Misplaced incentives all over the place. This one is going to be messy. But as many people have pointed out, much more slow moving than the previous financial bubble.
The solution is simple and obvious: All of us who have already paid off our loans are going to fund government-arranged loan forgiveness/reduction programs to those who over-leveraged their education.
As someone with student loans, I wish this wasn't the case for the previous generation. But at the same time, it's hard to blame current 23 year olds for decisions their parents and communities make about their kids' future finances when they're 16.
The majority of fault lies in the previous generation of parents, who both failed to vote out politicians supporting these policies and who pushed their kids into enslaving parts of their lives to lenders.
Agree 100%. I didn't mean to say the blame rests fully with the current generation, I'm just saying government policies going forward are just going to increase the moral hazard even more.
Off the top of my head, both the interest rate cap that passed this summer and the President's recent student loan proposals? What else would be under discussion here?
EDIT: nevermind, apparently both you and drcode are discussing hypotheticals only.
Those affect government loans, not the private ones which are the subject of the posted article. The loans issued by JP Morgan do not have their rate capped; indeed they float and are indexed to LIBOR.
I'm in the same boat. In the hospital, on the day of my birth my mother looked at me and said "college". Needless to say I did not do the proper cost/benefit analysis at the age of 17. I'm hoping my debt gets forgiven after 25 years. Being 80 years old and making student loan payments does not sound fun.
If making education free was the goal, why not stop messing up with student loans and provident students with scholarships. Every course you flunk or take incomplete, you pay out of your own pocket. Every course you pass you receive a partial (or total) refund based on the final grade. And if you keep your GPA above a threshold, you receive an living allowance about 3x-4x minimum wage (based on the number of credits you take).
This way students would get a free higher education... at least those that make at least some actual studying.
As someone who really hasn't thought about it very much, I'd love for someone to expand on this. What's the expected fallout? In the housing bubble, many people lost the places where they lived. But it's not like someone can "take back" your education if you default on the loan, so what happens instead?
The problem is that most money in circulation was manufactured by creating debt. When you destroy that debt through default, you destroy that money.
The fiction of student loans is tricky because under Bush they changed bankruptcy rules to exclude student debt. But fundamentally when banks are forced to write down bad student debt, their rosy asset picture becomes non-rosy. When that happens they are required by regulators to not lend. And this is ugly for the whole economy.
In 2008 we resolved the problem by having the US government find ways to lend tremendous amounts of money on very favorable terms, and then the Fed picked this up with a similar policy that they call quantitative easing. This creates lots of money in financial markets so that things like banks can continue to operate. The bigger long-term problem is how we'll ever exit the policy.
To give an idea how sensitive this situation is, a while ago Bernanke announced that if things continued to improve faster than expected, in a year the Fed would evaluate whether to exit QE 2 faster than originally planned. You can't come up with a milder statement that the policy might end. The markets went crazy. A few days later, Bernanke came out and said we won't be doing that after all, then markets calmed down.
There is no question, a student loan debt crisis will be responded to with more QE. The problem of exiting the mess will become bigger. Historically countries have exited this type of policy only after the crisis of a currency collapse. But so far the market players seem to be betting that they will get out of the USA before the other guy when the crisis hits, and in the meantime the USA looks safer than China and Europe.
However the financial economy is always a mess. And they are always finding another way to kick the can down the road. That will certainly happen again. And again. And again. Until it doesn't. Every time the doomsayers say, "We don't see how we can kick the can down the road again!" But we do. The dot com bust was resolved with easy interest policies that resulted in a housing boom that resulted in the financial crisis. That was resolved with QE.
Take your best guess as to whether we'll kick this can down the road as well...
The development of adult life is stunted. It takes longer to afford to rent an apartment on your own, buy a house, buy a car, get married, start a family, start a business, etc. If you're college educated you probably have a broad support network. So instead of being homeless, you move back in with your parents.
So instead of losing your home, you may never get it in the first place.
The consequences of defaulting on a student loan are also quite severe.
I am 25, and since my first serious job (I was 23) I've been in the government category for the most rich as possible in earning amount (the category is everyone in the top 5% of income... granted, there is still a GREAAAAT gap between the top and low of that... I reached the top 5% with 20k USD/year)
I don't own a vehicle (not even a bicycle), much less a living place.
I think if I sum all my possessions (literally, including my clothes, glasses, phone... without depreciation) and my debts, I am still negative.
According to my calculations, I will be able to buy my first apartment when I am about 35 years old, unless I move back with my parents and stop paying rent. Also I won't bother in buying a vehicle, unless it become really, really necessary (and then, I will buy a chinese QQ or J2)
When I think about that, it is really, really, really depressing and ridiculous.
The draconian terms are going to push some people to emigrate if they are forced to default. There are a lot of Americans teaching English in China who are running from problems like these.
Short version: The government makes money off student loans, and there is no defaulting on them (unless you die of course). There are no incentives to keep tuition costs in check because the lenders (government) are happy to put more money into the asset class. We're getting to the point where the price of education can't be made up with an eventual increased salary. The author considers this to be an unfair tax on the lower middle class and an eventual drain on the economy.
Students are getting loans from the government on terms that they wouldn't be getting from the bank. That creates more effective demand for schools which drives up the price of tuition.
If the banks did this and the student/graduate had to default, the bank would have to take a loss. The government isn't allowing default on the loans they themselves give the students, so they'll make sure they get their money back.
As far as I know it is impossible to default on a student loan. Even if you declare bankruptcy student loans have an exception so you can't get rid of them. If you stop paying them they can garnish your wages. The only way to end it is to pay it off or wait 25 years, after which they are forgiven.
It's not the impact on the individual who's defaulting that is the kicker, it's more the effect on the originating bank and the parts of the financial system that packaged up that loan with others of its type into financial products that are incorporated into the investment strategies of pension funds, mutual funds, municipalities, etc.
In the U.S. most of the outstanding student loan debt is held directly by the government. Pension funds and mutual funds don't really have exposure to student loans.
