Friday, April 17, 2015

Goldman Sachs: "An Update on Student Loans: A Bigger Headwind but Still Not a Deal Breaker"

by Bill McBride on 4/17/2015 03:06:00 PM

Some excerpts from interesting analysis by Goldman Sachs economists Alec Phillips and Hui Shan: An Update on Student Loans: A Bigger Headwind but Still Not a Deal Breaker

The upshot is that the student debt burden on young households has increased and it has become a bigger headwind to housing demand compared to a few years ago. That said, we still think the sheer size of the millennials who are currently in their 20s and whose housing consumption should increase sharply in the coming years will support aggregate housing demand.

However, we are skeptical that student loans would pose serious systemic risks even if default rates increased significantly from their already high levels. The main reason is simply that around two-thirds of the outstanding balance of student loans is held directly on the federal government's balance sheet, and most of the remainder is held in the form of asset backed securities that are guaranteed by the federal government, subject to a small first loss (up to 3% of the outstanding balance and accrued interest). ... The bottom line is that the non-guaranteed portion of federal student loan balances plus all non-federal student loans that have not yet been charged off by lenders is probably not much greater than $100 billion and could be as low as $20 billion.

Of slightly greater concern is the fact that student loan debt is in many ways senior to other forms of consumer debt. For example, student loans cannot generally be discharged in bankruptcy, and borrowers in default can face wage garnishments and reduced tax refunds, among other remedies. In theory, this makes it more likely that a borrower's limited income would be used to repay student loan debt rather than to service mortgage or other consumer debt. This could, in theory, increase the default rate on non-student debt during the next economic downturn.

That said, recent policy changes alleviate this concern somewhat. Income-based repayment programs, which limit required monthly payments to a manageable percentage of borrowers' income and, in some cases, allow remaining debt to be forgiven, should reduce the competition between debt service on student loans and other debt. The Obama Administration has recently expanded eligibility for these programs.

Overall, after updating our prior analysis on student loans we come away with the view that increased student debt levels, and particularly the concentration of higher levels of debt among some borrowers, could create some headwinds for consumers, but that the risk of an acute financial disruption caused by student loan defaults is low.