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The Student Loan Bubble Looks like “Déjà Vu”

July 10, 2012 J,

By Jason Hughey

It’s like watching a train wreck in slow-motion…twice.

Prior to 2008, it seemed that almost everyone agreed that home ownership epitomized the American Dream.  Housing prices consistently increased from 1995-2006, making it a seemingly “surefire” investment for middle class families.  But the government played a big role in propping up those prices.

Using tools like the Federal Housing Administration and mortgage giants Fannie Mae and Freddie Mac, policymakers actively encouraged individuals—even those with poor credit histories, insufficient income, or little money to make a down payment—to take on debt and buy a home.  Despite the risks of such hefty government intervention, lawmakers looked the other way.  After all, at the time nothing looked safer than housing.

Some experts spoke out.  They worried that artificially low interest rates, substantial increases to the money and credit supply, and highly-distortive government interventions were fueling an unsustainable housing boom.  So when most of the world was shocked by the subprime mortgage debacle in 2008, these students of “boom-bust” business cycles were not.  The first train wreck ended in a financial crisis and a terrible economic recession, and we are still suffering from its smoldering after effects today.

But now the question is: are we ready for another train wreck?

Today, it seems that almost everyone agrees that success in life requires a bachelor’s degree.  Indeed, our parents’ and grandparents’ generations found great opportunities by earning a college degree.  Admissions counselors, professors, and politicians all tell us that college degrees will place students in great jobs.  Even President Obama recently said “I’ve always believed that we should be doing everything we can to help put higher education within reach for every single American student.”

The problem: higher education is following the same pattern that housing did in the lead up to the 2008 financial crisis. Just like in housing during the previous decade, a student lending “bubble” is now being inflated by heavy federal interventions that could have severe unintended consequences.

The federal government’s interventions in higher education since Lyndon Johnson’s “Great Society” reforms in the 1960s have driven up costs and have artificially inflated the amount of student lending.  In the last decade alone, federal subsidies for higher education have increased by 164%.  Meanwhile, Congress has suppressed student loan interest rates from 6.8% to 3.4% since 2007.  These interventions make government—not students—the largest source of revenue for colleges, incentivizing colleges to set their tuition rates at astronomical levels.  Thus, John Stossel notes that government intervention has been one key factor in causing tuition rates to outgrow inflation by over 700% in the past thirty years.

The real tragedy is that by guaranteeing costly student loans and suppressing interest rates, the government has encouraged numerous students to take out loans they probably cannot afford—all under the increasingly spurious assumption that a college degree is the surest bet to a good life.  In April, the total amount of student loan debt surpassed $1 trillion, more than total credit card debt in this country, and roughly 36 million Americans have outstanding student loan debt.

If the parallel holds true, a burst in the student loan bubble would not be surprising.

Early warning signs have already started.  It has been widely reported that, among recent college graduates holding a bachelor’s degree that 53% either do not have a job or are underemployed.  The supply of laborers with bachelor’s degrees has rapidly increased even as the demand for such laborers has wilted since 2008.  Thus, the value of a college degree is falling even as costs and student loan debt skyrocket.  Many people feel that their only option is to take on even more debt to pursue a graduate degree, but that option entails more high-level risk without any guarantee of success.

There is no question that the higher education bubble strongly mirrors the pattern set by the 2008 housing bubble.  Due to vast federal overreach in higher education, students around the country are already suffering from higher tuition costs, and the country’s continued economic sluggishness is also the decreasing value of their college degree once they graduate.

Policymakers must recognize the risks of government interventions in higher education.  If they do not, in the future we run the risk of talking about the burst of the student loan bubble in the same way that we currently talk about the burst of the housing bubble.

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