If I’m correct, I believe that much of the loans are through the government and not through independent financial institutions so it’s got me thinking…back in 2007 everything tanked because these loans were all through private companies and were also subject to speculation, morphed into CDOs, etc, but I don’t believe that would be possible to do with student loan debt since no private firms hold much of the debt. So…if they go south, I imagine the economy tanks somehow, but how exactly would it happen?
What’s “a large number” in this context? As of August 7 million Americans are in default on their student loans…
I’m mainly just asking to know how financial institutions would be affected? I mean, they probably can’t be DIRECTLY affected, but, suffice to say, most would feel it on the back end of the crisis?
The federal government would end up eating a lot of it. Most student loans can’t be discharged by bankruptcy, true, but the principle of ‘blood from a stone’ does tend to take precedent.
There would be, IMHO, a few relatively short-term consequences.
Interest rates for student loans would rise in the aggregate. This would have the effect of leading fewer students to attend college and apply downward pressure on educational costs for most schools.
For-profit and smaller public schools would be completely screwed. They already have trouble showing bang-for-buck in many cases or have an inability to match costs with larger public schools.
It would - finally - encourage reform of the student loan system. Currently it’s broken with far more students taking on unjustifiable debt than can be sustained.
A certain type of investor would take it in the neck. Sallie Mae spun off Navient in 2014. Navient holds most of the loan portfolio from Sallie Mae. It’s also publicly traded and its shareholders would not enjoy a significant drop in performance of the stock due to widespread default. In addition, those people who hold Sallie Mae bonds could also see default in a negative light.
In short, it would be painful to see the default rate climb to 50% or more. Especially if it was a serious default…not a slow pay but a complete cessation of payments.
Nonetheless, I believe it’s coming and it will be a good thing over the long term. Ensuring that the next generation of workers and professionals begins their productive lives in debt is a terrible way to actually grow the economy. It’s allowing a subset to profit from the weaknesses of the rest of us.
It would bring the big banks crumbling down to their knees.
Just kidding. They’d re-adjust their rates, maybe re-allocate some capital, go have a sandwich and continue making huge profits.
Mmmm. In answer to this, Sallie Mae offers bonds based on anticipated return on their loans. These are investment grade bonds and are among the bonds available for most pension plans. Such groups - pension plans and other similar - are regulated in such a way that they can’t usually invest in bonds rated lower than BBB-.
In some quick poking around I couldn’t find numbers on who holds how much of Sallie Mae bonds but current runs of SLM bonds are sitting right at BBB- or a bit better. A slip and they may find their pool of bond buyers severely restricted. They won’t enjoy that at all.
Defaulting on student loans isn’t quite like defaulting on a business loan or mortgage. When a business defaults on a big loan, the next step is often bankruptcy and the winding up of the company. That loan will never be paid, since the company that owes it no longer exists. Defaulting on a mortgage is somewhat similar in practice (although not in principle). Although theoretically the defaulting homeowner still owes the mortgage, or rather the difference between the loan and the amount which his foreclosed house fetches at auction, in practice once he loses the house essentially nobody pays the mortgage balance, and banks simply write them off. (There are exceptions, and if you come into a windfall inheritance not long after defaulting on a mortgage, don’t be surprised if you get a summons.)
A student loan is different. It can’t be discharged in bankruptcy, the borrower doesn’t cease to exist (although obviously bondholders might quite like that to be a legal possibility), and the asset it was used to purchase (the college degree) can’t be taken away via foreclosure. So the usual reasons why the debt might be written off don’t apply. Furthermore, the Federal government guarantees these loans, which means if the lender himself can’t get the money, he sells the loan to the Feds – to whom the borrower then owes the money. And if there’s one thing the Feds have, it’s lots of time, patience, and the legal means to screw the money out of the borrower, sooner or later, one way or another. Income tax refunds will be garnished, licenses withheld, et cetera. You never want to get into conflict with an agency that doesn’t care if it spends $10x recovering $x, because it doesn’t need to make a profit.
As a practical matter, then, my impression is that most “defaults” aren’t permanent, in the sense that the loan will be written off. Rather, borrowers go into default for some length of time, then cut some kind of deal with the Feds that restarts the payment stream, once the Federal enforcement mechanisms start to bite. So a massive student loan default would be less of a large quantity of theoretical wealth simply evaporating (which is what happened with Lehman Bros et cetera) and more of a significant decrease in the yield expected on the bonds. Presumably that would lead to a lot of selling, which would cause losses to current bondholders and potential windfalls to new (depending on whether the reaction was an overreaction or not, and they usually are). It seems very unlikely to bring down the economy, because, as you point out yourself, student loans are probably not rehypothecated up the wazoo, since they have never been considered super high quality investments. They’re personal loans, after all. There is no underlying asset. It doesn’t seem likely there is some towering pile of debt waiting to be shaken down by a scare about the quality of the underlying collateral.
Then again, we’d have to ask: where would such a large and sudden stopping of payments come from? A gigantic surge in unemployment? That would produce much larger problems, besides which student loan default would be noise. A huge strike by people who can pay the loans but decline to? That seems as unlikely as a majority of people suddenly deciding to go on a tax strike and not fork out on April 15, and for pretty much the same reasons.
Ignore your student loans long enough and they will garnish your wages - so “they” will get their money (including accumulated interest, collection costs, etc.) eventually one way or another.
(I personally know people who have been out of college for ~25 years who are under student loan wage garnishment.)
In fact, student loan auction rate securities (SLARS) were affected by the financial crisis. Here’s a Barron’s article that touches on it:
The difference was that in 2008 home mortgages were a significant proportion of most banks’ portfolios. The total amount had increased exponentially as prices climbed and people overbought on low teaser rates and expectations of selling in future for a profit. then the banks resold these loans as bonds, thus poisoning even more of the financial institutions around the world… then the collapsing economy even jeopardized jobs and mortgage repayments that otherwise would not have been a problem… one big house of cards.
The student loan system, while big, is nowhere near the proportion of the financial system that house mortgages are. A significant number of people are paying down theirs, so their loans are not in trouble. As others mention, the government does not mess around when it comes to collecting, so it would take a significant financial earthquake or a very weird social movement before people would stop paying their loans in droves.
There’s a provision in the loan system that colleges with an excessive alumni default rate will lose their ability to qualify to accept student loans, so the colleges have an incentive not to overpromise or ridiculously overburden their students.
This will extend into retirement, by the way. They can garnish your Social Security payments if you still owe on your loan.
That would happen if market forces applied, but they don’t really. Federal student loan interest rates are set by Congress, so they wouldn’t necessarily increase in response to a mass default. What happens to rates would be dependent on politics.
As to your points about investors taking a hit, aren’t student loans guaranteed by the US government? If so, I wouldn’t expect investors to take a hit. The US deficit would simply widen.
Not all student loans are guaranteed. I’m seeing an ongoing increase in non-guaranteed private loans in my clients. It’s not a happy event.
Plus, mass defaults would cause real trouble at Sallie Mae even on guaranteed loans. The federal guarantee extends loans out and doesn’t kick in for quite a while. Given Sallie Mae’s business model of being self-sufficient it would certainly make them more chary of issuing loans to the more marginal students even though their mission statement is to make them for all qualifying students. If Sallie Mae wants to operate as a real firm they’ll behave like one when faced with mass defaults. Of that I feel certain.
As you can likely tell, I’m opposed to most student loan programs. We’re hammering new wage earners when they’re most vulnerable. And we’re doing it for something that benefits society as a whole - a greater aggregate education in the population will equal greater productivity and such. Instead we seem to be doing our best to drag that down for short-term benefit. It’s the same sort of thing the mortgage and derivative guys did ten years ago. Ugh.
The Fed could buy all $1 trillion of student loan debt just like they have bought MBS and Treasurys from the banks. The Fed could simply burn the notes. Instant debt relief.
Most of the people who are experiencing this are parents or even grandparents who co-signed a loan.
Better solution is not to borrow money on degrees in majors that have no market value. You don’t need more than 4th grade math to figure out $100,000 in loans for a $22,000/yr job is stupid. Main reason is market forces while painful for some ought to result in a rational choice of degrees.
It also affects people who go back to school as adults to get a degree. My sister was a physical therapist tech or something like that and wanted to be a physical therapist. So she went to an expensive private school[sup]1[/sup] in her 40s and rang up a huge pile of debt. She got her degree but I don’t think she’s going to pay it off before she retires. The way she put it was more like “you can’t collect SS if you have school loans”, which I don’t think is quite correct.
[sup]1[/sup] The school charged about three times as much tuition for a single term than I paid for my entire 4-year degree back in the 70s. And it took me 5 years to get that degree. OK, inflation has a lot to do with that, but inflation in tuition is generally higher than your ordinary CPI inflation. The only thing that goes up faster than tuition is pharmaceuticals.
But like I said, given the way the government can come after defaulters - it would take a seismic economic event, far worse than 2008, before a significant number of ex-students were in the situation of not able to pay back loans. At that point, student loans would be the least of the country’s worries. It didn’t happen even when GM and Ford and half of Wall Street were going down the tubes.
There was an CNN article last year that said the opposite - most of them are paying on their own loans, not cosigned loans for someone else. Oh, here’s the article: only 20% are struggling with student loan debt that is cosigned loans and 80% are their own educational debt. You can’t blame their kids for this mess.
In large part the student loan debt is guaranteed by the federal government. That’s why all these financial institutions find these loans so attractive. If there was a major default it would be the taxpayers who would be on the hook for it.
Also something you need to know about student loan debt, it does not go away even if you file for bankruptcy. So the compounding interest will accumulate and ruin people’s lives. This is already happening to some people, they are stuck with terrible debt burdens.