Benn Steil

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Is Federal Student Debt the Sequel to Housing?

by Benn Steil and Dinah Walker
December 18, 2012

student loans and defaults

Back in March, we showed that the $1.4 trillion in U.S. direct federal student loans that will be outstanding by 2020 will amount to roughly 7.7% of the country’s gross debt. This is 6.3 percentage points higher than it would have been had the scheme not been nationalized in President Obama’s first term.

The government’s net debt was not directly affected by the move, as the government acquires assets when it issues student loans. The problem is that projected default rates on such loans have been climbing as the volume issued has increased, as shown in the graphic above.

If we apply the projected default rate on loans originated in 2009 to the amount of student loans outstanding in 2012, we find that defaults on federal student loans currently outstanding are likely to cost taxpayers almost $80 billion. And the cost is projected to increase rapidly over the next decade as default rates continue to rise and the amount of student debt the federal government owns soars.

There is more than a whiff of resemblance between the rise of the federal government’s student debt liability and the mortgage bubble – the detritus debt of which wound up nationalized. There is little in the way of credit checks carried out, and no evaluation of future earnings prospects. In the ten years to 2008, the amount of mortgage debt tripled: $3.2 trillion to $9.3 trillion. The CBO projects that student loans on the government’s balance sheet will rise just as fast: $453 billion in 2011 to $1.4 trillion in 2020.

A 17.3% default rate on $1.4 trillion in loans would cost taxpayers about $240 billion. This is equivalent to 1% of the CBO’s GDP projection for 2020. It is also more than three times the 2013 federal funding level for the Department of Education, and just slightly less than ten times the amount the president requested for science, technology, engineering, and mathematics (STEM) programs in his most recent budget.

It is surely worth asking, therefore, whether this $240 billion could be used more effectively than it will be in writing off defaulted student loans.

Department of Education: Default Rates
Bloomberg.com: Student Loans Go Unpaid, Burden U.S. Economy
Wall Street Journal: Federal Student Lending Swells
Geo-Graphics: Will Student Debt Add to America’s Fiscal Woes?

Post a Comment 6 Comments

  • Posted by Alan Collinge

    Those budget projections are, and have always been, far, far lower than the actual lifetime default rates. For example, the most recent lifetime rate is 17.3%, Yet the most recent, 3-year default rate is over 13%.

    The lifetime default rate, by my best estimate (starting with a 2003 IG study that looked at 10,000 borrowers) is currently running at over 35% certainly, and could well be over 40%.

    You need to know this, and more before prescribing policy to fix this problem. Please see http://www.studentloanjustice.org/argument.htm

    Regards,

  • Posted by Philip Campbell

    Fantastic article and graph Benn and Dinah. Very insightful.

    One question I had was how the new Pay As You Earn (the revised IBR) would impact the estimated taxpayer costs since there could be large balances forgiven out into the future. The new version will likely have a lot more people in the program than the older version of IBR.

    Great work!

  • Posted by Esteban

    Default rates do not equal collection rates, so your cost estimate is likely too high.. Unfortunately for those who default are subject to extraordinary collection measures, as these loans are non-dischargeable for life.

  • Posted by Jacob AG

    That 17.9% default rate is from 2009. It could be a secular trend, or it could just be fallout from the Great Recession.

  • Posted by Nina

    The more appropriate question to ask is: is there a way to provide young people with education, career and earning opportunities without forcin making them go through years of expensive colleges, thousands of debt and then still keeing them unemployed and underemloyed for decades, so they can never repay those loans. Finally something proactive needs to be done.

  • Posted by Saurin Popat

    $240 billion (or close to $1/2 trillion with a 35% lifetime default rate) does not take in to account opportunity costs if these former students can not or do not use the education received in lieu of their borrowing.

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