Are Student Loans The Next Bubble Waiting To Pop?

This is a question that has been raised quite a lot within the finance community and I believe warrants a quick discussion. So let’s get started.

The main thing most people point to in terms of this student loan “bubble” is its eery similarity to the sub prime housing crisis. Let me explain, people point towards the fact that debt held by student loan borrowers is greater than that of credit card and even automobile debt. They also point out that virtually no one gets denied a student loan and finally its ability to act as a potential moral hazard. (Student debt is backed by US gov and you cannot declare bankruptcy on it). While all these are indeed valid points they really don’t make a good case in terms of the argument at hand. 

The main issue with the 2008 sub prime mortgage crisis was that the debt (Mainly consisting of SP mortgages) was massively securitized into CDO’s and other such derivatives and traded among financial institutions in the billions. What this meant is that these toxic derivatives stayed on the books of banks/hedge funds for weeks before they could be sold off or broken down. This kind of securitization does not exist (at least not at the same level as with sub prime mortgages) with student loan debt (Almost all is held by the US government [see graph 1]).federal-student-loans-outstanding-data_chartbuilder1

In short there is no packaging, no bank exposure, no securitization. All of the student loan debt in the US could default tomorrow and banks wouldn’t bat an eye because they down own it. Taxpayers would be on the hook, which would suck, but that doesn’t equate to a bubble bursting. Also the primary driver of 2008 was somewhat rapid devaluation of the underlying asset(housing) which can’t really happen in this case. Future earning ability can be considered the underlying asset but there wouldn’t really be some catalyst that will cause everyone’s earning potential to rapidly devalue.

So while there are legitimate concerns with this student debt situation (large default rate etc) the risk of it imploding into another worldwide recession is minimal at best.

Overall I believe a lack of understanding behind what really went down in 2007/2008 is what contributes to this fear of debt/financial institutions. Maybe one day I’ll run through it and hopefully alleviate any fears or misconceptions people have. Or maybe I wont.

-Hassan

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