Student Loan ‘Bubble’ Bursting

Even before the pandemic hit the U.S, many were struggling to repay their their student loans.

Back in February a group of activists held a protest at the University of California calling on people with student debt to stop paying it.

At the event, dozens of people burned their student loan bills.

As CNBC.com reported recently, student debt is over $1.6 trillion and hardly anyone is paying down their loans.

Thanks to President Donald Trump’s executive order, most student loan borrowers don’t need to resume their payments until January 2021.

What will happen when millions of young people get their bills in January 2021?

Antony Davies, an associate professor of economics at Duquesne University claims that the student loan bubble is about to burst.

„To understand what’s going to be happening with the student loan bubble, it’s useful to understand first what happened with the housing bubble“, said Davies in a video posted on Youtube back in 2017.

He claims that both bubbles are a result of government interference in the functioning of an economy.

When it comes to the housing bubble, the government „broke the link between risk and return“ by attracting more and more risky borrowers into the housing market.

Government-sponsored entities were lending money to risky borrowers artificially inflating demand for houses, which in return inflated prices of housing.

„What happens when the bubble bursts? Everything is fine until the market takes a downturn. When the market takes a downturn people’s incomes start to fall, and the first people who are hit the hardest are those riskier borrowers, who perhaps are living very close to the edge, you know, earning just about as much money as they’re spending. As the economy turns down, they start to get behind on their mortgage payments, eventually, a lot of them declare bankruptcy, and so what happens is that a bunch of these borrowers now disappear. But although they disappear, they have ceased making payments on their mortgages, their houses still exist. So two things happen in the housing market. One is, there’s a decline in the demand for housing, as these risky borrowers who used to be coming into the market now stop. Second, as these existing borrowers, who had already built houses, they go bankrupt, the banks confiscate their houses and turn around to sell them on the market. We now have an increase in the number of houses being offered for sale. So we have this combination of a decline in demand for housing and an increase in the supply of housing, as existing houses come back onto the market. And the result is, the price of housing declines. This is the crash of the housing market“, explains Davis, arguing that the same thing will happen with the student loan bubble.

Thanks to the government, more and more young people are encouraged to take on debt to go to college.

When the market takes a downturn, demand for college will decline.

„It turns out that the government is taking almost the same steps, in almost the same order, in the college loan market that it took in the housing market. And again, the effect is going to be breaking this link between risk and return. So the government institutes Stafford and Perkins loans (these are taxpayer-subsidized loans) to college students. The Taxpayer Relief Act provided a tax credit for college debt, much the same way as the government provided a tax credit for housing loans. In the Affordable Care Act, the Department of Education is set up to loan directly to students. So the Department of Education now is doing in the student loan market the same thing that Fannie Mae and Freddie Mac (government-sponsored entities) did in the housing market. The Loan Forgiveness Program allows for student loans to be forgiven, and this is an interesting thing because it sounds quite magnanimous to say that we’re going to forgive student loans until we remember that the government doesn’t have any money with which to forgive those loans unless it first takes it from taxpayers. So what the government really means when it talks about loan forgiveness is, let’s force people who didn’t go to college to pay for people who did. The Community College Act calls for taxpayers to pay for students to attend community college, this was proposed in 2015. Debt Forgiveness Act, also proposed in 2015, calls for student loan debt to be dischargeable in bankruptcy, which it currently isn’t. And then finally, we have again the Federal Reserve doing what it has done since 2000, which is holding interest rates at historically low levels. So what are the consequences of all of this? The consequence is that high school students who actually would do better in technical schools are being encouraged to get college educations because the cost of a college education is artificially low. College students are being encouraged to major in fields that have little earning power. What this results in, is a bubble demand for a college education. People are being encouraged to take on debt to go to college, who actually would be better off not, or people are taking on debt to go to college to study things that actually they’d be better off not studying, and so we have the demand for college rising, and college tuition commensurately rising as well“, claims Davies.

He argues that the bubble will burst and the taxpayers will be stuck with up to $1,7 trillion in student loan debt.

„Millions of low skilled students will find that they wasted years of their life obtaining a college degree that does not have the value that they anticipated it would have. Notice there’s an additional problem here, with the college loan market, that did not exist in the housing market, and that additional problem is this: In the housing market, when I, as a high-risk borrower, borrowed $300,000 to build a house, and then I find I can’t make my monthly mortgage payments, I at least have an asset, this $300,000 house, that I can sell to recoup some of the money that I owe the bank. But that dynamic doesn’t occur in the student loan market. If I borrow $80,000 to go to college, and when I’m done with college I find that I can’t pay off my student loan, I have no commensurate asset that I can sell to turn around and raise money to pay off some of this debt. College presidents will be decried as greedy profit-seekers in the same way that bank presidents were decried as greedy profit-seekers“, argues Davies, who adds; „I don’t mean to defend bank presidents; some of them certainly were greedy profit-seekers. But the banks did exactly what the government encouraged them to do, by breaking the link between risk and return. When the government said, “You banks go ahead and loan out whatever you want, and keep the profit, and I, the government, will bear the risk,” banks did what anybody could have anticipated. They turned around and they started loaning to everybody in sight. Similarly here, college presidents, when the government says to colleges, “Go ahead, admit whoever you want. I, the government, will subsidize it, I’ll provide low-interest loans, I’ll provide grants to these students.” What do college presidents do? The same thing any reasonable person would do; turn around, open the doors, and let anybody who wants in to come in. The end result its, many small colleges, like many small banks, are going to go bankrupt. There will come a point, in the not too distant future, when a large swath of students who have gone through college turn around and discover they can’t afford to pay for this debt that they have incurred. And the world will go forth to high school students, “Don’t go to college, because all that will happen is you’ll be saddled with this large debt that you can’t repay.” And so, there’ll be a tremendous decline; like the burst of the housing bubble, there’ll be a tremendous decline in the demand for college education, and many small colleges will go bankrupt“, claims Davies.

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