17.06.2024 Issuer Call Redemption Notice

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Sandeep Rao


US Student Loan Relief vs US Economy

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As per the New York Federal Reserve’s Center for Microeconomic Data, Q2 saw US household debt rise above $16 trillion in Q2 2022. Of the debt components, mortgage, auto loan, and credit card balances saw an increase over the past quarter while student loan balances remained largely unchanged.

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Over the long run, student loan balances have seen a steady increase over the years in the total mix of debt balances.

As per the US Federal Reserve, the total amount of outstanding student-loan debt in the U.S. is around $1.75 trillion, of which 92% – around $1.6 trillion — is held by the government. This works out to about 6.5% of U.S. gross domestic product (GDP). Student debt, as a whole, has grown nearly threefold since the 2008 Financial Crisis.

However, this threefold increase in student debt isn’t really supported by a threefold increase in college graduates. Long-term trends suggest that there has only been a 8-9% increase in college graduation since 2007/2008.

As it turns out, after hospital services, college education has seen the largest increase in price over the past two decades.

This explains the growing historical share of college debt in US household debt. As per the non-profit Education Data Initiative, which pools data from academic and public sources, there are 43.4 million borrowers with federal student-loan debt.

The ballooning college debt isn’t just a “young person’s problem”. Debtors aged 50-61 held the third-largest pool of college debt and owed the largest average amount across all other age categories.

As the New York Federal Reserve noted, mortgage balances showed the biggest quarter-by-quarter increases within the total basket of household debt. The rising mortgage prices do have a correlated effect with the Federal Reserve’s rate hikes but housing prices also play a part in denominating the principal owed. Over the course of the Year Till Date (YTD), median home sale prices have been trending down due to reduced demand.

Interestingly, as a percentage of GDP, total household debt is estimated to be trending downwards since the highs seen during the height of movement restrictions and lockdowns during the pandemic.

Despite rising mortgages and student debt (where interest accumulates daily, unlike credit cards and mortgages), rates of serious delinquency are at historical lows, with the Federal Reserve warning that this masks “potential distress”.

As last week’s article stated, the economy is a multi-factor interlocking network of inputs and outputs. In an article written almost exactly a month ago, data showed low-income areas and population segments experiencing a surge in loan defaults. Now, mid- to higher-income population segments are more likely to enter college. These segments are showing a tendency to pay down and “rationalize” their debts. In other words, the “higher income” college graduate population segment is increasingly more geared towards paying debt than building equity while “lower income” population segment is being priced out of building equity with loan defaults and resultant economic costs. Despite different routes travelled by denizens on either end of a widening wealth gap, the result is largely the same: a reduced tendency to partake in high-priced goods and services across the board.

Thus, while the purchase of goods and services is a fundamental driver of the economy, neither the “working class” nor the “middle class” show a forward-looking tendency to be able to sustain this practice. This doesn’t bode well for the US economy in the near- to mid-term, at least.

Interestingly, as a percentage of nominal GDP, total household debt is estimated to trending downwards since the highs seen during the period when lockdowns and movement restrictions were in place.

Given the high cost of mortgage and college debt, it’s a fair bet that this implies that there was reduced participation and inclusion in both these categories of economic activity. A number of other countries show a markedly higher household debt to GDP ratios.

Among “Western” countries, Australia, Canada and Sweden show much higher ratios while South Korea, Hong Kong and Japan do the same among “Eastern” countries. With regard to “Eastern” countries, China draws up about par with the U.S. in the 62-64 range while India is the least burdened by debt is in the 14-18 range.

On the 24th of August, US President Joe Biden announced a plan to staunch the drain on personal incomes due to ballooning student loans. There are three broad provisions:

  1. Student debt forgiveness of up to $10,000 per borrower—and up to $20k per borrower in many cases—among households with income up to $250,000;

  2. A continuation of the pause on current student loan payments through year-end, after which payments will resume;

  3. An income-driven repayment plan that would cap monthly payments to 5% of a borrower’s discretionary income (from 10% under an existing program)

As per the Penn Wharton Budget Model, a group of economists and data scientists at the University of Pennsylvania who analyze public policy to assess its economic and fiscal impact, the total cost of “forgiving” that debt could mount to $519 billion over the prospective 10-year horizon.

While the data suggests that the biggest beneficiaries would be “middle class” income segments, the proposed action is actually expected to have the biggest impact on debtors with the smallest amount of federal student loans. The more education one has, the higher the debt load tends to be. For instance, to obtain a “basic” medical degree, about $200,000 in loans are availed on average. For people with larger debts qualifying for the program, their total debt servicing payments are scheduled to increase substantially once the moratorium on loan payments originally applied during the pandemic is lifted. It should be noted that, during this period, interest accruals didn’t stop. While there has been a lot of noise in the media about how this could either vastly improve personal savings or create extra inflationary pressures on the government, the markets seem to have largely shrugged off the proposed plan’s effects in its present form. As per Goldman Sachs economists Joseph Briggs and Alec Phillips, the following points bear keeping mind:

  • If all borrowers eligible for the program enroll, student loan balances would reduce by around $400 billion, or 1.6% of GDP. This is more or less in line with the Penn Wharton Budget Model’s findings. Of course, historically, no federal assistance program has ever had full enrollment.

  • While lower-income households will see the largest proportional cut in debt payments, most of them don’t have student debt. Middle-income households will benefit the most but the sum effect is only $10,000.

  • Loan payments will fall from 0.4% of personal income to 0.3%.Goldman Sachs estimates only a 0.1% point boost to the GDP in 2023 with smaller effects in subsequent years.

  • While “debt forgiveness” with lower monthly payments is slightly inflationary in isolation, the resumption of payments is likely to more than offset this.

  • The cut in the size of many borrowers’ monthly payments when they resume in January would increase household disposable income while increasing the federal deficit. For instance,When payments resume in January, payments will increase by around $35 billion on an annualized basis instead of $55 billion.

  • The sum total of effects would lead to the deficit increasing by roughly $400 billion over the next two years. However, since the government has already funded those loans from its coffers, there will be no substantial impact on Treasury issuances.

As of at the time of writing, the US market is being tested for new lows. Ed Clissold, chief U.S. strategist at Ned Davis Research mentions in his note dated August 31: “Recession fears are the most likely trigger of a retest of the June lows. From a seasonality perspective, a retest could come in the next several weeks.” Vanguard Group reported on September 1 that it’s downgrading its forecast for U.S. economic growth for this year after two straight quarters of contraction. The firm now expects economic growth between 0.25% and -0.75% for 2022, down from its estimate last month of about 1.5%.

The modest boost in personal savings seemingly promised via the US Student Loan relief measures wouldn’t be enough to turn this sentiment around. The fundamental problem with the US college debt situation is the cost of education and not the debt availed. If the former wasn’t so high, the latter wouldn’t be an issue. While the proposed measures do bring some relief to a large number of people, said relief is quite limited. The fundamental problem continues to receive no reprieve in the compromise-driven corridors of power in Washington DC.

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