Should investors worry about ballooning U.S. student debt?

Outstanding student loans have hit an all-time high in the U.S.: $1.3 trillion. Many wonder how all these fresh graduates will be able to repay their debts with an economy that’s shown mediocre growth, high unemployment and limited wage progression. This scenario closely resembles the growing amount of residential mortgage debt in the mid-2000s.

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Between 2006 and 2010, college enrolment grew by 19% annually, compared to 5% in the prior five years. This was largely a function of decreasing viable job opportunities in the economy; young adults recognized it and deferred looking for employment in favour of pursuing higher education.

During that period, student debt rose by 13% annually, as overall tuition costs steadily increased and more lenient repayment schedules helped originations outpace debt paydowns. The average graduate in 2012 had $25,000 in student debt, compared to $15,000 in 2004.

However, there are significant differences between the mortgage crisis and the rising level of student debt. The housing market was driven primarily by speculation that residential housing prices would continue to inflate. The long-term benefits of higher education are more fundamentally sound.

The median income of millennials (age 25 to 34) with a college education is twice that of those who only complete high school. The unemployment rate is 3.2% for college grads and 9.1% for those with a high school education, showing that education will often increase the borrower’s long-term ability to repay.

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Another structural difference between mortgage and student debt is that, $1.1 trillion of the $1.3 trillion outstanding student debt is owned or guaranteed by the federal government. This limits the likelihood of mass defaults having the same contagion effect that the housing crisis did on the broad economy.

Since the great recession, financial institutions have written off over $1 trillion in bad debt expenses; even in the most bearish scenario there is no chance the student debt market experiences an absolute write off anywhere near that figure.

Therefore, the rapidly growing amount of student debt obligations in the U.S. does not possess the same systemic risks that the mortgage market did. However, the debt issue is something that we closely monitor, as it does have a profound impact on the spending habits, lifestyle choices and home purchase decisions of one of the U.S.’ most influential cohorts.

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Gareth Watson is the Vice President, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @Gareth_RGMP