Is Federal Student Debt the Sequel to Housing?

Back in March, we showed that the $1.4 trillion in U.S. direct federal student loans that will be outstanding by 2020 will amount to roughly 7.7% of the country’s gross debt. This is 6.3 percentage points higher than it would have been had the scheme not been nationalized in President Obama’s first term.

The government’s net debt was not directly affected by the move, as the government acquires assets when it issues student loans. The problem is that projected default rates on such loans have been climbing as the volume issued has increased, as shown in the graphic above.

If we apply the projected default rate on loans originated in 2009 to the amount of student loans outstanding in 2012, we find that defaults on federal student loans currently outstanding are likely to cost taxpayers almost $80 billion. And the cost is projected to increase rapidly over the next decade as default rates continue to rise and the amount of student debt the federal government owns soars.

There is more than a whiff of resemblance between the rise of the federal government’s student debt liability and the mortgage bubble – the detritus debt of which wound up nationalized. There is little in the way of credit checks carried out, and no evaluation of future earnings prospects. In the ten years to 2008, the amount of mortgage debt tripled: $3.2 trillion to $9.3 trillion. The CBO projects that student loans on the government’s balance sheet will rise just as fast: $453 billion in 2011 to $1.4 trillion in 2020.

A 17.3% default rate on $1.4 trillion in loans would cost taxpayers about $240 billion. This is equivalent to 1% of the CBO’s GDP projection for 2020. It is also more than three times the 2013 federal funding level for the Department of Education, and just slightly less than ten times the amount the president requested for science, technology, engineering, and mathematics (STEM) programs in his most recent budget.

It is surely worth asking, therefore, whether this $240 billion could be used more effectively than it will be in writing off defaulted student loans.

Department of Education: Default Rates

Bloomberg.com: Student Loans Go Unpaid, Burden U.S. Economy

Wall Street Journal: Federal Student Lending Swells

Geo-Graphics: Will Student Debt Add to America’s Fiscal Woes?