Confronting the Sub-Prime Student Loan Crisis

Student Loan0TheFool / Pixabay

Mortgage debt is only recently starting to rise again after years of deleveraging and credit card debt has continued to fall from its crisis era peak, but student loan debt is growing as if nothing ever happened, from less than half a trillion in 2006 to an estimated $1.2 trillion by the end of this year. We would probably already be staring down a serious asset bubble if normal financial principles applied, but they don’t.

In a recent Bipartisan Policy Center roundtable on the student debt crisis, Recap Real Estate Advisors chairman David A. Smith called the problem a subprime education crisis, where mismatched incentives and moral hazard give companies like SLM Corp (NASDAQ:SLM), better known as Sallie Mae, good reason to extend huge loans on overvalued assets to people who may never be able to pay them back – just like during the subprime housing crisis.

Recent graduate entering a difficult labor market straddled with debt can’t get any relief from declaring bankruptcy, unlike homeowners who bought too much house just ahead of the market crash, and suggestions to change the law raise concerns that it will once again come out of taxpayer pockets.

Loss should be borne by those who profited from overlending: Smith

“If student loan debts are to be cut or restructured, the economic losses should be borne by those who profited from over-lending: Sallie Mae and the universities,” Smith writes, echoing the kind of first-loss provision that regularly gets floated in conversations about Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) reform.

Unlike almost any other market, the price of the commodity (in this case an education) is set by the same group of companies who finance the deal and then collect on the debt. And unlike any other sector, the debt must be honored even if the promised good is never supplied. For-profit universities that churn through students, with little or no effort of helping them get an education or a degree, have made a killing from student loan debt.

Treating student loans like other kinds of debt can reduce moral hazard

“Lending a student $60,000 to attend a private school he may have little chance of graduating from is not terribly different than the mortgage lenders who gave imprudent loans to people buying homes they could not really afford,” writes George W. Bush Institute senior fellow and president of Capital Policy Analytics Ike Brannon in The Weekly Standard. “Both the school and the company that made the student loan get their money regardless of what happens to the student, and as a result neither has any compunction about helping a student attend a school where his prospects are poor.”

Treating student loan debts like any other kind of debt, and putting lenders in a first loss position if that loan goes bust, should put pressure on Sallie Mae and the more predatory universities out there by making them share the risk that they’re currently pushing onto the rest of us.

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About the Author

Michael Ide
Michael has a Bachelor's Degree in mathematics and physics from Boston University and Master's Degree in physics from University of California, San Diego. He has worked as an editor and writer for several magazines. Prior to his career in journalism, Michael Worked in the Peace Corps teaching math and science in South Africa.

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