Student Debt – The good, the bad and the ugly

Increase in Student Loans as % Change in PCE

The Good:

Many of us remember the excitement of accepting a place at a university that wanted us.  New friends, new paths, new horizons and a good bit of freedom were all just ahead of us.  The four (or five depending on how much fun we stumbled upon) years gave us experience, lessons learned both in and out of the classroom and that all important education.  At the end of it all we headed out to find a job that would take us to the next stage of our lives.   Ah geez what wonderful and exciting times.

The Bad:

Today, however, there is a major downside to graduating.  That’s when the student loan payments begin to kick in.  Americans currently have $1.3T of student debt outstanding.  This obviously is the highest level we’ve ever seen and the reality is if you had asked any economist or loan specialist or politician for that matter 10 years ago if we could see student debt levels increase 10x over the course of a 6 year period you would have received a resounding “No damn way”.

But so ok debt is higher but as long as these kids are getting jobs the theory remains the same.  You borrow and invest that in your future as a student.  So it’s not frivolous spending so much as it is a sound investment, right?  Well the problem is that student debt started sky rocketing as the economy was collapsing and with it jobs.  Now this would not have been a bad trade if during the 4-6 years following the collapse good jobs requiring college educations increased to levels that could sustain college grads entering the marketplace.  Unfortunately this has not occurred.  The labour participation rate for ages 25-29 is at its lowest level since tracking began in 1982.  Currently more than 4 million young adults that age have fallen outside the labour zone.  Since the end of 2008 an additional 511K 25-29 year olds are not working or even looking for work.  If we look at just those with college degrees, 45% of recent college graduates are working in jobs not requiring a college degree and thus not paying wages sufficient to cover student debt.

The Ugly:

I know I know this seems so strange given the market is at all time highs and according to those non stop talking heads that must mean everyone is doing well.  They point to a couple things to defend their stance.  First and foremost earnings are strong!  Well look a little deeper and we see earnings growth is not a function of better revenues due to increased demand but of financial engineering such as stock buy backs, dividend outlays, enormous reductions in capital investment (necessary for future growth and jobs) and good old fashioned firings.  Then they retort vigorously with “Hey ok sure you got us there but there are demand increases just look at consumption growth and consumption growth is 70% of GDP!”  Well let’s look a little deeper there too.  There have certainly been modest increases in consumption since the collapse when adjusted for inflation.  So let’s look at those increases and what is driving them.  If we take the year on year net increases to total student loans and we put those against year on year increases in personal consumption expenditures (PCE) we find that student loans since 2008 equate to 30% (average over that period) of the increase in consumption.  Refer to the chart below for yearly figures.  In 2009 the decline in consumption would have been 58% larger than it was had it not been for increases to student loans.  Initially one might say well then it’s a good thing we have been pumping this cash into the economy.  However, on second take one realizes OMG!  We are simply borrowing our consumption.  If one adds in the increases to social welfare over the same period it takes us to over 50% of the increases in consumption have come directly from these two areas of debt (yes social welfare is also debt since we are running deficits).

I’d like to add that it isn’t just 25-29 years olds taking on student debt.  And many of these folks are not so much interested in the education bit as they are substituting debt for income and not by choice.  In discussing this matter with an old banking colleague I was reminded that we saw this in the mid 2000’s via home equity loans.  There is a major difference though this time around in that home equity loans were used for discretionary purchases.  People bought cars, boats, cabins, etc as they saw it as easy earned money.  Today many folks are using student loans to purchase basic staple items.  They are using them to survive.

The fact the Fed is not raising rates has very little to do with inflation.  In fact inflation is notably on the rise even according to prior statement’s by various Fed govs.  Fed cannot raise interest rates for two significant reasons.  First, the economy has not recovered sufficiently to withstand higher rates.  That is a broad statement but is meant to be as it is the broad economy that has not sufficiently recovered.  Second, is the glaringly obvious fact that the government is holding $17.5 T worth of debt and current students and graduates are holding $1.3T in student debt.  The majority of loans are Federal program loans and remained fixed for the life of the loan.  That said, students must take out new loans for each year and will be subject to new rate levels with each new year.  Further and perhaps more worrisome are the appx. 40% of loans that are private which typically have variable rates meaning as interest rates increase so too will monthly payments.  It may seem silly that the Fed would make decisions on interest rates based on student debt but when you look at the chart below you see student debt has been a major driver of consumption and has a huge number of Americans currently backed into a corner.  Add that to the $9T worth of debt the government has added since 2008 and well silly no longer comes to mind.  This is the ugly part of the nightmare before we wake up screaming only to realize this isn’t just a terrible dream.


Student Loan Impact on PCE