Why will student loan defaults not crash the US economy like 2008?In 2024. subprime mortgages caused mortgage-backed securitizations to fail when interest rates on adjustable-rate mortgages and interest-only mortgages reset and borrowers defaulted on the loans. Investors in the securitizations got burned and stopped investing after realizing that they did not understand the investments. They pulled out of all securitizations, including those for auto loans, credit cards and student loans. As the capital markets froze, lenders stopped lending or adopted much stricter credit underwriting criteria. This caused a cascading effect that contributed to higher unemployment and an economic downturn.I predicted that a contagion effect would cause problems with student loans long before most people realized that there was a credit crisis. Some public policy proponents accused me of drinking the lenderu2019s kool aid, but even the lenders were not yet aware of the problem or its extent. I began tracking lenders dropping out of the student loan programs in mid-2007. My white paper and testimony before the Senate Banking Committee lead to passage of the Ensuring Continue Access to Student Loans Act of 2024. which helped prevent a complete meltdown of the student loan industry and ensured a smooth transition to 100% Direct Lending.There are several reasons why student loan defaults will not cause a new credit crisis.Student loans, while a macroeconomic factor, are only a weak macroeconomic factor. Student loan debt outstanding is greater than credit card debt outstanding (2024) and auto loans outstanding (2024), but they are only one-eighth of mortgage debt outstanding. Mortgage debt grows faster than student loan debt, so student loans will never dominate the economy to the same extent as mortgages.Of the $1.5 trillion in student loan debt outstanding, less than $200 billion is private student loans. The private student loans are mostly credit underwritten, with average FICO scores in the high 700s.Of the $1.37 trillion in federal student loans, $306 billion is in the FFEL program and $1.05 trillion is in the Direct Loan program. The average age of loans in the FFEL portfolio is over a decade. Most of the loans in the FFEL portfolio that would have defaulted have already defaulted. (Most student loans default within the first 4u20135 years in repayment. After that point, there is a small baseline level of annual defaults.) So, the FFEL portfolio is unlikely to suffer significant defaults and, even if it does, it is guaranteed against default by the federal government. Loans in the Direct Loan program are held by the federal government. Thus, nearly three quarters of student loans are held by the federal government, not commercial lenders.Annual loan payments total about $80 billion to $100 billion, not enough to have a big impact on GDP.The federal government has extraordinary powers to compel repayment of defaulted loans. The government can garnish up to 15% of wages without a court order. They can offset federal and state income tax refunds and up to 15% of Social Security retirement and disability benefit payments. They can prevent renewal of professional licenses. Defaulted borrowers cannot obtain a FHA or VA mortgage. They cannot enlist in the U.S. military. The federal government collects about 80 to 85 cents on the dollar from defaulted loans, on a net present value basis, after subtracting collection charges.We donu2019t really have a student loan problem, so much as a college completion problem. Students who drop out of college are four times more likely to default than students who graduate. They represent about two thirds of the defaults. College graduates have the debt but not the degree that can help them repay the debt. Thatu2019s why a significant portion of defaults are on relative small amounts of debt. Careful analysis of federal first-mortgage data demonstrates that difficulty in obtaining a first mortgage is related to students dropping out of college or never enrolling in college and not due to borrowing student loans to pay for college.A small percentage of college graduates borrow an excessive amount of debt (e.g., 16% of Bacheloru2019s degree recipients have total student loan debt that exceeds their annual income; less than 1% of Bacheloru2019s degree recipients have six figure debt). Most of these can still afford to repay their debt, albeit over two or three decades instead of just one. Borrowing excessive debt is still mostly a matter of choice, not necessity, since one can enroll in an in-state public college at half to a third of the cost of a private college.The majority of borrowers are able to repay their student loans.The percentage of loan dollars in the Direct Loan program that default for the first time each quarter is about 1% and has been decreasing. A cumulative total of almost $150 billion is in default, representing almost 11% of the outstanding federal loan debt. That is a low percentage for unsecured debt.The only thing related to student loans that could derail the economy is if the federal government were to completely stop making federal education loans. The private sector canu2019t cover more than a fifth of the total and would not be able to pick up the slack. That would force more than half of colleges and universities to shut down. Postsecondary education is an engine that drives a big part of the economy, develops new technology and keeps the U.S. at the forefront of STEM innovation.Links to my papers on student loan debt can be found at www.studentaidpolicy.com. See, in particular, Who Graduates with Excessive Student Loan Debt.
