Can Government Stop the Student Debt Crisis?



Democratic Senator Elizabeth Warren brought the “Bank on Students Emergency Loan Refinancing Act” to the table this month. The act would have made federal student loans cheaper by allowing students to refinance their debt at current lending rates. But last Friday, the Senate voted 56-38 against the bill, falling short of the 60 votes needed to beat a Republican filibuster and take the legislation to the next stage.

Senator Warren’s proposal would have allowed students to refinance loans at an interest rate of about 3.86 percent, the rate at which new students can take out loans under the Bipartisan Student Loan Certainty Act. This is much lower than the 7 percent or higher interest rate that students have been paying since the 2000s. Senator Warren proposed that the financial burden of refinancing the federal student loans should be borne by wealthy households earning more than $1 million per year.

Apart from the fact that the proposal demands wealthy taxpayers to pick up the tab for refinancing student loans, Republicans happily disagreed with the bill on the grounds that it did not address the core problem, which is outsized tuition costs. The rise in tuition costs has been exponential and according to them, reducing the cost of borrowing will hardly help reduce the overall size of student debt, which has been tearing through the roof since 2007.

The number of student borrowers has increased by 70 percent between 2004 and 2012, and the size of borrowing per person has also gone up by 70 percent, Federal Reserve Bank of New York data shows. The data show that an average borrower now owes about $30,000. According to Bloomberg, tuition costs are up 535 percent since 1985, way above the overall increase in inflation of about 121 percent.

Students have historically been charged higher interest rates on loans because of the outsized risks involved in lending to that demographic. Student loans have a longer tenure and higher default rates than most loans. The total amount of student debt reached $1.11 trillion in May 2014, a rise of $125 billion over a year, and the delinquency rate at 11 percent is a disturbing number. This delinquency rate is higher than the rate for auto, home, personal loans.

The proposal to reduce student debt gains importance when one looks at the chunk of loans given out by the government versus the portion loaned out by private banks. According to The Wall Street Journal, the top seven lenders to students in the country issued loans worth $6.9 billion in 2013, a rise of 8.1 percent from the previous year. Yet private student loans are only a very small portion (13.9 percent) of the total student loan deck. The government services the rest of the $1.2 trillion student loan market.

Senator Warren’s proposal may have bombed, but senators in the past have successfully convinced members to reduce lending rates for certain kind of student loans. The Bipartisan Student Loan Certainty Act passed last year lowered the federal loan interest rate to 3.86 percent for undergraduates. “Exploding student loan debt is crushing young people and dragging down our economy,” Senator Warren said in a press release on Friday, “These students didn’t go to the mall and run up charges on a credit card.”

News about student loans and the student debt bubble always seems to go from bad to worse. Earlier this month, we looked at four specific ways the the debt burden on students and graduates is having a material impact on the overall economy. Here are those observations.

Source: Thinkstock

Source: Thinkstock

1. It reduces disposable income

Disposable income is money that can be spent on goods and services, which is what helps other companies and organizations prosper. As student loans force people to cut back on their spending, it directly impacts businesses throughout the country. If people aren’t going out to eat as often, spending as much on clothes, or buying little things that add up over time, it’s preventing GDP growth. 

“The associations definitely suggest that growing student debt is a drag on consumption,” Wilbert van der Klaauw, an economist with the Federal Reserve Bank of New York, tells TIME. “This is still something we’re discussing. There are a range of views on this. My personal view is that the increasing reliance on student loans for financing college education is going to be a drag on consumption for some time.”

It doesn’t just reduce disposable income for a few years, either. A recent Pew Research study shows that 37 percent of households headed by an adult under 40 have outstanding loans, with the average student debt burden at $13,000, compared to 22 percent in 2001. This means that student debt can significantly impact the amount of money that a household has over decades.

Source: Thinkstock

Source: Thinkstock

2. It stalls major purchases

When you think of graduating college, you’re probably picturing getting a job, making your first big purchases such as a car and home, and working toward building up a healthy savings. In reality, it’s becoming harder and harder to even qualify for a mortgage if you have student loans, says Andrew Haughwout, an economist with the New York Federal Reserve. After the recession hit, banks tightened underwriting standards, making it much less willing to grant house and auto loans at low-interest rates. If you’re a graduate with debt, it will be harder than ever for you to save for a down payment or qualify for a mortgage.

When the housing market was at the top of its game, the U.S. was producing 1.4 million additional households every year. That number dropped to a meager 500,000 during the recession and then rose a bit to 700,000, where it seems to be stuck. Rohit Chopra of the Consumer Financial Protection Bureau gave a presentation in 2013 drawing a direct correlation between the housing market and student loan debt. “The fact is that student indebtedness impacts the credit profile of first-time homebuyers. Three-fourths of the fall in household formation can be attributed to younger adults under 34,” Chopra said.

Auto loans show a similar trend. In 2008, 37.6 percent of 25-year-olds with student loans also had an auto loan, but in 2013 that had fallen to 31.4 percent, per an article by The New York Times

Many college graduates aren’t even able to live on their own due to the heavy debt burden they’re facing. The Census Bureau estimates the percentage of men ages 25 to 34 living in their parents’ home rose from 13.5 percent in 2005 to nearly 17 percent in 2012. 

Source: Thinkstock

Source: Thinkstock

3. It impacts retirement security

A Consumer Finance report, titled Student Loan Affordability, suggests rising student debt is increasing financial pressure on older Americans, posing a risk to their retirement. According to AARP, for families who are headed by someone in their 50s or 60s, “increasing debt threatens their ability to save for retirement or accumulate other assets, and may end up requiring them to delay retirement.” Many parents are now helping their child pay for college or pay off student loan debts instead of focusing on making high contributions to their retirement savings. 

Sometimes parents don’t even have a choice. If their child has taken out money through federal and private loan programs and can’t afford to pay them off, their parents will often be on the hook for repayments, according to a report by the National Association of Consumer Bankruptcy Attorneys. Parent borrowing is up 75 percent since the 2005-2006 academic year, averaging $34,000 in student loans, which rises to about $50,000 over a standard 10-year repayment period, the report shows.

In addition, the Student Loan Affordability report also shows the rising student debt for younger consumers could delay their participation in employer-sponsored retirement plans, causing them to miss out on saving in their early growth years.

Source: Thinkstock

Source: Thinkstock

4. It cuts down on new businesses

Brent W. Ambrose, a professor of risk management at Pennsylvania State University and a co-author of a preliminary study, explains that people only have a certain amount of debt capacity, meaning those with student loans are less likely to start businesses of their own. In fact, areas with higher relative growth in student debt show lower growth in the formation of small businesses (one to four employees.) 

If a student uses up their debt capacity on student loans, they don’t have any to commit anywhere else. An entrepreneur must be able to obtain financing, and “student loan debt, which cannot be discharged via bankruptcy, can have lasting effects later in life and may impact the ability of future small-business owners to raise capital,” the study says.

Ambrose maintains that since 60 percent of jobs are created by small businesses, shutting down one’s ability to start a new business directly harms the economy. 

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