The subprime mortgage crisis was a disaster built in the shadows of the financial system. Banks were making home loans to people with shaky finances on the wishful idea that home prices wouldn’t fall. Those loans were pooled in mortgage-backed securities and collateralized debt obligations and markets snapped them up without a second thought as to the quality of the mortgages they contained. Credit default swaps were created to hedge the risk, but they turned into another way to profit from speculation and resulted in a system so complex and opaque that nobody knew their own financial position.
Could transparency have prevented the crisis? What if banks would have looked to make sure homeowners could afford their mortgage payments? What if investors would have looked into the sustainability of the loans in the portfolios they were buying? What if someone untangled the intertwining bets of credit default swaps so investors knew what they were actually investing in?
Perhaps none of it would have been enough, but if faced with the same problem, shouldn’t we at least do something? Well, as the New York Times’ reports, here’s our chance:
Imagine that a big, complicated company holds a huge portfolio of loans, many of which are in default or delinquency. The company’s leadership and some vocal shareholders demand a detailed review but receive a thin and incomplete report from the loan division.
Financial analysts at headquarters want to scrutinize the data. But the loan division doesn’t turn it over. Without better data, the first can’t move forward.
This dysfunctional enterprise is fictional, but in at least some respects it bears more than a passing resemblance to the United States government, which has a portfolio of roughly $1 trillion in student loans, many of which appear to be troubled. The Education Department, which oversees the portfolio, is playing the part of the loan division – neither analyzing the portfolio adequately nor allowing other agencies to do so.
How on earth could this happen? Student loan debt surpassed credit card balances in 2010. It soared above a trillion dollars in 2013. And it has continued growing exponentially, now hovering around $1.2 trillion. All of the data we know points to a crisis – the number of borrowers is growing, the size of balances is growing, the total debt is soaring, and, most troublingly of all, defaults are on the rise.
Just how bad is it. Ponder this crazy statistic: Of those students who began repaying their loan debts in 2009 more than a quarter of them have already defaulted. By comparison, of those homeowners who took out mortgages in 2006, just a year before the catastrophic housing bust, only 18 percent have defaulted.
Contrary to popular belief—especially among the pundit class—it’s not just those with exorbitant student loan debts that are in trouble. The data shows that 34 percent of students with just $5,000 in outstanding debt will default.
Unfortunately, none of these headline numbers really helps us quantify the risk in a way that guides decision-making.
“We are fairly confident in the aggregate statistics—over a trillion dollars in loan balances outstanding, 43 million borrowers and the highest delinquency rates of any form of household debt,” Federal Reserve Bank of New York President William Dudley said at a recent meeting. “But we know a lot less about the precise causes and consequences of the heterogeneity in the net returns to educational investments. . . “
Dudley then reeled off a list of questions that we absolutely should have the answer to, but don’t. What types of borrowers are associated with higher rates of repayment? Are their types of degrees that are correlated with better debt repayment? Which colleges have a low future earnings to debt ratio? What interventions are most successful in helping borrowers limit default? Do income based repayment programs work? Do they delay asset accumulation in a way that creates more harm than good?
These are questions that we have to answer if the federal government is going to avoid a student loan debt crisis for which taxpayers will be on the hook. Sadly, the same incentive that led the Obama Administration to create a stream of easy money is also leading them to be less than forthcoming with data. The goal of increasing access to a higher education is laudable, but not at the cost of condemning an entire generation to a life of indebtedness. The government can reform the process without undermining the objective, but first it needs data.