Student debt could cause financial crisis

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By Katie Burke, Daily News Editor
Published February 4, 2013

In 2008, subprime mortgage lending shocked the U.S. economy, leading to a major economic crisis from which the nation is still recovering. In 2013, a more overt concern could repress the economy once more: student loan debt.

Combined federal and private student loan debt is currently more than a trillion dollars. According to a Sept. 2012 Pew Research report, 95 percent of households in debt owed $92,842 or less, while only 25 percent owed $6,190 or less.

University researchers and professors see a cause for concern with this level of debt, though opinion varies on what will actually result from the record levels. A variety of causes have been identified and solutions have been proposed.

What happened in 2008

Mortgage contracts were not the main concerns of the Federal Reserve and economists in 2007. More people were able to borrow money for homeownership, but were also responsible for bearing most of the risk of these loans.

Economics Prof. Miles Kimball said the burden of these hazards was one of the leading causes of the housing market crash.

“Somebody bearing that risk wouldn’t have caused problems if it had been somebody with very deep pockets,” Kimball said.

However, homeowners and banks were shouldering the debt, leading to financial failure of firms, such as Lehman Brothers, Fannie Mae and Freddie Mac.

Kimball added that those in trouble expected the government to bail them out and provide assistance, but Congress was slow to act. This increased the national sense of panic. The nation entered the crisis in an era of optimism, but the country’s outlook became pessimistic even as the economy slowly recovered.

The scale of the crisis was due to the nature of the housing market in which the subprime loans were being handed out by financial firms to borrowers who were unlikely to make their payments, Kimball said.

“Usually, the big crashes come after some sort of big increase in asset prices,”

What’s happening in 2013

College affordability has been a policy issue for decades, and changes in legislation and state funding in recent decades coupled with rising tuition rates have added to the ever-increasing debt.

Under Title IV of the Higher Education Amendments of 1992, private, for-profit institutions became eligible for federal loans and grants.

According to the Institute for College Access and Success, the average amount of student loans received by full-time freshmen at Devry University, Michigan was $9,017 in the 2010 to 2011 school year and $9,154 at the University of Phoenix-Metro Detroit Campus. Both schools are classified as private, for-profit, four-year institutions.

In the same data, the University of Michigan, Grand Valley State University and Michigan State University, which are all public, four-year institutions, reported $6,502, $6,288 and $6,207 for the same year, respectively.

Donald Grimes, senior research specialist and economist at the University’s Institute for Research for Labor, Employment and the Economy, said too much money is being given to for-profit institutions, adding that students often are unable to earn as much with those types of degrees.

“The government became too generous,” Grimes said. “They were giving (loans) to go to … for-profit colleges and universities, and more people are actually not making money after they get a degree to repay the charges.”

All 100 percent of full-time freshmen students at Devry received student loans in the 2010 to 2011 school year, compared to 37 percent at Michigan, 66 percent at Grand Valley and 50 percent at Michigan State.

Grimes said loan debt is growing at about 10 to 15 percent per year, which is similar to the rate mortgage loans were growing before the recession.

Worsening the problem, 9.1 percent of students default on their federal student loans within two years, according to the U.S. Department of Education report from Sept. 2012.

Under the Health Care and Education Reconciliation Act of 2010, the Federal Direct Loan Program was instituted and banks were cut out of the lending process.

The increased dependence on the government for loans would cause it to be the institution that would suffer most from loan defaults.

“When people don’t make the payments on the loans, the person who holds the bond portfolio will go to the federal government and say, you guys pay,” Grimes said.

Grimes added that private lenders make up only about 10 percent of all loans made, putting the majority of the burden on the government.

Unlike mortgage loans, there are no assets that can be seized to make up for unpaid debts, leading to a direct financial hit to those lending.

Among forefront policy issues, student loan debt isn’t high on the list, and was only briefly mentioned in “>President Barack Obama’s second inaugural address.

Grimes said in the cases of 2008 and 2013 loan debt, lowered standards for lending made it easier to own a home or go to college, and the nature of these loans makes for “an unnerving parallel” between the past and present situations.

What comes next?

There is no clear solution to the mounting debt that student loans are creating; however, University experts have been considering the future of the issue.

Education Prof. Edward St. John said federal loan programs aren’t running as proficiently as they should.

“Pell Grants has been an Obama issue. He sacrificed funding for other need-based grant programs in order to maintain Pell, but we haven’t maintained Pell at a level that is efficient to pay the average need of a low-income student,” St. John said.

He suggests education funding should be worked out within states in order to increase levels of efficiency and fairness in policy for such programs.

Low community college funding adds to the attractiveness of for-profit institutions, leading to higher completion rates for such trade-specific schools compared to less-costly community schools.

St. John said the problem lies in the inaction of past generations and explains the current administration must work to decide the future attitude of the nation towards student loan debt.

“In general, we haven’t faced up to the issue as a society as to whether we want to be a lending nation or not,” St. John said.

Kimball, the economics professor, said the current pessimism will prevent any major student loan debt crisis from occurring on the same scale as the 2008 mortgage debt crisis.

“There will always be some losses on student loans,” Kimball said. “I don’t see anything sudden happening."

Grimes said it is important to continue to encourage college enrollment and lending for all socioeconomic backgrounds; however, caution must be exercised in which institutions the investments go to. He added that along with potential reforms, standards for lending should be tightened on the federal level.

“It’s really hard to think about what’s happening, what sort of monster we may have set up here. We don’t need another financial crisis.”