Published March 29, 2012

Student-Loan Debt Tops $1 Trillion, Continues to Push Up Overall Consumer Credit

During his semiannual Congressional testimony, Federal Reserve Chairman Ben Bernanke gave us a glimpse into his ordinary life when he mentioned that his son, Joel Bernanke, would likely rack up $400,000 in student-loan debt during his time at medical school in New York.

Bernanke commented that student-loan debt requires "careful oversight" from regulators; it exceeded $1 trillion last year, outstripping credit-card debt.

On an aggregate basis, total consumer credit expanded by $17.78 billion in January to $2.512 trillion, according to data released by the Federal Reserve. Nonrevolving credit – which includes student loans – was up $20.72 billion to $1.711 trillion. That's its biggest increase since November 2001 and a fourfold climb from 2008 – a sign that persistently high unemployment in the US has prompted many people to go back to school.

The bubble situation in the market for student loans has been developing for years. In 2009, policy makers tried to alleviate some of the moral hazard in the student-loan industry with the passage of the Student Aid and Fiscal Responsibility Act (SAFRA). The bill eliminated federally subsidized private loans, and in their place implemented a policy whereby all federal student-loan funding would come directly from the federal government.

Lax lending standards (i.e., giving student loans to anyone with a pulse) and artificially low interest rates for government-subsidized loans have continued to exacerbate tuition increases, while academic achievement has remained stagnant. While continued easy-money policies and growing demand – as the weak job market pushes more people into academia – continue, there is little incentive for universities and governments to keep college tuition in check.

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Here is a quick overview of the growing bubble: since the federal government guarantees student loans, when a student defaults, the federal government pays the loan originator the balance of the loan plus interest. The government then hires a collections agency to recoup its money and adds a 25% collections fee to be paid by the defaulting student, which benefits both the lender and the federal government. Universities also benefit, since they receive their tuition payments whether or not a student pays his debt or finishes his degree.

Naturally, since universities have no incentive to keep prices in check (since they get the money whether or not a student graduates), tuition prices have increased in line with the amount that prospective students can borrow – which, not so coincidentally, is set by the federal government.

This excessively subsidized education system has yielded few positive results, even on the most basic level: the number of Americans between 25-34 who have attained a college education – including either a two-or four-year degree program – is exactly the same as the percentage among 55-64 year-olds, at 41%. Even worse is that thirty years ago that 41% figure led the world in college grads; now we're sixteenth and falling.

But – even though achievement has stagnated and tuition has increased nearly six times the rate of inflation – the federal government and private-loan operators continue to dole out loans. As of 2010, two-thirds of graduating students who took out loans had an average of $25,250 in debt, up 5% from 2009.

If the government's goal was to get more kids into college, it has succeeded, as the number of students with a bachelor's degree increased 30% between 2000 and 2009. But the quality of the degrees have fallen, since 36.9% of the degrees awarded were in the liberal arts, up from 36.1% in 2000. In contrast, high-paying degrees in engineering were down from 8.8% in 2000 to 6.4%; biomedical science degrees dropped 0.1% to 5.0%; and computer and information sciences fell to 2.4% from 3.1%.

Additionally, according to PayScale, science, technology, engineering and math (STEM) majors are out-earning liberal arts majors by a wide margin. The top 25 on the list for starting and mid-career median pay are exclusively STEM majors, and of the top 50, only three majors would fall under the guise of liberal arts: film production; occupational health and safety; and American studies.

Even with fewer job opportunities and dismal salary options for liberal-arts majors, cheap loans are still available without any consideration for what the student plans on studying. In step, millions of doe-eyed students have been enticed into loans that they will most likely be paying off the rest of their lives. According to a recent survey by Young Invincibles, a Washington D.C. nonprofit representing the interests of 18-34 year olds, almost two-thirds of US student-loan borrowers misunderstood or were surprised by aspects of their loans, with only one-third of respondents forecasting that they would ever be able to pay their debt.

Peter Thiel, one of my favorite investors, once said, "A true bubble is when something is overvalued and intensely believed." If anything, higher education typifies this definition: as parents who have long dreamed of their children attending college to create a better life for themselves, along with kids being inundated with the mantra "You can be anything you want" since grammar school, it's no wonder that high-school seniors are signing up for loans in excess of $100,000 to study subjects that ultimately don't teach them how to create value in our highly technical society.

It's sad, really, because these individuals are being set up for failure. Why would the government even consider guaranteeing a $100,000 loan for a degree that may not yield that much of a return in the student's lifetime?

Maybe it's because the Treasury, universities, and their debt collectors have been making way too much money off the system. As politicians try to patch the system with laws like SAFRA, they are only making the situation worse. As with bubbles of old, once the euphoria wears off, the swelling liberal-arts community will be faced with harsh economic realities in the form of monthly, steep, and unsustainable student loan repayments.