Last night, Goldman entered into unchartered territory with its first observations of the student loan bubble in a piece titled "Are Student Loans Driving Consumer Credit Growth?" Most of the observations are nothing new, although author Alec Phillips does bring up one amusing implication of what the soaring student debt may mean in macro terms. Specifically, to Goldman the rise in debt is merely "A more important source of countercyclical credit. Since federal student lending standards are looser than most other forms of credit, they now rely mainly on Treasury borrowing for financing, and demand for them appears stronger when the labor market weakens, it seems likely that education-related debt will grow fastest at times when the economy slows and other lenders are pulling back." In other words, the rate of change in student debt is inversely proportional to the improvement in the US economy, or directly proportional to its deterioration. So since the student debt chart is, for lack of a better word, parabolic, what does that mean for the broader economy?
Source: Name The Bubble
Below are some of the other implications of the student debt bubble according to Goldman. All are oddly spot on:
- A potential offset to lost savings. Declining home values and tight lending standards mean that households cannot finance college education through home equity loans and home equity line of credit as much as they did during the housing boom. Part of the rise in education-related borrowing may also be attributable to declines in financial investments; statistics released by the College Board indicate that total assets in college savings ("529") accounts grew by 32% from 2007 to 2011, compared to 182% from 2003 to 2007 (some of the earlier growth may also be due to the fact that these accounts were only established by Congress in 2001, and thus grew quickly in their early years).
- A potential burden on younger consumers and homebuyers. While educational loans can potentially offer economic benefits, the growing share of recent and soon-to-be graduates with student loan debt could also negatively affect consumption and the macroeconomy. For example, Dynan (2012) uses household-level data to show that all else equal, households with a higher fraction of their income going toward debt service payments also experience slower consumption growth. In an environment where lending standards are tight, individuals with significant educational debt may also find it difficult to obtain a mortgage to purchase their homes or have to pay a higher interest rate to secure a car loan. In addition, Gicheva (2011) finds that student loans decrease borrowers’ long-term probability of marriage, which could negatively affect household formation.
- A potential fiscal risk, which may at some point prompt a tightening in lending. Like other federal credit programs, the cost of student lending programs is accounted for using a framework specified under the Federal Credit Reform Act of 1990 (FCRA), whereby the net present value of cash flows over the life of the loan is discounted at the Treasury's effective borrowing rate; this estimated cost is counted as federal outlays in the fiscal year in which the loan is originated. Because of the difference in the Treasury's borrowing cost and the interest rate paid by student borrowers, these estimates typically show that each dollar lent under these programs generate a profit for the federal government. The assumption used in the President's most recent budget is a negative subsidy rate of 21%, i.e., a profit that reduces the reported deficit by 21 cents for each dollar of student loans disbursed in the fiscal year. However, given the elevated delinquency and default rates among borrowers--federal projections already assume significant defaults--this methodology may understate the cost to the federal government. The Congressional Budget Office has estimated that using a market-based discount rate, loans expected to be originated over the 2010-2020 period would be estimated to cost $52 billion, rather than save $68 billion as is estimated under official projections (see "Costs and Policy Options for Federal Student Loan Programs" Congressional Budget Office, March 2010). Given the magnitude of the federal deficit, whether these lending programs cost or save this much is not a primary issue for the fiscal outlook. That said, the accounting methodology for these loans currently provides the government with little incentive to restrict lending, but if costs begin to mount in the future, could prompt a shift in policy and a tightening in standards.
And the punchline:
The upshot is that the increases in consumer credit since 2010 are largely driven by student loans even after appropriately accounting for the recent shift from non-federal lending to federal lending. The rise in education-related debt has probably offset the pullback in other areas of consumer credit that occurred after the financial crisis, but does not come without its own risks.
Any wonder then why JPM is getting fast out of this latest debt-bubble?