What The Student Loan Crisis Means For You
With roughly 1.1 trillion dollars in outstanding student loan debt, a default rate of 13.4%, why would Congress sit back and let interest rates double on July 1, knowing that it will only increase pressure on college graduates whose only prospects are taking part-time gigs at gas stations?
Could it be because if they don't, the entire financial market will collapse?
As reported in Elite Daily on March 4, Wall Street chops up outstanding debt and resells it. Which sounds a bit silly, but let me explain in English how it works. First, you borrow $26,600, which according to The Institute For College Access and Success, is the average loan balance held by graduates. The bank you owe this whopping sum to, knowing that your communications degree will barely get you a job as a barista due to an over-saturated labor pool, sells the debt to some other sucker before you can default.
This third party, let's call him Mr. Sucker, is then allowed to collect the debt that you originally owed to the bank. This practice of buying and reselling promissory notes has been around for centuries in one form or the other. And generally, for the reselling to be "legal," the loan must be in good standing, meaning the obligator must have not defaulted on it at the time the debt was sold. Furthermore, (and remember this key point) if the obligator defaults before the bank can sell it to Mr. Sucker, then it must "realize" the loss on its balance sheet.
In 2012, a White House directive ordered the department of education to start a very forgiving re-consolidation process, allowing graduates who qualify to enroll in a lower installment system. If you were dead broke, you paid nothing for that month. For those drowning in debt, it was a dream come true.
Now why would the government, who worked so hard to make it nearly impossible for students to discharge loan debt in bankruptcy, suddenly want to be so forgiving?
Well, one thing is clear. If you enrolled, and you don't make enough to pay anything under the new program, your loan technically isn't in default. Yes you're under-employed, making minimum wage unclogging toilets with your BS in Math, and you're unable to pay anything without giving up a meal; but on paper the loan is still in good standing. Meaning the banks can still sell it. And if a bank thinks an "asset" is going to tank, do you think it won't hesitate to sell it to some other sucker? Isn't that what they did during the 2008 housing crisis?
The bigger question is how much of this 1.1 trillion dollar market is made up of obligators that are enrolled in this new extended repayment program (assuming they make enough to repay anything)? No numbers have been released yet, but for the sake of argument, if it were just 10%, then it could be said that the total non-performing loans (adding our 13.4% default rate) could be in actuality, about 23.4%. From an investment prospective, that's apocalyptically scary.
Think about it. Would you buy a security that promised to give you meager 3.4% annual return on an assumption that everyone pays? Maybe. Would you still buy the debt if there was a near 1 our of 4 chance you were going to get nothing back? Probably not at those rates.
But would you at 6.8%? Maybe. So is it a coincidence that Congress has done nothing regarding the doubling of rates at a time when default rates are at an all-time high? And if you're a bank with a lot of student debts on your portfolio that you feared were going to tank, wouldn't you be desperate for anything that might help in off-loading them to Mr. Sucker (who could be anyone from a private investor to a pension fund)?
You do the math.
Sallie Mae could offer some anecdotal evidence to support the theory that the student debt market is beginning to implode behind the scenes. Last month, the lending giant announced it was segregating its student loan division from the rest of the company. Which sounds similar to creating a "bad bank" where the government nationalizes a bank, segregates the worthless assets from the depositors (i.e. you), and settles for pennies on the dollar with the creditors. Is that happening here? Only time will tell.
Regardless, if we've reached the tipping point, the government may be forced with no choice but to step in and bailout the system.
David Gotzh | Elite.
Photo courtesy ABC Action News/ Tumblr/Flickr