Student Loans, the Next Big Threat to the U.S. Economy?

Fed economists are increasingly concerned about the surge in student loans. A rapidly expanding credit market with government guarantees is “what we saw with housing”.

Outstanding student debt topped $1 trillion in the third quarter of 2013, and the share of loans delinquent 90 days or more rose to 11.8 percent, according to the Federal Reserve Bank of New York. By contrast, delinquencies for mortgage, credit card, and auto debt all have declined from their peaks.

The New York Federal Reserve’s move to measure the size of the student loan load says a lot about how concerned the central bank is about a possible threat to the economy. “Our job is to really understand what’s happening in the financial system,” and the “very rapid rise in student loan debt over the last few years” can “actually have some pretty significant consequences to the economic outlook,” New York Fed President William Dudley told reporters in November. “People can have trouble with the student loan debt burden—unable to buy cars, unable to buy homes—and so it can really delay the cycle.”

The federal government is the source and backer of most of the loans. “I’m always made very nervous by a credit market that benefits from government guarantees and is expanding very rapidly,” Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, said on Jan. 10 at a Greater Raleigh Chamber of Commerce event in North Carolina. “That’s what we’re seeing with student loans, and it’s what we saw with housing.” As the New York Fed’s Dudley explained in November, “to the extent that student loan burdens become very, very high, there are presumably going to be losses” to the federal government.

The subject a student majors in can have a direct effect on his or her ability to service a loan. “If you’re a pre-med student, you’re an engineering student, and you take out $40,000 or $60,000 of loans, I have no problem with that,” John Silvia, chief economist at Wells Fargo (WFC), told the audience at the January Chamber of Commerce event in Raleigh. “But if you’re going to be a French major, you’re going to study social welfare, and you’re going to take out $60,000 of loans, who is making the economic judgment there?”

A student loan crisis would “force parents and students to think about” their expected financial return on education, Silvia said in Raleigh. “Like in housing, we learned by going through that craziness, and now hopefully the next generation won’t make that same mistake.”

More From Bloomberg Businessweek: