In the US, most students have resigned themselves to the fact that they will leave college carrying a massive debt burden. Students are simply expected to contribute towards their
own tuition fees. And they are expected to carry this private debt with them through much of their working lives.
There, the value of student debt is now over $1trn – that’s bigger than car loans, or even credit card debt. What’s more, it’s closing in on the value of subprime debt which peaked at $1.3trn in late-2006, early 2007.
Now, I’ve long argued that governments use debt to further their economic goals. Not just debt raised in their own name, but by encouraging citizens into debt too.
In the States for example, they like to interfere in the mortgage market. You’ve probably heard of quasi-government institutions Fannie Mae and Freddie Mac. These institutions guarantee nearly half of all US mortgages. When Bill Clinton wanted to encourage home ownership among the poor, it was to these mortgage guarantee firms he went.
Similarly, for student loans, the government established Sallie Mae to provide federally backed loans. Today it’s a private company, trading on the stock market – but the aim is the same.
When the economy goes into a tailspin, the planners’ solution is always the same: stoke up debt. So for them, it’s handy to have a hand on the lever. In fact, since the downturn, they’ve encouraged more and more Americans into college and into debt.
In fact, that trillion dollars of student debt I talked about stood at half the size at the start of the financial crisis.
And when the government coerces people into debt, things nearly always go wrong…
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Notice the odd one out
Here’s a really interesting chart. It shows how student debt delinquency (red line) has been soaring. In fact, student loans are now more risky than credit card debt!
The fact is that youth unemployment is a particular problem these days. And so it’s no surprise that delinquencies have gone through the roof over the last year.
But here’s the thing that worries me: subprime lending was based on an asset, thus giving lenders a bargaining chip. Homeowners (I use that term loosely) often stayed in the home, paying some sort of peppercorn rent. And if the situation was that bad, at least the house could be foreclosed on.
The thing about student debt is that it’s mostly based on a promise to repay. And today, many borrowers are walking away.
The chart makes for compelling reading. Just look at how default rates on all the other types of consumer lending have been falling over the last three years. People have been saving to pay down their massive debts. And yet, this one type of debt goes completely against the grain.
The cracks are starting to appear…
In order to keep the funds flowing, Sallie Mae routinely taps the market for more cash. And given that investors have been keen to find any sort of yield they can, the market for Sallie’s bonds has been robust.
That is, up until now!
In its latest offering, the banks couldn’t find enough punters for Sallie’s $225m offering. I guess it was down to those rising default rates!
There are a couple of things that should concern us about this story. First, remember how quickly the subprime destruction spread. Losses started cropping up in obscure French and German funds… later appearing in little-known Norwegian municipalities. Debt destruction comes quickly.
Now, the nature of the student debt I’m talking about is different to subprime; it’s not quite as manufactured by financial alchemy. But the fact is, when debt goes bad, it destroys wealth… it ripples through the financial markets. And you can’t hide from the fact that student debt is going bad.
The second thing is, here in the UK, we are now marching down the same road as in the States. In the same way that we developed our own breed of subprime (which, incidentally, may be yet to implode), we’re about to start ramping up the student debt model.
With college fees heading quickly towards the £9,000 a year figure, it won’t be long before students start emerging with a good £50,000 to £100,000 of debt. And that’s not to mention the worrying increase in parents going deeper into debt to help fund their offspring’s education.
The bigger point here is that students aren’t the only targets for this debt. You are too. The truth is that the government does everything it can to saturate society with debt. And we have been too happy to do its bidding. From new cars to holidays to property – too many of us load up on debt to sustain our lifestyles.
The trouble is that this problem could be about to blow up in our faces.
• This article is taken from the free investment email The Right side. Sign up to The Right Side here.
Information in The Right Side is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. The Right Side is an unregulated product published by Fleet Street Publications Ltd. Fleet Street Publications Ltd is authorised and regulated by the Financial Conduct Authority. FCA No 115234. http://www.fsa.gov.uk/register/home.do
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