Is Student Loan Debt The Next Financial Crisis?

There's no doubt that we're all still a little sensitive when it comes to the economy. Although it's been nearly four years since the start of, what we now call, The Great Recession, the world still hasn't let down its guard. The new warning making its way through the financial media is the rising student loan burden. Some believe that this could bring down the economy in much the same way as the 2008 and 2009 mortgage crisis, but is that true? (For related reading, see Student Loan Debt: Is Consolidation The Answer?)

Background

For generations, young people have heard that the only path to success is through a college education. College remains the accepted path for 68.1% of high school graduates, according to the Bureau of Labor Statistics.
For most students today, student loans are the way to pay the expenses of a higher education. The average student loan debt for a college student in 2010 was $25,250, up 5% from the previous year, according to a study by the Project on Student Debt. For the first time in history, total student-loan borrowing for one year surpassed the $100 billion mark in 2010, making the total outstanding debt more than $1 Trillion.

Some believe that the problem will continue to get worse. Over the past 50 years, the rate of college tuition inflation has ranged from about 6 to 9% annually, sometimes twice the normal rate of inflation. With college becoming more financially out of reach and the economy largely failing to put all of the college graduates to work, experts believe that more and more people will be unable to pay these loans. (For additional reading, see Keeping Your Student Loans In Check.)

Bankruptcy

The problem doesn't stop there. Current laws don't allow student loan debt to be written off by bankruptcy proceedings, regardless of how bad a person's financial situation becomes, so graduates who are bankrupt will likely continue to pay on their student loan debt. Some students with more than $100,000 in debt may pay the equivalent of house payment each month for sometimes more than twenty years.

Economists fear that as this problem continues to grow, traditional purchases like homes and other economy-stimulating activities could be largely stifled, impacting the growth of an already fragile economy.

This problem is much more than a theory. A recent survey found that around 50% of bankruptcy attorneys reported significant increases in clients who list student loan obligations as a significant financial burden. Another survey of the class of 2005 found that one out of every four became temporarily delinquent or haven't paid for a significant period of time.

The Fix

Bankruptcy attorneys believe that the only way to fix the problem is to allow for student loan debt to be discharged in the same way as credit card or other debt through bankruptcy proceedings. Some believe that this would be just another taxpayer bailout of the student loan industry but since a large portion of debt is through government agencies, much of the debt is already held by taxpayers. Others believe that college tuition inflation needs to be brought under control, but there is little hope for that in the near future.

The Bottom Line

There's no doubt that the student loan system is in desperate need of reform but comparing it to the mortgage crisis may be inaccurate. Although the total amount of outstanding student loans now stands at about $1 trillion, that number is small compared to the roughly $13.5 trillion in outstanding mortgage debt. (To learn more, read Student Loans: Paying Off Your Debt Faster.)