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The explosion of student debt could be 'a drag on the financial well-being of the nation'

student loans debt
student loans debt

(Demonstrators in Union Square, in New York City, wear signs representing their student debt during a protest against the rising national student debt.Reuters/Andrew Burton)

The US has faced a striking increase in student debt over the past decade. Total student debt now sits at roughly $1.3 trillion, and over 40 million Americans have student loans to pay back.

While the White House believes the growth of student debt is actually a good thing, the Federal Reserve Bank of New York's Liberty Street Economics blog disagrees.

In a post, NY Fed economist Rajashri Chakrabarti outlined the possible effect of the growing mountain of student debt.

Chakrabarti noted that not only has the amount of outstanding debt increased, but the rate of default for these loans has skyrocketed as well. That could be a problem for the whole US economy.

"The trends in the student debt market we observed and the default rate patterns we have described paint a sobering picture of trends in higher education loans," Chakrabarti wrote. "If these outcomes do not improve substantially over the near future as the economy continues to recover, these may serve as a drag on the financial well-being of the nation."

Chakrabarti found that the default rate for all types of schools — including for-profit two-year colleges and public, not-for-profit four-year universities — has increased considerably over the last 15 years. For-profit schools, however, have consistently had much higher rates of default than not-for-profit ones.

"From 2004 onward, the default rate at for-profit institutions is roughly two to three times the rate at any other type of four-year institution," Chakrabarti wrote. "As may be expected, the default rates at all institution types rose the most during and immediately following the recession."

Screen Shot 2016 09 09 at 9.29.14 AM
Screen Shot 2016 09 09 at 9.29.14 AM

(Federal Reserve Bank of New York; Liberty Street Economics)

While default rates for for-profit schools in total are higher than for not-for-profits, the default rate for two-year public colleges has recently surpassed for-profit institutions' rate.

"Among the 2012 cohort, public two-year schools have a default rate 2.3 percentage points higher than for-profit two-year schools — which had default rates of 19.1 percent and 16.8 percent, respectively," Chakrabarti wrote.

Overall, Chakrabarti concluded, the student loan market looks much worse than it did in 2000.

"The health of the student loan sector has deteriorated quite steeply from 2000 to 2015," Chakrabarti wrote. "While this is mostly concentrated in for-profit, four-year schools, the decline is much more widespread in the two- and less-than-two-year market and essentially spans all types of institutions in this market."

In addition to the percentage of people that take out loans who are in default, the number of people in default has exploded as well, according to Chakrabarti. Again, four-year for-profit schools are seeing the greatest increase.

"Between 2000 and 2007, total loan originations at four-year, for-profit schools grew by 430 percent," Chakrabarti wrote. "Between 2000 and 2012, when many of these borrowers would have entered repayment, [the number of borrowers in default] at these schools rose by more than 1,900 percent."

In Chakrabarti's opinion, if the number of people in default does not subside, it is likely to prevent those people from spending on other goods and services and could lead to a nationwide economic slowdown.

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