Direct Loans One Year On: Government-Held Nonrevolving Debt Grows 66%; GDP, 3.7%

In March 2010, President Obama signed the Health Care and Education Reconciliation Act. One of its provisions terminated the infamous Federal Family Education Loan Program (FFELP), leaving the Department of Education as the sole originator of all federal student loans via the Federal Direct Loan Program, which has existed since 1993. Starting July 1, 2010, all new federal student loans would be Direct Loans, and this is a good thing, at least because the FFELP was monumentally wasteful. It allowed banks to play middlemen over nondischargeable student debt, grossed ED an average $1.22 on every $1.00 for every defaulted loan, and fueled the Student Loan Asset Backed Securities (SLABS) trade. Direct Loans alone, the thinking went, would solve these problems once and for all. As I’ve written elsewhere, the government is making two crucial errors. One, its accounting system doesn’t measure student loans’ full market risk; two, it doesn’t hold higher education accountable, sitting by while universities capture student loans’ value and increase tuition above inflation regardless of job availability (Gainful Employment Rule aside).

One year after switching to Direct Loans exclusively, looking at the Federal Reserve’s G.19 Release and the Bureau of Economic Analysis’s nominal GDP values, we find that the Direct Loan Program’s sole result is… increasing student loan debt. Government-held nonrevolving debt grew 66%, GDP only 3.7%. In numeric terms, during the 2010-2011 academic year (second quarter-to-second quarter), government nonrevolving debt grew $147.5 billion ($222.6 billion to $370.1 billion), GDP, $529 billion.

How do we know that government-held nonrevolving debt is mainly student debt? According to the Office of Budget and Management, in FY 2010 (October 2009 – September 2010), ED lent $74.709 billion in Federal Direct Loans, bought $56.909 in student loans off the market ($131.618 billion) and spent the final $42.141 billion in FFELP loans. In FY 2011 (October 2010 – September 2011), it calculates that it will have lent out $133.507 billion in Federal Direct Loans, and in FY 2012 it will increase that to $145.129. So these numbers mostly line up, but it’s important not to confuse Federal Direct Loans and government-held nonrevolving debt.

To give you a better idea of how bad 2010-2011 was for Direct Loans, here’s what nonrevolving debt has looked like over the past decade (second quarter-to-second quarter).

And here’s its ratio to GDP:

From 2008 to 2010, total nonrevolving debt fell by $26.1 billion, yet government-held nonrevolving debt grew by $118 billion due to more universities switching to the Federal Direct Loan Program and the federal government buying up FFELP loans, doubling the government’s holdings of nonrevolving debt.

So in the 2010-2011 school year private sector holdings of nonrevolving debt contracted by $81.3 billion, yet the government’s increased by $147.5 billion. Government-held nonrevolving debt is the only kind of consumer debt that is increasing during a time of excess private sector debt and low GDP growth. That’s bad, and it would be decreasing if student debt were dischargeable in bankruptcy. By comparison, revolving debt (credit cards) has fallen to 5.26% of GDP, the lowest this century.

(These are end-of-year data and not Q2-to-Q2; 2011 projections are my own; additional source: 1.54 Release (mortgage debt: 2009-2011, archives 2004-2008 (the February updates show the data from five years earlier))

Naturally, education is something we expect to provide value in the future rather than in the present by creating more productive workers, so ED wants the public to believe that once the economy recovers all this debt will be paid down and the debt-to-GDP ratio will fall. This outlook assumes that higher education is reasonably priced and provides the value it claims to—two points that are likely false and are certainly unsubstantiated.


To illustrate the implications of the current policies, it’s worthwhile to predict what will happen if they continue, so let’s assume that the 2010-2011 school year is indicative of the future; in other words ignore the FY 2012 increase in Direct Loans. Basing the future on the recent past isn’t implausible. As far as I’m concerned, if Krugman thinks the Congressional Budget Office is fantasizing a recovery in 2015, I’m convinced too, so we’ll assume the nominal GDP growth rate is the same over this decade as in the past school year. I’ll also assume that others’ holdings of nonrevolving debt will contract at the same rate as in 2010-2011 (it’s not really relevant beyond the $700 billion of remaining FFELP loans and another $100-200 billion in private student loans). The one place I’ll break is with the government’s holdings. If we believe that it’ll grow at 66% indefinitely, then we’ll have $35 trillion dollars of government-held debt by 2020, and that, frankly, is absurd. Given the budget data from above, the government is willing to lend out roughly $135 billion every year, so I’ll increase government-held nonrevolving debt linearly rather than exponentially like everything else. We get this:

And the ratio to GDP:

That’s $1.6976 trillion in government-held nonrevolving debt (from $370.1 billion after Q2 2011), and a debt-to-GDP ratio of 8.19% (up from 2.47%). Although I’d trust the accuracy of this projection through, say, 2014, in my opinion the crude result appears right: government-held student debt will approach 10% of GDP. The only things that could shift this are better macroeconomic management (e.g. a Newer Deal), the Asian Import Fairy, a Euro breakup (which would worsen the situation), and the Gainful Employment Rule forcing for-profit colleges into private sector student loans—not that it’d help the overall situation, but it would change the debt composition. What happens to the remaining several hundred billion dollars of FFELP loans and private student debt is anyone’s guess.

What does this mean?

The good news about the student debt bubble: The U.S. government is NOT Lehman Brothers. It can NEVER go bankrupt. Lehman failed because it couldn’t pay its creditors with its earnings. The United States is not a bank. It has the power to tax, and all its debts to bondholders are denominated in its own currency. It may end up raising taxes or minting a pile of platinum coins if bondholders get scared, but it will not go belly up due to Federal Direct Loan defaults.

Speaking of which: Yes, student loan defaults will continue to increase. The chart ED issued recently probably conceals many more defaults beyond the two-year cohort it normally tracks. Yes, IBR/ICR will leave ED holding the bag. Yes, legislators will realize this is a severe problem. Whether they simply decide to terminate the student loan programs and leave current debtors to suffer or instead cancel the outstanding student debt is debatable. The latter, whether by direct cancellation or bankruptcy reform, is the preferable and responsible solution as the government should realize it will not get its money back and that there’s an inherent moral conflict between shepherding the public fisc and playing for-profit bank. If the government opts to force student loan repayments in the name of austerity, debtors will respond with a mass default and tax resistance as well. Note that we’re still only talking about Direct Loans, and the outstanding FFELP and private student loans will require additional government action.

While it’s not going to be as significant a financial collapse as the eight trillion dollar housing bubble, the student debt bubble will re-teach the American elite that democracy fails when people believe their government no longer represents them. Americans revolted over taxation without representation; how will they respond to outright peonage to their stubborn government?

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