Student loan defaults: The next subprime crisis?

1st October 2012

"The Federal student loan bubble has not only popped, but has all the carbon copy makings of the next subprime crisis."  That's how Zero Hedge reacts to a report  Friday by the U.S. Department of Education that show that more than one in 10 borrowers have defaulted on their federal student loans. The default rate, for the first three years that students are required to make payments, was 13.4 per cent.

According to Zero Hedge, this number is "stunning" because it's a 50% increase over the old benchmark, which tracked a two year default cohort, which was a "mere" 8.8% for the year 2009.

"Federally funded student loans are now increasing at a rate of over $60 billion per quarter. This means that in just about 18 months, the total size of the Federal student loan market will hit $1.3 trillion. Why is that number important? Because that is how big the subprime market was at its peak in late 2007, when everything went to hell and the last credit bubble popped…..And the biggest problem: unlike housing where there is always at least some recovery of collateral, as the house remains, with student debt there is no recoverable asset as the asset is a human being.

"We give Bernanke at most 2 years before everyone is aware of the true extent of not only the student debt bubble, but that it has already popped, at which point student loans will be the next "asset" to be monetized by the Federal Reserve."

U.S. Secretary of Education Arne Duncan, also concerned by the numbers said in a statement: "We continue to be concerned about default rates and want to ensure that all borrowers have the tools to manage their debt. In addition to helping borrowers, we will also hold schools accountable for ensuring their students are not saddled with unmanageable student loan debt."

Terry Smith of the Columbia Daily Tribune, however, calls the student debt crisis a myth that is "inflammatory, misdirected and mischievous."

"Currently outstanding student loans total $876 billion – a lot, to be sure. There is $22 trillion owed on mortgages, with $8 trillion lost in defaults since 2008. If all students defaulted on their loans, the impact on the economy would be only one-tenth that of mortgage defaults. (One student in six is currently in default.) The student loan bubble is simply alarmist hyperbole."

He continues: "When I went to school in the 1960s at a nearby private college, my parents took out a personal loan to pay for part of my tuition. It was unthinkable for me to borrow enough money to allow me to live in a fancy off-campus apartment, buy a nice car and take exotic spring breaks. Times have changed, and today student loans pay for many things, some of which have little to do with getting a good college education.

"Maybe the student loan crisis is not economic. Maybe it's cultural."


Previously on The Financialist:

'Emerging market investment: looking beyond the BRICS'

'15 high-risk shares that could rise fast'

'Facebook is at the beginning of what could be a monster comeback'

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