The Heavy Consequences of American Student Loan Debt

Too cumbersome, Americans’ student loans hamper the consumerism and social development of young people and pose a long-term threat to general levels of education.

Economic current affairs in the United States have largely been dominated by considerations of economic recovery, the evolution of monetary policy and the risks of political disagreement over the budget. These issues have overshadowed a disturbing trend in student loans. Even if this trend is not comparable to the one that led to the outbreak of the global crisis, the threats to the economy are nonetheless real.

Evolution of Student Loans in the U.S.

The total amount of American student loans has dramatically increased. In fact, since 2008, outstanding (current stock of debt) student loans have risen by over 50 percent and now amount to nearly $1 trillion, or about 750 billion euros. Thus the average debt per university student in the United States is $25,000. In this context, the total amount of student loans is certainly lower than the total amount of mortgage loans, but student loans are now higher than other types of loans, such as car or consumer loans.

Two factors explain these runaway figures in student loans:

First, this trend reflects an increase in the cost of education with an increase in enrollment fees of over 30 percent in private universities and over 40 percent in public universities.

The increase in student debt also reflects a greater than 20 percent reduction in student scholarships.

The hike on interest rates for these loans has recently increased. In fact, whereas previously the interest rate guaranteed by the federal government for students meeting certain conditions of financial need was 3.4 percent, this rate has doubled since July 1, 2013 to 6.8 percent. The increase in interest rates for these students entails an average additional cost of $4,600 per student.

Loan defaults are reaching alarming levels. In fact, the number of students taking out loans to finance their education increases year after year, and defaults reached 11 percent in 2012. In other words, one in 10 students cannot fully pay back their student loans.

Raising a Number of Issues and Concerns

American graduates must return to the family unit. As in many developed countries, young generations coming out of the university system are struggling to enter the job market. In the United States, this phenomenon is exacerbated by an unfavorable economic climate with a lackluster economic recovery struggling to establish itself, and which is currently largely dependent on an exceptional monetary policy. Unlike in other developed countries where student loans are still marginal, this method of financing education is widely used in the United States. The uniqueness of the American situation therefore lies in the combination of a difficult economic context with a very high debt burden. In this situation, more and more young graduates are being forced to return to live with their parents because they don’t have the means to pay rent.

Younger Generations Constrained by the Weight of Their Debt

The weight of debt limits the economic independence of the younger generations. Indeed, with the financial burden associated with repaying their debts, young graduates must postpone their other goals, both economic (buying a car, housing expenses) and personal (marriage, starting a family). Personal possibilities of social development are automatically limited, as well as the potential to contribute to the economy as a consumer. Indeed, because the youth of a country and its dynamism contribute to the country’s economic growth, the country as a whole is affected. In fact, instead of spending money purchasing capital goods or a house, young graduates dedicate the majority of their revenue to paying off debt. An average debt of $25,000 represents 60 percent of the average annual salary of a young, higher-education graduate in the United States, and debt may be as high as 75 percent, depending on the state.

All of Society Affected

The situation more widely affects all of society. Actually, apart from the indebtedness of students, it is sometimes the families that support the weight of debt connected to financing the education of their children. In this context, nearly one in five households in the United States is facing this problem. Also, note that over 40 million people are still paying off student loans after the age of 30. For example, U.S. President Barack Obama and his wife, Michelle Obama, didn’t finish paying back their student loans until 2012. Finally, note that the doubling of interest rates on student loans will automatically continue to complicate access to higher education for the low-income population.

Less Education, Fewer Qualifications: The Risk of a Deterioration in Human Capital

Over the long term, these effects could prove to be very negative. Indeed, it should be noted that the rising debt burden could discourage some from investing in their educations and encourage others to stop studying, especially in an economic context in which job prospects are limited. This leaves about 30 percent of 20 to 24-year-olds currently unoccupied; that is, they don’t have jobs and aren’t pursuing an education. In this situation, beyond the immediate economic implications, the medium- and long-term risk of a degradation of human capital is very real. In other words, this phenomenon could lead to a decline in the average skill level of the American population, with potentially significant implications for future economic growth.

The Specter of a New Financial Bubble

Some fear the formation of a bubble like the one that preceded the global crisis. In fact, in certain respects, the student loan dynamic resembles that of the mortgage loans that [hastened] the formation of a financial bubble. It finally popped in 2007, triggering the current global crisis. The acceleration of the volume of student loans and the rising defaults on these loans might lend credence to this idea.

Nevertheless, the two situations are not completely comparable. Three elements temper these fears:

First of all, even though student loan debt is increasing (about $1 trillion), it remains below the total of mortgages, and, importantly, it remains 10 times less than the level of mortgage debt before the crisis.

Second, while real estate debts are held by the banks, student loans are largely held by the state. In fact, 80 percent of student loans are guaranteed by the state. In this context, even in the case of default, the debt is not likely to bankrupt a bank as was the case in 2008, with the chain reaction of consequences that ensued.

Finally, in the case of nonrepayment of loans, the “price” of education and the value of diplomas will not fall, contrary to the same situation in the real estate sector. In other words, in the case of a wave of defaults on student loans, this would not be a reason for diplomas to lose their value in the job market. Thus, the student will still have the ability to find a job, which might enable them to repay the loans. The situation is different in the case of the housing market. Indeed, a widespread wave of defaults automatically entails a fall in the value of goods, and thus a corresponding decrease in the ability to repay loans for the people holding these goods.