Sludenl loan debt outstanding in the United States is approaching SI trillion. It surpassed outstanding credit card debt for the first time in 2011. In the eight years between 2003 and 2011, outstanding student loan debt increased from approximately S25Ö billion to more than $900 billion , according to the Federal Reserve Bank of New York , It has outpaced the growth rate of outstanding debt for credit cards, auto loans and mortgages over the same time period. Tuition costs, governmental initiatives to encourage funding for higher education (e.g., the Federal Direct Student Loan Program), an increase in for-profit proprietary schools and a desire of recent graduates to seek a second degree when they are unable to find a full-time job are some of the reasons for this incredible rise. Currently, student loan debt ranks second on the list of consumer debt in the U.S. Nearly 8 percent of total debt outstanding as of year-end 2011 is made up of student loans. Although this figure looks small in comparison to mortgage debt, which is 76.9 percent of total debt outstanding, two experts in the field, Leighlon Hunley and Jonathan Glowacki , wonder if student loan debt could become the next subprime crisis and cause turmoil in the market. Both gentlemen work for Milliman, one of the world's largest providers of actuarial and related products and services. They recently published their thoughts oo this topic. Hunley and Glowacki looked at Lite historical delinquency trends between both mortgage debt and student loan debt to see if they could provide an indication of whether sludenl loan debt has the potential to be the next subprime crisis. The delinquency rate for seriously delinquent student loans (defined as the balance of loans 90 days or more delinquent divided by the total balance of outstanding loans), according to Hunley and Glowacki, has been steadily climbing from about 6 percent in 2003 to more than nine percent in 2011. A prolonged increasing trend in serious delinquencies, they found, is likely not sustainable for any type of credit risk, and the trend will eventually have to correct. The correction might be through write-offs on principal balances or might come from belter underwriting from issuers of student loans. Indeed, in recent financial quarters, the percent of student loans seriously delinquent has decreased to less than 9 percent. "What we have learned from the mortgage crisis is that you really need to have a good sense of who you arc lending money to," says Hunley. "What is their credit history? What is tlieir bicorne potential? - and other attributes. And at a more macro level, what is the current economic environment like? That's what we mean by belter underwriting. We want to truly understand who Is receiving this money and how can they repay this money in the future." Hunley wants "smarter" underwriters and "smarter" loan consumers. Borrowers, he says, should be better educated. He would hke to see schools offer more personal finance classes, maybe even making them a requirement for those students who will have a high debt load when they leave school. "Coming out of undergrad, I didn't have a good sense for how much it was going to cost me at the end of the day when 1 was finished with college. I got the paperwork filled out, signed away, and I was in college and happy to be there. I didn't really give much consideration to what my debt might be when 1 was done with my schooling," says Hunley. In today's job market, where prospects for finding reasonable employment might seem dismal, some graduates are opting to further their education. Such decisions, although well thought out, create even more student loan debt. Hunley has a few' suggestions on how underwriters can deal with this. Underwriters, he says, should take die student's situation hito consideration wlieu determining the terms of a student loan. For example, he envisions a system in which students pay debt back in proportion to their income level once they graduate, vvfiether with a bachelor's or a master's degree. He also suggests that underwriters should require students who are carrying an already high debt Load at the time that their student loan is underwritten to make a down payment to secure the loan, much like those who arc seeking a mortgage must do. "A system like this might be beneficial so somebody deciding whether to continue to pursue job opportunities or to go back to school can assess whether they have 20 percent to put down before they go back to school and if that's really the right option for them," says Hunley. Loan underwriters are well within tlieir rights to turn away individuals seeking a mortgage if they are high-risk borrowers. This approach, however, does not work in higher education. All individuals have the right to an education. Indeed, the U.S. economy heavily relies on its luglter education system to fill both the high-tech and low-tech jobs of the future. Hunley is not suggesting that underwriters prevent individuals from pursuing an education. Rather he is searching for middle ground where underwriters can "scrutinize loans more closely and take into account some of the borrower's attributes a litde bit more - but at the same time keep promoting education. "We certainly want this country' to flourish in that respect," he says. The dollar amount of seriously delinquent sludenl loans as of December 2011 was approximately $95 billion , while the dollar amount of seriously delinquent mortgages was approximately $600 billion (down from approximately $800 billion in December of 2009). And student loan debt, unlike most other types of debt, is nondischargeable in bankruptcy. Individuals who default on student loans owe that money regard- less of their financial circumstances. The outstanding balance of student loan debt, though it is high, is dwarfed by that of mortgage loans, for student loan debt to cause serious damage to the U.S. economy the default rate on smdent loans would have to be greater than 50 percent on all student loans outstanding. This would produce a dollar amount of seriously delinquent loans comparable to mortgages, Hunley and Glowacki write. Fortunately for the U.S. economy, a seriously delinquent rate of this magnitude is not likely and the potential credit loss experienced with student loans will likely be significantly less than the credit losses experienced with mortgage debt. A large majority of funding for student loans is supported by the government through various initiatives and programs. For the 2011 calendar year, 95 percent of all new' student loans were supported by the government (this is an increase from 2007 when about 75 percent of ail new student loans were supported by the government) either through direct leading (e.g., (lie Federal Direct Student Loan Program) or government guarantees for credit and interest losses on the loans (e.g., (he Federal Perkins Loan Program). On average, from 1995 through 2011, approximately 10 percent of student loan funding has been from the private sector and 90 percent of the funding has been from government programs, according to the College Board Advocacy and Privacy Group's Trends in Sttuient Aid 20! L This means that the large portion of government funding for student loans limits die private sectors exposure to smdent loan defaults. But it's a different story tor die mortgage market, where over the past 20 years, approximately 50 percent of mortgage risk has been assumed by the private sector. During die build-up of die subprime crisis, the percent of mortgage risk assumed by the private sector was approximately 70 percent with a significant portion of die risk being in "subprime" and second-lien mortgages. When these mortgages want south, the private sector absorbed die majority of die credit losses, resulting in capital and liquidity strain for the large hanks. If defaults on student loans increase, the majority of credit losses will be absorbed by die government, not die private sector. liven with the government's backing, llunley is not ready to say that the U.S. economy can't he affected by defaults on student loans. He points out that the private sector's exposure is directly tied to each cohort, those students whose repayment schedules begin in a given year. Fur example, the borrowers who enter repayment of their loans in 2007 experienced a far different economic climate than those who entered repayment in 1992. "It's difficult to paint wkh a broad brush. ... the cohorts from 2006 and 2007 are dealing wich high unemployment rates and tough economic dines, similar to diose individuals wrho look out mortgages in those years and have had to deal with housing price crashes and high unemployment. You really have to look at eacli individual year, and to gel more granular, each individual borrower" to determine the private sector's exposure, says llunley. Hunley and Glowacki see another similarity between student debt and the growth in subprime debt: die recent growth and amount of debt in for-profit proprietary schools. Proprietary schools are a bit of an anomaly in higher education because they are for-profil organizations and some of them are publicly traded, llunley and Glowacki sec potential for a conflict of interest because these schools might be admitting students as a way to increase revenue and profit and not screening out students who might not be prepared for a higher education. "Al a publicly traded company, you have investors, and you need to satisfy' their needs and balance that with the needs of your students. So there is a polenlial, we're not saying that this is the case, but there is a potential where certain interests may outweigh others. And that could become problematic," says Hunley. The average debt per student at for-profit, schools is generally three to lour limes higher dian that at «imparable public universities and one and a half to two times higher than comparable private nonprofit universities, llunley and Glowadd write. At public and private nonprofit schools, 60 percent and 70 percent of the students use debt to finance their educations, respectively Al for-profiLs, that number is nearly 95 percent. For students who do finance their educations, according to Glowadd and Hunley, students at for-profil schools finance 99 percent of their educations while students at public and private nonprofit schools finance 70 percent and 85 percent of their educations, respectively. Default rates at foi-profit schools are two to three limes higher than at public and private universities. The number of individuals who are borrowing to attend foi-profit schools is grow'ing, and like those individuals who borrowed during the build up to the subprime mortgage crisis, these borrowers have both liiglier levels of debt and default risk compared to other borrowers. Although the student loan market is not likely to be caLcgorized as the next subprime crisis, the full impact of ballooning student loan debt on consumers is currently unknown, and the burden might have an adverse impact on the purchasing power of borrowers and co-signers in the future. llunley is uncertain about how' all of this will play out over the next few years. "The smdent loan industry lias a lot of tentacles. You have a lot of co-signers signing diese loans, so it's hard to gauge the impact of somebody not being able to pay off their student loan debt but then also having their parents co-signing with them not being able to pay off the debt as well," say's Hunley He fears that the U.S. economy might experience a hit of a ripple effect if the bottom were to drop out of the student loan industry'. "1 can't say we can all rest easy' because there is too much uncertainty there." savs Hunlev.
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