in the U.S. economy in the same way that global warming is a crisis. The threat is real, but the causes and consequences are slow moving in aggregate. A student loan “bubble” will not “burst,” causing an acute hard-hitting tornado-like economic crisis, rather, the student loan problem will continue to slowly blunt the ability of young adults to consume the way their parents consumed. Recent research has demonstrated that larger student loan balances hinder student’s propensity to consider graduate school, to relocate physically for a new job, to purchase homes, and to start families. These outcomes, or lack of outcomes, certainly represent a crisis in the individual lives of students saddled with the debt.
To understand the differences between the financial crisis and a crisis tied to student loans it is important to understand the acute cause of the financial crisis. Most proximately the crisis was the result of a large concentration of mortgage-backed securities held by systemically important financial institutions. Moreover, these institutions used mortgage-backed securities as collateral in short-term financing contracts. When the value of mortgage-backed securities were called into question as housing values began to decline, the value of the mortgage-backed securities in the financing contracts became suspect. As a result, systemically important financial institutions (think Lehman Brothers) were no longer able to finance their immediate obligations, and so they went bankrupt. These bankruptcies spread to the real economy because of how interconnected these banks were to other financial institutions and to financing contracts that fueled economic activity on main street.
Having seen the effects of a spike in mortgage defaults, analysts frequently wonder whether a sharp increase in student loan defaults would have similarly disastrous effects to the real economy. Here is where student loans are quite distinct from mortgages. Student loans are not being securitized and held by systemically important financial institutions – which means they are also not being used as collateral in financing contracts for systemically important financial institutions. Rather, student loans over the past decade have been funded almost exclusively by the federal government. Though the government is exposed to roughly $1 Trillion in student loan debt, a spike in defaults as high as 25-30% would result in government liabilities of $250B. Although $250B is a large number in an absolute sense, it would not represent a substantially large cost when compared to the type of spending the government engages in during war times, for example. According to the Costs of War Project by the Watson Institute for International Studies at Brown University, the U.S. government has spent almost $2 Trillion on the war in Iraq, with an expected liability of an additional $4 Trillion over the coming decades. In other words, a $250B liability would be equal to about 6 months to one years’ worth of money spent on the Iraq war (depending on how one defines the length of the war).
The real crisis of student loans, then, is in the lives of individuals who cannot purchase homes and move from their parent’s basements, or who accept jobs they might not otherwise accept because of their student debt. Does this constitute a crisis? Yes. But student loans are not likely to create an acute economic crisis in spirit similar to the financial crisis of 2008-2009. Rather, the crisis is slow moving and long lasting, with especially real consequences to those feeling the effects.
Taylor Nadauld, PhD