August 1, 2016    4 minute read

The Student Loan Debt: A Bubble Waiting To Burst

Danger Ahead    August 1, 2016    4 minute read

The Student Loan Debt: A Bubble Waiting To Burst

In the Dot Com bubble, Silicon Valley start-ups grew massively starting in 1997 (much akin to Twitter and Facebook, except now these two have the possibility of massively monetize their user bases), but had no real basis for the monumental growth and quickly became unsustainable, with investor confidence vanishing. Then the collapse occurred.

There are also property bubbles as individuals flock into the long-held belief that owning a house is a solid investment (it is actually a liability until your bank sends a letter saying amount owed = £0). And also 0% interest rates don’t help the capital rush into housing – which is generally landlords looking to rent out, but price movement mechanics mean supply and demand remain unaltered.

The New Bubble

One bubble that has only become clear and commentated on more regularly in the last 2/3 years is a behemoth worth $1.2trn: the US student loan market. There are many reasons why this is such a giant risk to the US, and therefore to many other dependent economies.

The primary and most directly linked to the market failing short-term is the fact that default rates are rapidly accelerating. After the financial crisis, consumers reduced their average household debt, but the debt on student loans and car financing increased. Financing a vehicle, however, is not geared towards the youth whereas the stresses of student loan financing most certainly is. The over 90 days delay on student loans right now is at 11% of the total amount of loans. This statistic is double that of 2003. Where the US creators of the student loan package have been really clever is that these poor citizens who are having cash trouble are unable to rid the burden of a student loan in the law system. One can, however, default due to certain circumstances. Which leads to:

The Domino Effect

One’s credit rating is highly significant. To get a loan, you have to prove you are a safe and reliable option. Even for a mobile contract, an employee of Vodafone has to carry out a credit check. Some finance jobs, too, carry out credit checks. So imagine loads of US students defaulting. This means that their access to credit is made harder in the long term, which then means they are likely to consume less which has a knock on effect on aggregate demand. Consumption is involved as a key component in the aggregate demand equation C + I + G + (X – M) where, C is consumption, I investment, G govt. spending and X – M is the difference between Exports and Imports, also known as the balance of trade. If people don’t consume domestically there is a decrease in price levels and a dovish Fed (with low interest rates). This is a highly basic result but what it provides right now is the following. The job data coming out of the US right now is rather gloomy and has no longevity.

It is a well known fact that many students will have skills that will be redundant in the future. A research paper, written in 2013, found that 47% of 702 US job roles were susceptible to automation. Moreover, it found that low skilled and low paid jobs were at risk more than their higher skilled counterparts – and that educational qualification will determine who gets the highly sought after roles.

It is evident, automation will be a real game changer in the coming decades. Even over the last 10 years, many trading roles have ceased to exist, to be replaced by black box systems and mathematics majors. Eventually, everyone will suffer from the inability of thousands of students to pay these loans back, because they will not be able to be employed at a wage enabling them to do so. Then the bubble will burst.

So, why are is one allowed to borrow so much money with the expectation to return it once one has their degree, with no collateral at all, apart from that piece of paper? Human capital is sadly becoming more and more redundant.

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