Most people are aware that the Great Recession of 2008 was triggered by sub-prime lending, what those of us in the real estate industry called a “no-doc” loan, also called a “liar’s loan” by a few. Anyone in the business saw it over and over — people who couldn't afford a five-bedroom, 3,700 square foot home with a three-car garage and theater room, but there they were, claiming income north of $150K a year to get a mortgage, a second wrap-around mortgage, and a personal home equity loan in order to afford it. It’s not much of a surprise to anyone that financing scheme didn't last.
When the sub-prime market blew up and big banks lined up for a taxpayer bailout, you might have thought the banks learned something from the sub-prime crisis — and they did, but not the lesson you might expect. What they learned was that there was a far more lucrative market, where borrowers were trapped into paying back their sub-prime loans, even if they couldn't afford them. Just like with mortgage loans, the whole scheme was backed by the federal government. In the wake of the housing crash, banks discovered student loans.
They learned was that there was a far more lucrative market, where borrowers were trapped into paying back their sub-prime loans — in the wake of the housing crash, banks discovered student loans.
A report by the New York Federal Reserve showed that student loan debt more than doubled between Q1 2005 and the end of 2012, with the steepest increases being chalked up for those under 30. The average balance soared to nearly $25,000 as the total student loan debt in the nation neared $1 trillion dollars. Student loans now trump credit cards, auto loans, and home equity loans for the top debt spot, and were the only type of debt to rise through the Great Recession. Only mortgage loans account for more debt nationally than student loans.
Economic Time Bomb
Student loan debt has far more insidious implications for the economy than home loans. Since most student loans can’t be discharged in bankruptcy, young people are saddled with an economic albatross during the most financially productive years of their lives. According to another report by the Cleveland Fed, the ongoing debt crisis is causing young people to put off household formation, which means they’re getting married and buying a home later in life. Student loan debt is almost certainly a large part of that equation, as 43% of 25-year-olds, nearly half, are carrying significant student loan debt. Young people between 18 and 34 years old now account for three-quarters of the shortfall in household formation.
Having nearly half of the most productive members of workforce opting out of the American dream throws a wooden shoe into the gears of economic recovery. We have the greater share of 18–34-year-olds living in a household formed by their parents. Instead of buying homes and cars and lifting our national GDP by taking on big ticket purchases, that productive fraction of our workforce is living in their parent’s spare room applying for loan deferments because they can’t find a job, stretching out student loan payments — and the headwind for our economy — for decades.
Waiting For a Spark
Eventually the housing bubble burst, lead by a growing wave of mortgage defaults as economic inertia finally caught up to people who couldn’t afford their homes in the suburbs. Similarly, the student loan crisis is just waiting for a spark that could trigger the next recession. Only the next recession won’t be solved by “jingle mail,” when strapped homeowners left the keys to their house in the mailbox and skipped town. There won’t be any escape valve for the student loan recession; borrowers will be stuck with insanely high loan balances, due to interest and late fees being added to the balance.
Instead of a recovery, the student loan recession will be followed by decades more of economic inactivity, as crushing debt keeps an entire generation of young Americans on the sidelines. In some ways the coming student loan crisis could dwarf the housing crisis as a drag on the economy.
So how do we fix this, in the absence of a crisis to bring a rare moment of unity in Washington? We don’t, it’s really that simple. Political gridlock practically guarantees we won’t be taking any of the serious steps necessary to manage this situation before it becomes a crisis. We’ll just have to wait until the economic time bomb goes off, and deal with the aftermath. It’s a terrible waste, but that’s the price we pay for handicapping our political process.