Another balloon

The student loan bubble in the United States was born out of shortsighted education policies. After the last administration tried to equip every American household with their own home (without much success), the goal is now for every American to receive a higher education.

Often during economic growth, bubbles form as prices rise in various sectors of the economy. Looking at the economic development of the United States in recent years, we can note two frequently commented bubbles. The first is the so-called dot-com bubble, characterized by large speculations in the market of high-tech companies in the United States. After some time of inflation in the prices of these companies, it turns out that they cannot justify the high expectations of investors for generating income, and the bubble bursts at the beginning of the 21st century. Then comes the turn of the “inflation” in the real estate market. “Thanks” to the noble desire of the American government to provide every household with their own home, housing prices rise to record levels. The bursting of this bubble in 2008 led to disastrous consequences for both the American and global economies. Apparently, distorting the market through state intervention is fashionable in the United States, because the American economy is facing another one.

According to the Federal Reserve Bank of New York’s quarterly report on Household Debt and Credit, the amount of student loans in the United States has increased almost fivefold over the past nine years (see Chart 1). Interestingly, since the third quarter of 2008, this has been the only category of consumer debt in the United States that has grown. In addition, over the same period, the percentage of student loans that are delinquent (more than 90 days past due) has increased from just over 6% to 8.69% at the end of the first quarter of 2012. The amount of student loans (8% of all consumer debt) now exceeds that of credit card debt (6%) and auto loans (6%). To some, this statistic may seem encouraging, given the prevailing view that an investment in education is always worth it. The problem is, however, that the high demand for higher education in the US and the high levels of debt associated with it benefit a certain group of people (university professors and administrators and certain politicians) and create a young generation burdened for many years with paying off these debts, which led to the acquisition of a relatively less competitive diploma.

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How was this bubble created?

The student loan bubble in the United States arose because of short-sighted policies in the field of education. After the last administration tried to equip every American household with their own home (without much success), the goal is now for every American to receive a higher education. The problem is that the majority of student loans are now granted through various federal programs, which turns them into debts guaranteed by the government. This type of guarantee creates an incentive for young Americans to enroll in some higher education program, because if they fail to repay their debts, they will be covered by taxpayers. Ultimately, the so-called moral hazard is created, where credit institutions profit by receiving interest on the loans granted, but losses are borne by the taxpayer. The parties that win and lose are different, and this distorts market incentives.

What will this bubble lead to?

The consequences of creating a bubble in higher education in the United States are several:

1. Making higher education more affordable doesn't make it more affordable. It incentivizes universities to continually raise their fees, which benefits faculty and administrators. Today, the average cost of higher education in the United States is six times higher than it was 30 years ago.
2. On the other hand, according to official data, about 30% of students in the US leave university before graduating, leaving with a lot of debt but no diploma. The high levels of debt that all recent graduates are burdened with suppress the consumption of this group of individuals and delay decisions related to buying a new home, starting a family, etc., which may negatively affect economic activity and the demographic structure of the US in the future.
3. According to data from the U.S. Bureau of Labor Statistics, the majority of unemployed people over the age of 25 have some form of college education (see Chart 2). That is, for the first time in the history of the world’s largest economy, lower-skilled Americans are enjoying greater success in the labor market. It also turns out that a large proportion of college graduates are starting work in a sector radically different from their specialization.

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What is the solution to the problem?

Of course, this problem would not have been noticed if the American economy were in good health and enough new jobs were being generated for all graduates. For now, however, there are no particular prospects for restoring high economic growth, and therefore the emphasis should be on implementing reforms in the education system to stop the artificial creation of bubbles. One of the measures that should be implemented is the elimination of all federal programs for guaranteeing student loans, which would eliminate moral hazard in the system and create market mechanisms for determining the demand and supply of higher education. Another measure is to increase competition between higher education institutions. This can be done by entering the market of distance learning forms via the Internet. Most specialties could be taught online, which would reduce the cost of education dramatically. This would undermine the business of existing universities and force them to lower their prices. The final result would create more accessible education and a more competitive market environment for everyone.

It seems that the American economy has boldly embarked on the path of creating bubbles through state intervention in the markets. Perhaps this is also part of the policy of the American government to make its compatriots increasingly dependent on the state apparatus. It is also worth noting that the increase in students distorts labor market statistics, because they do not enter the labor force (for an explanation, see this article ), and thus the unemployment rate is underestimated. No matter what the reasons are, the facts are clear - the bubble exists and continues to inflate. The question is rather when it will burst and what the losses for American taxpayers will be from this.

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