Tuesday 13 March 2012

Student Debt Time Bomb

The Washington Post recently warned of a potential debt time bomb in the form of student loans, which they say have skyrocket from $100bn to $800bn in 4 years! This figure represents more than the US consumer's total credit card debt!



With student fees increasing from £3,000 to £6,000 (£9,000 for some uni's), I thought it prudent to wonder if the UK has the same problem.

What you will be happy to hear is that our student debt pile is worth just £30bn ($48bn), not even close to our brothers across the pond. The more astute readers would immediately realise that two absolute numbers cannot be compared until we put them in context.

Against GDP, US student debt pile (SDP) stands at 5%, while the UK SDP is at 2.5%. If we look at the number of domestic students in each country, the UK has 1.2m while the US has 14.6m. Normalising for US Students, the UK would have $580bn of debt.

So far it seems that the UK do not have as big a debt burden than the US. However factoring in the average cost of university (£6k to £20k per annum for US and UK's £3k) we can see a different story entirely. If the average cost for US students is roughly 4x more than UK while the US has 10x as many students, we would expect the debt burden in the US to be 40x the UK's. This clearly is untrue as the ratio is roughly 20x. A possible reason for this may be that a lower percentage of US students tend to use the student debt facilities in the first place (the average UK debt of $15k is a lot more palatable than US's $90k student debt).

What does all this mean? The Washington Post continues by telling us the amount of bankruptcy proceedings resulting from student debt has risen 80% a year as parents undersign their children's student loan with their assets. They use the story of a war vet whose house is endanger of foreclosure as his daughter has not managed to find a permanent job since graduating.

*Courtesy of the Daily Telegraph

The questions I want to ask in this article are somewhat different. Firstly do we even have a problem? and second, will the increase in tuition create a debt time bomb down the line?

Is the debt load a problem *Govt loans only*

At this point it is prudent to split US students into two groups. According to statistics, around 50% of college goers attend a university with charging £6k per year. These are lower attainment universities and I would assume the average household earnings is lower. Conversely 25% go to £20k per year premium universities such as Yale or Harvard. In this group I will again assume that the amount of college goers that use loans is rather limited and so I will ignore this group altogether.

So with that in mind, upon graduation, US students typically have $25k debt (£18k) compared to the UK's £14k (this has more than doubled over 10 years). This goes hand in hand with the fact that they are expected to earn more (£33k vs £25k).  The final piece of the puzzle is the interest rates payable on these loans. I will leave savings rates out simply because this generation tends not to be accurately portrayed in these analyses.

For the Brits, the APR on your debt is 1.5% while americans have to accept 3.5% rates, so annual interest for your average UK student is £210 and £540 for his American compatriot (0.84% of Gross earnings vs 1.6% respectively.)



On the face of it, despite UK being the clear winner, it does not seem that America has it that bad. Well the problem that America has is not in the affordability of debt but rather the availability of solid graduate jobs. The FT puts youth unemployment in the USA at about 17% whereas for the UK it is 21% and so even if the interest rate fees are cheap, how can a student pay them when he has no job!

The short sighted man


In my humble opinion, one of the problems with human beings is that we are myopic in nature, ie we tend to attach way too much weight to the short term and hold less regard for any longer term developments. It seems that we are just in the lows of the business cycle and while I agree this low is potential more aggressive than the 'average low', it is certainly possible for recovery to occur. With this in mind, I do not believe that the current state of youth unemployment will cause the ballooning student debt pile to be a problem. Furthermore as these are govt credit mechanisms, it is perfectly feasibly for interest rate charges to be halted if the situation were to become increasingly dire.

Unfortunately, those who were privately financed to go through university have a more uncertain outcome, as the financial institutions that distribute this debt have to maximize profit, rather than social welfare.


Will the Increase in Fees Cause a Problem Down the Road?

The increase in fees will move student tuition from c.£3k to c£6k (and in some cases £9k, but those who pay the 9k will be members of the elite and probably wouldn't take a student loan anyway). Using numbers from the above, we can assume debt will increase to £25k (significantly more than the US). or £375 interest per month, which is still easily affordable.

Concluding this adventure into student loans, I think that the size of them is of little concern. What is concerning is the drive towards higher education. 50% of UK children now enroll in higher education and the problem is that this causes a dangerously one sided economy (which has already happened) and expectations of an increase in living standards when anyone knows that as the supply (of skilled labour grows) while the number of jobs remains constant, the average wage will decrease. If this were to be the case, the current crop of graduates would see a falling marginal benefit to university education. If we don't want an even bigger problem in 10 years, subsidize industries to take on youngsters while encouraging more applied learning channels.

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