The Fed’s most recent report showed total indebtedness down 11% from its 2008 peak. An uptick in auto loans, mortgage originations, and credit card balances displays a rebound in consumer confidence. The bad news is that there’s more student debt coming on, and it’s becoming increasing delinquent. The total amount outstanding of $956 billion represents a 4% increase from last quarter alone. A touch over one tenth of these loan balances are 90+ days delinquent. The warnings signs of a bubble about to burst have revealed themselves.
Here’s the tricky thing about student loans. There’s no Troubled Asset Relief Program; the government is not going to be able to bail out the banks this time. These kinds of loans, unlike mortgages, do not get cancelled by bankruptcy. In other words, those toxic student loans are here to stay like sticky poisonous chewing gum.
Current solutions include garnishing parents’ assets or utilizing debt forgiveness programs. Both are not optimal and will prolong the pain. Going after parents who co-signed for the debt by garnishing their social security or claiming their retirement savings will lower family consumption. Debt forgiveness may be available for students who enter certain philanthropic occupations, such as being a doctor for an underserved population. However, such positions normally come on the lower end of the wage scale. Here’s what that means for the economy: lower aggregate discretionary income, lower consumption spending, and lower tax revenues. And don’t forget that the government is footing the bill, in a sense, by waiving the debt.
What has led us to this student loan crisis is the lack of competition in the lending process. Student loans are non-discriminating in terms of earnings potential. A student can get a loan if he is pursuing a major of study with typically high unemployment, such as folklore and mythology, as easily as a student majoring in engineering or economics.
Adopting a private equity-like approach may be a possible solution, because it essentially creates a market for this type of debt. Let’s imagine that college educations are funded just as start-up companies are. In this scenario, loans are granted by private equity firms after extensively screening the candidates, perhaps based on academic performance, major, etc. Once the student graduates and gets a job, the private equity firm has a share in the paycheck. The firm retains the right to participate until the loan is repaid. Introducing competition to this process can help ensure that loans are paid back in a timely fashion ,and might be what our country needs to avoid student loan bubbles in the future.
 The Quarterly Report on Household Debt and Credit, November 2012. Federal Reserve Bank of New York, Research and Statistics Group, Microeconomic Studies.