Student Income Loans Transfer Wealth to Investors, Risk to Students

Kenneth J. Saltman:

At more than $1.3 trillion dollars as of 2016, US student loan debt has become widely discussed in the media, the business press and academia as a new debt bubble with the potential to burst and trigger a global economic crisis that puts everyone at risk. The student debt bubble is regularly compared to the subprime mortgage debt bubble that resulted in the failure of banks, the great recession and the public bailout of Wall Street and the auto industry in 2008. Prior to the subprime crisis, high- and low-risk mortgages were packaged together into investment bonds so that when enough of the high-risk mortgages defaulted, the bonds that had been rated as safe collapsed. Similarly, one form of student debt investment security, Student Loan Asset Backed Securities (SLABS), is composed of pooled student debt.

A crucial difference between the subprime debt bubble and the student debt bubble is that the properties that comprised subprime mortgage securities served as collateral to the mortgage debt. If a homeowner defaults on a mortgage, the bank claims the property in its stead. Student loan debt has traditionally not been collateralized. In other words, if a student or former student defaults on student loans, there is no tangible asset for the bank to claim. However, since a great deal of student loan debt has been federally subsidized and especially reinsured, private banks that package student loan debt into investment securities have been able to sell these investment securities because they carry the full faith and credit of the federal government. Despite having no collateral, they have the federal guarantee.