American student debt now stands at more than $1trn and more people than ever are defaulting. Is another subprime crisis on the way? James McKeigue investigates.
What’s the problem?
Spiralling university costs have pushed the total value of outstanding student loans in America over the $1trn mark. Indeed, university debt, which stood at just $200m 12 years ago, has now overtaken credit-card debt and car loans to become the second-biggest type of debt, behind mortgages. The problem is defaults are shooting up too – around 21% of outstanding loans have missed payments or haven’t been paid back at all.
Why is this happening?
The obvious culprits are the universities themselves. Ivy League institutions such as Harvard raised prices in the early 1980s when they realised “they could boost prices with impunity because of the scarcity value, social cachet and quality of the education they offer”, says Jonathan Laing in Barron’s. These universities are, in theory, non-profit organisations, so fees are used to pay (some argue overpay) for top-notch staff and facilities. The leading universities also command billions of dollars in endowments. Harvard sits on a pot of $32bn.
At the other end of the scale are public universities. State funding cuts have forced them to push up their prices but, on average, they are still only one third of the cost of their private-sector peers. The heaviest criticism is directed at ‘for-profit’ education providers.
These institutions, many of which are listed companies, target less affluent students who need to take on more loans than your typical Ivy League scholar. In the past decade they have grown ten times as fast as other universities and now account for 12% of the total student intake.
This has all been made possible by the government’s growing system of loans and subsidies (it offers a means-tested grant of $5,550 per year and an undergraduate loan of $57,500). Other factors include the growing number of people going to university and the decline of American manufacturing, which has seen more people look for jobs that require academic qualifications.
The tough jobs market, where the recent crisis pushed unemployment as high as 10%, has also encouraged workers to return to university. Student debt for 34 to 49-year-olds has risen by more than 40% in the last three years, more than for any other age group.
Will the debts be paid back?
The default ratio is now 21% and some worry that student debt could trigger a new crisis. After all, it’s “a fast-growing, federally subsidised industry that happens to be aggressively targeted” at people with low incomes, says Financial Times blogger John McDermott.
The main worry is the for-profit universities. They only serve 12% of the college population, but are responsible for almost 50% of all defaults. The reason they perform so badly is that “their course content is often risible, and graduation rates horrible”, says Jonathan Laing. The typical rate for a four-year course is 38% at for-profit universities, compared to 58% at public universities and 66% at non-profit private institutions. Many students who enter hoping to graduate and thereby enhance their career leave with nothing but debt.
The other worrying trend is that the government has back-stopped student loans. That means the taxpayer would be on the hook if there were a widespread default. American banks are already looking for the exit – JP Morgan Chase says it will stop underwriting some student loans from July.
So is another ‘subprime’ crisis on the way?
Not yet. Student loans are just one-tenth of the size of the American mortgage market. A key reason why the mortgage market caused so many problems is that it was securitised – loans were split into tiny pieces that were bundled together to make lots of new financial products. It meant no one could be sure what would be the next seemingly safe financial product to collapse because it contained bits of dodgy American mortgages. That process hasn’t happened with student loans.
No need to worry then?
Student loans might not be about to trigger a meltdown, but they are still a serious economic problem. Two-thirds of American students graduated with $25,500 of debt in 2010. Many are unable to buy houses or start families. “We are creating a zombie generation of young people, larded with student debt and, in many cases, without any diploma,” says Moody’s Analytics chief economist Mark Zandi. This could act as a brake on consumer spending and on America’s competitiveness with emerging markets. Yet that hasn’t stopped Britain following America’s lead.
Could Britain be going the same way?
From September, English universities can charge students up to £9,000 per year for tuition. This is triple the rate current students are paying. Given that higher education in England was free until 1998, it is an even more dramatic fees rise than in America. Students in England who also need to borrow for their accommodation costs are likely to leave university £40,000 in debt.
However, graduates in England only start repaying their loans when they earn more than £21,000 per year. What’s more, the interest rate is capped at the inflation rate and debts are cancelled after 30 years. In America, students have to repay loans regardless of whether they have a job. Failed payments cause back interest to be added to the principle, meaning that for many the debt gets larger. Almost two million US student debtors are over 60 years old.