Student Loan Debt: Wall Street’s Next Bubble?

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Student Loan Debt: Wall Street’s Next Bubble?

Student Loan Debt: Wall Street’s Next Bubble?
Tue, 4/24/2012 - by David Pritchard
This article originally appeared on Occupied Chicago Tribune

Illustration: Hope Asya

In the eight months since the Occupy Movement first emerged as a mass phenomenon, student debt has grown into a flashpoint issue. Occupy Education, a group affiliated with the movement, called for a National Day of Action Against Student Debt on March 1st. Some in the media have even heralded a springtime resurgence of Occupy protests, with recent sit-ins, strikes and other direct action directed against exploding debt levels. Middle class families have seen their wages stagnate for decades, while the cost of college education has risen more than 300%. Lingering unemployment means new graduates are hard-pressed to pay off their burdensome debt, which now averages more than $25,000. In 2007, 50% of college graduates were able to find work immediately. In 2009, this figure had dropped to 20%. Increasingly, graduates and drop-outs are facing a lifetime of struggle and indenture-ship after leaving college.

However, far from being a narcissistic pet issue for the disproportionately young Occupy crowds, student indebtedness in countries without universal education systems is a symptom of the same underlying pathologies that brought down the housing market five years ago, and could soon be the cause of another sudden, catastrophic economic contagion.

A Cost Crisis or Price Crisis?

The crisis is ultimately due to rapid and unsustainable increases in college tuition rates at both private and public institutions. The increases can be partly explained by the rising costs of today’s higher education. Writing in Forbes in 2010, economists Robert Archibald and David Feldman pointed out that higher education remains labor intensive, must lure an extremely educated workforce (who have their own education debt to contend with) with sufficient wages, and requires the latest technology. After all, 21st century study of advanced chemistry requires more than just chalk and beakers. The price of these goods is inflating much faster than overall consumer prices. As a result, lawmakers are forced to choose whether to decrease funding to schools or raise taxes.

However, many economists agree that the major impact on rising tuition costs is on the demand side: A seemingly unlimited supply of student dollars, provided by an industry of lenders, is available to purchase a product that has never been in higher demand. Young adults seeking skilled employment have no choice but to enter this market; lenders have no incentive to deprive them of the funds to do so; and schools have no incentive to keep their tuition costs lower than what the market will allow.

Yet the demand for education does not tell the whole story. Total outstanding student debt in the economy has already surpassed credit card debt, and is approaching the trillion dollar threshold. But that is nothing compared the value of SLABS. That is, Student Loan Asset Backed Securities, a repackaging of many loans into an asset backed security (ABS) that raises cash for the holders of loans so they can make more loans. A similar type of securitization in the mortgage market is widely blamed for the risk-shielding that led to the 2007 meltdown. The total value of the SLABS market at the end of 2011 was estimated to be $2.67 trillion. To compare, the total value of the mortgage securities market at its height in 2007 was $7.98 trillion, adjusted for inflation.

A form of market failure is when prices are unresponsive to any risks inherent to the transaction. However, investors in the SLABS market are shielded from risk of default in two unique ways:

Student debt cannot be discharged in bankruptcy. An indebted former student will find herself hounded by creditors forever until the entire loan plus interest (which is on the rise) is paid off.

The federal government subsidized most privately-issued debt (through the Federal Family Education Loan Program, or FFEL) before July, 2010, at which time the program ended. Even if these borrowers default, the lender is reimbursed by the taxpayer.

At least in the housing bubble, the collateral in question was a house: a physical asset that can be liquidated, and thus, poses risk. A college degree, however, is completely illiquid – it cannot be sold for any price. With the 99% assuming nearly all the risk, the SLABS market presumably remains one of the few "safe" places for the 1% to put their money. And lots of money can indeed be made in return.

Growing Bubble?

Not only are SLABS a major factor raising the profitability of student lending, and thus its price, but also provide a substantial amount of collateralized credit to Wall Street. So, with the federal government backing a great majority of this debt, why all this talk of a bubble?

One reason is the recent emergence of a world-wide student revolt against debt indentureship since the financial crisis. The Occupy Student Debt campaign has called for debt holders to stop paying off their loans en masse. At DePaul University in Chicago on March 3, students occupied the space near administrative offices in protest of a plan to raise tuition rates. Signs at the rally read, “I’m $50,000 in debt for an education that should be free.” Outside the United States, a continuing revolt in Québec that began last month against plans to raise tuition at the Université du Québec system has seen over 200,000 students participating in a general strike, according to organizers. In Chile, where both the cost and low quality of higher education is acutely onerous, a student movement erupted in May last year that has shaken that country’s entire political climate. Britain, Canada and Argentina have all seen unrest related to rising debt. Uniting all of these movements is the belief that higher education is a right, not an asset, and should be free to all qualified young adults in a society.

Another reason is that the private (not federally-backed) student loan market is picking up again, this time without federal subsidies. Naturally, they are targeting subprime borrowers attending proprietary (for-profit) schools, who are unaware of federal direct loans. We can expect, like their mortgage-backed counterparts, for these toxic assets to be mixed in with the government-backed stuff on the securities market. According to one study, less-than-prime mortgages comprised 5% of the underlying value of collateralized debt obligations in 2000, and 36% in 2007. Indeed, on March 5, the Federal Reserve Bank of New York released a disturbing report indicating that 27% of all indebted graduates not in forebearance were thirty days or more past due in repayment. Only 40% of all current student debt is actually being repaid.

Coupled with a massive non-payment movement, a scenario could develop where default rates spiral upward, the Deptartment of Education is eventually unable to continue to underwrite subsidized debt and the underlying asset value of SLABS rapidly deteriorates. At a critical juncture, market faith in the "risk-free" rating of the $1 trillion-dollar student loan pool will disappear, and contagion will spread. Warnings of a student loan meltdown are appearing even in the 1% media nearly daily.

Toward a United Opposition

It would appear that students united against onerous debt face a catch-22: they either live in servitude or precipitate an approaching contagion. The federal government, which is ultimately on the hook for most of the debt, can be forced to act. Thus, a direct action strategy against lenders must have as its ultimate goal a universal system of higher education, free and available to all, and the gradual forgiveness of outstanding student loan debt to a reasonable level. The student loan market then will have no reason to exist. Student loan derivatives markets must be frozen, the underlying loan assets seized, and exposed creditors forced to accept a drastic "haircut," or reduction in reimbursement. Of course, this has implications for a potential reform of the banking system itself. Students with debt, then, are at the vanguard of several of the most pressing imbalances our economy faces. Are we collectively willing to threaten the system that feeds off us with the prospect of deliberate mass defaults, even in the face of the most unfair bankruptcy laws in existence?

Finally, what really may be needed is a deeper, radical new look at education itself. The relationship between education and social class has long overshadowed the relationship between education and proper living. More money is spent regaling Wall Street-bound business graduates with hors d'oeuvres than showing citizens how to improve their communities, or what a community even is. For too many, the dream of liberation that accompanied a college degree has become a nightmare, both financial and professional. What goals should higher education serve? How do we make the academy more inclusive, representative and relevant? Most important, what experiences should we consider a part of that emancipatory growth that we associate with "cultivation," and how do we link these experiences with the dreams of our youth?


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