Lenders hand out money with scant regard to the borrower’s ability to repay.
The borrowers use the money to make a big-ticket purchase, and the sellers happily stuff the money in their pockets. What do they care if the borrower can’t pay it back?
When borrowers ultimately default, the taxpayers pick up the tab.
Sound familiar? Does the great housing price bubble come to mind, along with the foreclosure disaster?
It sure does. But this column is about student loans. Could they be the next consumer bust?
Education debt is soaring. Student loans stood at $1.2 trillion as of May, up 20 percent since the end of 2011, according to the Consumer Financial Protection Bureau. That doesn’t include debt that students put on the credit card, or that their parents put on the house through home equity loans.
Student debt is now second only to mortgages on the list of things weighing down family budgets.
Tuition has been rising faster than personal income for decades, but that’s the smaller factor behind the recent debt explosion. The Great Recession gets the bigger blame. It squeezed family finances, and they haven’t yet recovered. Students borrow more because families have less in the bank.
Meanwhile, the weak job market is causing more people to seek new skills, taking on debt to pay for it.
Rohit Chopra is the consumer bureau’s student loan ombudsman. He was in St. Louis last week for a symposium on student debt sponsored by the Federal Reserve Bank of St. Louis.
Chopra draws lots of parallels between the mortgage bubble and student loans today. In both cases, those making the loans and pocketing the money have little interest in seeing it repaid.
“Posh U” arranges a federal student loan and gets the money, but it’s not on the hook of Joe Student goes broke. Hence the bath of advertising from for-profit colleges on daytime TV, hoping to reel in the idle.
All this reminds us of mortgage lenders who made bad loans, then sold them off to the government-sponsored mortgage companies, which guaranteed them. Home sellers got paid. So did the lenders. They made Uncle Sam the sucker.
More than 80 percent of student loans are federal or federally guaranteed.
A BET ON THE FUTURE
To be fair, no lender can assess the credit of an 18-year-old. The loan is a bet on the kid’s future. (Private student lenders usually require a parent’s guarantee.)
So, the government must rely on the schools to admit people with ability, then give them the training they need to get jobs.
How are they doing on that? Well, the default rate on federal student loans stands at nearly 15 percent and rising. Any bank with such a default rate would be out of business, but Uncle Sam can’t go broke.
Default rates are truly spectacular among the for-profit schools, where tuition is often high. It’s common to see 20 and 30 percent of their students go broke three years after leaving school.
Obviously they’re admitting the wrong students, giving them poor training, or both.
The Obama administration proposed denying student loans at schools with the most horrid default rates. It eased the rule somewhat after strong lobbying from the for-profit schools, and they’re still beating the bushes for students.
It is very easy for a student to take on debt, as Paul Peanick can tell you.
Peanick, 26, will graduate from the University of Missouri-St. Louis soon. The good part: He’s a smart young man and he’ll have a degree in economics, one of the more valuable degrees in the job market.
More worrisome: He’ll have $56,000 in student loans. That’s well above the median student debt of $13,640.
Peanick grew up in south St. Louis, and graduated from Gateway High School, a city public school. His family couldn’t help much with college costs, so he embarked on the classic way to get a degree on the cheap. He went for two years to community college, then transferred to a state university.
But UMSL’s total cost — tuition, books and living expenses — is $24,000 per year, and his scholarship offer was lean.
Indecision was his pitfall. He started off wanting to be a doctor. After getting far into that course, he changed his mind and started looking for an alternative. He dropped out to help his family, then came back. He ended up taking lots of courses that wouldn’t count toward his degree. His quest stretched long beyond the standard four years.
“When you’re young, it’s kind of hard to know what to do with your life,” he says.
He’s not very worried about the big debt. He is hoping for a good-paying job in finance, and he expects to live lean while paying off his loans. “I don’t need an 80-inch TV or a $40,000 car,” he says.
That’s if a good job materializes. According to Chopra, student borrowers’ problems today are “astoundingly similar” to mortgage borrowers — the job they expected either never appeared or went away.
If student loans do become the next big bust, it would not play out like the foreclosure mess. To the most part, homeowners could give up the house and escape the debt. There’s no escape from student debt — it usually can’t be erased in bankruptcy.
The federal government is a mean collector. “They’ll garnish their wages. They’ll take their federal tax return,” Chopra says.
On the other hand, the government is fairly lenient with people who ask for help before they default.
There are payment forbearance programs for people who can’t find jobs. An “income-based repayment” program limits payments to about 10 percent of income, and erases the remaining debt after 20 years. The forgiveness time is shorter for people working for government or charities.
By contrast, lenders of private student loans tend toward the unforgiving.
Chopra thinks the defaults are mainly among dropouts, but data on that is scarce. Many of those defaulting may simply not know about the federal forbearance programs.
“They are paralyzed by the magnitude of the situation. Some bury their heads in the sand and hope the loan will go away,” says Paul Combe of American Student Assistance, a nonprofit group that helps students plan their debt.
Despite all that, a college degree is still worth it, even if you have to borrow. The median pay for a high school grad is $36,000 per year. The median with a bachelor’s degree is $66,000. A master’s degree brings $71,000, and a professional degree (think doctor or lawyer) brings $105,000.
Over a lifetime, a college grad will earn $1 million more than a high school grad. That estimate has held for years, but the reason has changed. It’s no longer that pay for college grads is rising, notes Chopra. Actually, it’s fallen since the recession. But pay for high school grads has fallen faster.