Student Debt and the Siren Song of Systemic Risk

What are we to make of growing levels of student indebtedness?

On the one hand, commentary in the popular media consistently extols[1] the virtues of investing in higher education, and serious economists back them up.[2] On the other hand, borrowing by students to pay for college has increased dramatically in recent decades, and that debt can be a crushing burden for some borrowers. A greater percentage of borrowers has gone into default in recent years, no doubt slammed by a more difficult economy and higher monthly payment obligations on larger balances. In the context of steadily increasing education costs, this all looks like a crisis brewing. The trick is recognizing the nature of the crisis.

More information has become available, although we still do not know enough about student debt; one economist I recently spoke to suggested that we know as much about student debt now as we knew about mortgage debt fifteen years ago. One thorough, sophisticated, and provocative new study drew on data from both the federal Education Department and the Internal Revenue Service to shed new light on the education and life outcomes experienced by borrowers. The study’s findings are slowly spreading; even an article in The New Yorker has now cited it.

The study by two researchers, Adam Looney of the Treasury Department and Constantine Yannelis of Stanford University, found that much or even most of the increase in default rates over the past few years is the result of growth in the number of students attending for-profit institutions and, to a lesser degree, community colleges. The study characterizes these borrowers as “non-traditional,” because “historically there were relatively few for-profit students and because 2-year students rarely borrowed.” In the recession following the financial crisis of 2008, the number of such students swelled. Nearly three-fourths of students who began repaying student loans in 2011 and defaulted by 2013 were non-traditional borrowers, the authors report. As the number of non-traditional students declines, the study suggests, overall default rates should decline, too.

These findings make clear that any student loan crisis is not the product of growth in the number of student borrowers who owe more than $100,000 (about 4 percent of borrowers, according to the College Board). Those borrowers with high balances are often the focus of media coverage, even though other research by the Federal Reserve Bank of New York has found that default is more likely for students who have borrowed relatively smaller amounts than it is for those who have borrowed larger amounts; those in the latter group tend to earn more. The crisis involves students who borrowed smaller amounts to attend institutions associated with worse outcomes, like lower graduation rates and poor employment opportunities. This means that the problem of higher education finance is not indebtedness but access to quality.

Recognizing differences between traditional and nontraditional borrowers does not end the story. Even if student lending does not represent a crisis for so-called traditional students attending four-year, nonprofit and public colleges and universities, there still is concern that student debt could somehow contribute to a future financial crisis. After all, as newspaper headlines remind us regularly, more than 40 million student borrowers collectively owe more than $1.2 trillion and that is a lot of money. Is this a student loan “bubble” that could burst, like the real estate bubble of a few years ago?

The answer, I contend in Student Debt and the Siren Song of Systemic Risk, forthcoming in the Harvard Journal on Legislation, is probably not. The article notes the increase in student borrowing overall, but puts the amount in the context of home lending, which at its peak before the financial crisis was more than nine times greater – more than $10 trillion. Students have not borrowed that much, at least not yet. Unlike home loans, most student loans are not resold to investors, and without trading of securities backed by student loans, the impact of defaults on student loans cannot spread among investors, intensifying any crisis. The federal government, which is the largest lender, keeps loans on its books; indeed, they are an asset to the federal government (and critics like Senator Elizabeth Warren complain that the government should not reap “profits” from lending to students). Private student loans, those not made by the Education Department but by commercial entities, constituted less than 10 percent of the amount loaned in 2014-15, according to the College Board.

All of this is not an argument about the causes of the financial crisis. Home loans were only a piece of the story. The report of the Financial Crisis Inquiry Commission and analyses by scholars like Jennifer Taub, who chronicles the development of the crisis in Other People’s Houses: How Decades of Bailouts, Captive Regulators and Toxic Bankers Made Home Mortgages a Thrilling Business, and Robert Shiller, who undertakes a similar task in The Subprime Solution: How Today’s Global Financial Crisis Happened and What to Do about It, make clear that the crisis had several causes, including regulatory lapses and reckless, naïve, greed.

But the short-sighted homebuyer who invested in real estate beyond his means remains a powerful character in the narrative of the crisis, and that narrative poses a serious threat in the context of student loans. After all, the appealing tale goes, if excessive borrowing to invest in real estate helped cause a financial crisis, then excessive borrowing to invest in education can have a similarly tragic impact. The implication is that credit to those buying higher education should be limited, just as credit to excessively risky homebuyers should have been limited. Yet acting on this analogy would have the effect of closing the doors to college to those of lesser means – precisely the people whom federal student aid is supposed to help in the first place. This truth highlights the nature of the crisis the nation faces in higher education finance. It is the same crisis that we have faced for decades, and it is not a crisis of debt. Again and still, it is a crisis of access.




The preceding post comes to us from Jonathan D. Glater, Assistant Professor of Law at University of California, Irvine School of Law. The post is based on his article, which is entitled “Student Debt and the Siren Song of Systemic Risk”, available here and forthcoming in the Harvard Journal on Legislation.