Did Income Inequality Cause the Financial Crisis?
Policymakers and academics have identified income inequality as a proximate cause for a number of society’s ills, from deteriorating social cohesion and unhappiness to high mortality rates. But could America’s widening income gap also be responsible for the 2008 financial crisis?
That’s the controversial conclusion reached by economists Michael Kunhof and Romain Rancière, whose 2011 report for the IMF explains how rising inequality incentivizes poorer households to over-leverage, eventually leading to financial crises. In their model, households are broken down into two groups—the richest 5 percent, representing capital; and the bottom 95 percent, representing labor. As in the real world, Kunhof and Rancière assume the capital group experiences large and persistent income gains over time, while wages for labor grow slowly or stagnate. But the top 5 percent cannot consume all of their disposable income (you can only buy so many cars), so they create financial wealth through loans to the bottom 95 percent, who need credit to maintain their accustomed level of consumption. As inequality grows, credit supply from the top and credit demand from the bottom expand simultaneously, increasing the probability of systemic default as risk and debt build.
If Kunhof and Rancière’s model sounds familiar, that’s because it is. In the United States, real average annual earnings for production and other non-supervisory workers peaked in 1972 at $40,884, while total consumer credit amounted to just $2,804 per person. By 2008, average annual earnings had fallen by $6,408 to $34,476, and households were making up the gap with an extra $4,940 in credit per person—more than triple the ratio of credit to earnings as in 1972.
As in Kunhof and Rancière’s model, U.S. politicians responded to growing income inequality and stagnating median wages in the years leading up to the financial crisis by promoting policies to prop up the living standards of the indebted lower and middle class. But instead of addressing the root causes of inequality (such as regressive tax policy and declining collective bargaining power), they cut the cost of borrowing even more, pouring gasoline on the already fiery housing market. Low income families were incentivized to take on second and third mortgages they could not afford, and the financial class pounced—diverting capital into financial gimmicks like mortgage-backed securities to obfuscate and distribute the underlying risk.
There is some disagreement within the economic community as to whether the relationship between higher levels of inequality and financial crises are causal or correlational. But consider this: when someone making $20,000 a year gets a raise, they spend it. When someone making $2,000,000 a year gets a raise, they invest it. And as an ever greater share of national income accumulates at the top (and discretionary income for the bottom 95 percent stagnates), the greater the demand for high-yield financial innovation independent of the faltering demand-side consumer economy. Until real median wages rise and the income gap begins to narrow, debtor nations such as ours will continue this disastrous boom-bust cycle.
Graph of the Day: Going Over the “Fiscal Cliff” Would Cause Another Recession
Yesterday, the nonpartisan Congressional Budget Office released their analysis of the upcoming “fiscal cliff” (“taxmageddon,” for those more eschatologically inclined), and the results aren’t encouraging. Unless Congress finds a way to delay the $607 billion worth of tax increases and spending cuts that are scheduled to kick in automatically at the end of this year, the CBO expects the United States will fall briefly into another recession.
That presents policymakers with a dilemma. On the one hand, the expiration of the Bush tax cuts and the payroll tax holiday would generate over $300 billion in revenue next year. Deep cuts to the military budget and to safety net programs would save another $65 billion, shrinking the budget deficit by over 5 percent of GDP. But rapid debt reduction comes at a steep price (as Europe is well aware): the economy would take a sharp downturn, contracting 1.3 percent annualized in the first half of 2013, followed by 2.3 percent growth, for a measly 0.5 percent increase over all. Unemployment would rise above 9 percent, tax revenues would fall, and the government would be forced to increase spending on unemployment insurance, food stamps, and other social programs.
However, if Congress delays these deficit reduction measures in the near-term, the CBO predicts real GDP will expand by a robust 4.4 percent in 2013, and that unemployment will continue its downward trend. Comparable fiscal constraint would still be needed in the medium term (federal debt held by the public is at its highest level since 1950; a matter of bipartisan concern), but policymakers would minimize damage to the economy (and to the individuals, families and businesses that make up economies) by agreeing to tackle deficit reduction only after a meaningful recovery is secured.
The One Percent’s Jobless Recovery
Something strange has happened in the U.S. economy. Nearly three years after the Great Recession officially ended in June 2009, unemployment remains stubbornly high at 8.1 percent and real wage growth is nonexistent, but corporate profits and GDP have never been higher. Six million workers have dropped out of the labor force in the last two years—twice the number of people who have found new jobs—but the Dow Jones and NASDAQ are trading above pre-recession levels as if nothing had ever happened. Economists like to call this incongruity a “jobless recovery,” but you might as well call it a recovery for the 1 percent: according to recent data, that small fraction of the nation’s wealthiest captured a stunning 93 percent of a income gains from 2009–10. Income growth for the bottom 99 percent was just 0.2 percent.
This unequal pattern of growth is highly unusual in recent history. For most of the post-war years, periods of economic recovery were defined by a rapid return to high employment and GDP growth. But for the past two decades, there has been an increasing disconnect between the strength of the economy and the health of the labor market. When the economy crashed in 2008, businesses aggressively laid off employees while demanding greater productivity from their remaining workforce. Without a union or effective labor laws to protect them—and with fierce competition for their jobs—many workers resigned themselves to more work for the same salary.
That’s not how it used to be. Research shows that until the mid-1980s, labor productivity tended to slow during recessions, as it was difficult for businesses to downsize effectively. But with the sharp decline of unions during the Reagan years, the correlation between productivity and employment turned negative. “These days,” writes economist Brad DeLong, “U.S. labor productivity looks to be countercyclical: firms take advantage of downturns in demand to rationalize operations and increase labor productivity, pleading business necessity in the face of the downturn to their workers.” Which explains why business sector productivity soared 5.3 percent in the depths of the Great Recession, driving corporate profits up 116 percent to a record $1.4 trillion. Although the stock market boom did little for the 70 percent of Americans who received less than 2 percent of their income from capital gains, the returns to the 1 percent were enormous.
The divergence between productivity and labor (including wage compensation and employment) is the key to understanding rising income inequality, the stagnation of average wages, and the current state of our jobless, 1-percent-oriented recovery. “Productivity and the compensation of the typical worker grew in tandem over the early postwar period until the 1970s,” writes Lawrence Mishel, president of the Economic Policy Institute. “However, the experience of the vast majority of workers in recent decades has been that productivity growth actually provides only the potential for rising living standards.” In reality, average wage growth has stagnated, while the gap between productivity and compensation has accelerated.
According to Mishel’s research, this divergence can be explained primarily by growing income inequality and a recent shift in the allocation of compensation from labor to capital. Part of this story is the rise of the 1 percent, whose earnings grew 156 percent from 1979 to 2007. But Mishel differentiates between this divergence at the top—attributable to the extraordinary growth of executives’ compensation (especially in the financial sector)—and the wage stagnation of the middle class, who have suffered disproportionately from ”laissez-faire policies … including globalization, deregulation, privatization, eroded unionization, and weakened labor standards.” Wage inequality at the bottom is similarly a unique phenomenon, the result of continual high unemployment and the eroding value of the minimum wage.
Mishel’s research strongly suggests that improving labor standards—including a higher, inflation-indexed minimum wage and stronger protections for collective bargaining—must be central to any effort to reestablish the historical link between productivity growth and rising median wages. Here the experience of Europe, with its longstanding support for labor and milder income inequality, should be instructive. Another way to increase workers’ leverage would be to return to full employment, putting upwards pressure on wages. But most economists expect that could take years at current trend growth: businesses will continue to squeeze productivity gains from ever-smaller workforces until an increase in consumer demand requires them to begin hiring again. And consumer demand will not return to pre-recession levels until the jobs crisis is resolved.
It sounds like a catch-22. (That is, until you remember the role of the U.S. government, which can borrow cheaply to stimulate the economy, creating outsize returns on investment.) Of course, in the long-term, the market will find equilibrium on its own—it just may not be the equilibrium we want or expect.
Feeling stressed? Here’s some food for thought on a Friday afternoon: Americans now work an average 122 hours more per year than their Anglophone counterparts in Britain, and 378 hours more than the industrious Germans. That’s partly because we work more hours per week than anywhere else in the developed world. But it’s also a result of our weak labor laws. Every other country in the OECD has legal protections for weekends, paid annual leave and mandated days off for public holidays. And of course the United States is one of the only countries in the world that doesn’t guarantee paid maternity leave, along with Sierra Leone, Liberia, Samoa, Swaziland and Papua New Guinea. Enjoy the weekend!
Nobel Prize-winning economist Paul Krugman, fighting the good fight on Morning Joe this morning, in support of his new book, End This Depression Now!
Graph of the Day: Public Sector Layoffs are Undermining the Recovery
April was another lackluster month for job growth, according to today’s official report. Only 115,000 new jobs were created last month—a not-unexpected but still disappointing slowdown from December to February, when job growth was averaging 252,000 a month. The unemployment rate fell a tenth of a point to 8.1 percent, primarily because discouraged workers continue to drop out of the labor force. And the number of Americans without a job was essentially unchanged at 12.5 million, nearly half of whom have been unemployed for over six months.
The takeaway, writes economist Jared Bernstein, is that fiscal austerity isn’t working. “It doesn’t work here, it doesn’t work in Europe, it doesn’t work for state and local governments. I’m tempted to ask how many data points we need to recognize this crucial economic truth, but I’m afraid data points don’t have much to do with it.”
And there are plenty of data points. The graph above, of net monthly job growth since 2008, shows how public sector layoffs have created a substantial drag on growth as the economy struggles to take off. While we’re finally back to a net positive number of private sector jobs since the start of 2009, state and local governments have shed over 600,000 workers—12,000 in the past month alone. Nine out of ten of those jobs were in local education, which is down over 200,000 since 2010.
Boosting state and local government employment—especially of public school teachers, whose job it is to educate our children—should be a nonpartisan priority for legislators. But somewhere along the way, collective action became controversial and civic duty became politicized. Many conservative commentators now encourage public sector layoffs in the belief that smaller government is preferable to creating or maintaining government jobs. As if thousands of unemployed teachers will find more socially productive work now that they’re off the taxpayers’ dole.
Sadly, this is the state of the debate. We have the tools to stimulate the economy and get America back on track towards full employment, but half the political establishment is ideologically bound to tax cuts for the rich and dismantling the social safety net. For now, it looks like the economy will have to recover on its own.
The Right Wing Radicalism of Paul Ryan
Representative Paul Ryan (R-Wis.), current chairman of the House Budget Committee and the eponymous author of the Republican’s 2013 budget proposal, wants to lower taxes on the rich, eliminate assistance for the poor, uninsure millions of Americans and increase military spending. His plan would cost $4.6 trillion in lost tax revenue over the next decade (not including the $5.4 trillion loss from the Bush tax cuts) and save $5.3 trillion in nondefense budget cuts. Two-thirds of those tax breaks would go to households earning over $200,000, and two-thirds of the “savings” would come from gutting programs that benefit the poor—a radical redistribution of wealth from the bottom to the top. So how has Ryan become “the most popular guy in Washington,” asks Jonathan Chait, “revered as much by the mainstream media as by the tea party”?
The answer, according to Chait, has everything to do with the moderate image that Ryan has cultivated over the years—as a humble, self-sacrificing policy wonk and courageous fiscal austerian. “The Paul Ryan that has been introduced to America is a figure of cinematic rectitude—a Jimmy Stewart character, but brainier,” Chait writes. “He is America’s neighborhood accountant, a man devoted to the task of restoring our fiscal health, whatever slings and arrows may come his way.” As a result, the right wing radicalism of Ryan’s budget proposal has gotten an unusual pass from media figures like the New York Times‘ James Stewart, who insist that Ryan “seems very genuine.” This despite the fact that the Ryan Plan “would likely produce the largest redistribution of income from the bottom to the top in modern U.S. history,” according to CBPP president Robert Greenstein, “and likely increase poverty and inequality more than any other budget in recent times.”
Conservative commentators like former Bush advisor Michael Gerson are presently trying very hard to advance the notion that Ryan’s approach—which Gerson brands “Reform Conservatism” in a recentWashington Post column—is a ”modern, market-oriented way” to fix a broken system. This is preferable, he suggests, to the Tea Party’s “Rejectionist” strain of conservatism, which seeks to “fundamentally reorder the role of the federal government.” It’s a straw man argument that allows Gerson and other Establishment conservatives to distance themselves from their party’s fringe element while praising the “disproportionate creativity and influence” of Republicans like Ryan.
Yet one glance at Ryan’s actual proposals reveals a startlingly radical agenda. According to TCF budget analyst Andrew Fieldhouse, the Ryan Plan consists of four component parts:
1. New tax cuts (49.7% of benefits go to households making over $500,000 a year)
- Individual income tax rates consolidated to 25 percent and 10 percent brackets
- Alternative minimum tax (AMT) repealed
- Taxes included in the Affordable Care Act repealed
- Corporate tax rate cut to 25 percent
- Corporations no longer taxed on foreign income
Total cost: $4.6 trillion in lost revenue
2. The extension of the Bush tax cuts
Total cost: $5.4 trillion in lost revenue
Which would be funded by
3. Non-defense spending cuts (62% of cuts come from programs that assist low-income households, like Medicaid and food stamps)
Total savings: $5.3 trillion
4. Trillions of dollars in unspecified offsets
Total savings: ???
Altogether, that amounts to an additional $4.7 trillion deficit over the next decade, which Ryan suggests will be offset by reductions in tax expenditures in the future. Republicans like Gerson want to sell this budget as an honest effort at reform, the brainchild of a moderate policy wonk reaching across the aisle in good faith. But it only takes one look at the numbers to grasp how radical such a “reform” would be. Without specifying which loopholes and deductions he would eliminate, the Ryan plan is revealed for what it is: the end of the social safety net as we know it and a trillion dollar windfall for the rich.
Video: Timothy Noah on America’s Growing Inequality Crisis
This morning I had the pleasure of helping host New Republic senior editor Timothy Noah for the first discussion of his newly released book, “The Great Divergence: America’s Growing Inequality Crisis and What We Can Do About It,” at The Century Foundation in New York City.
Joining Tim were four excellent panelists (from left to right in the photo above): Greg Anrig, vice president for policy at The Century Foundation; Timothy Noah; Daniel Alpert, Century Foundation fellow and founding managing partner of Westwood Capital; Robert Hockett, Century Foundation fellow and professor at Cornell Law School; and Dorian Warren, assistant professor of International and Public Affairs at Columbia University.
I’ll be posting more about Tim’s presentation and his new book later this afternoon, but in the meantime, check out the video recording of the event below.
Graph of the Day: Has the U.S. Fallen Behind in Higher Education?
Despite having the unfortunate distinction of being the first and only industrialized nation to amass over $1 trillion in outstanding student loan debt, the United States no longer leads the world in college graduates. According to the latest data from the OECD, sixteen countries now have a higher percentage of college graduates than the US, which had arguably the most educated workforce in the world during the postwar years. (The graph below does not include Japan, which also outranks the US.)
In absolute terms, the United States is not producing any fewer graduates than in the past. But as a percentage of the population, our numbers haven’t budged in a generation. Only 41 percent of 25- to 34-year olds held a college degree in 2009, the exact same percentage as their parents. The rest of the world, meanwhile, has surged ahead, leaving us 48th in math and science education, and near the bottom among industrialized countries on international math tests. Compounding the problem is the fact that just 60 percent of undergraduates actually complete their education within six years. The other 40 percent still have to repay their student loans—but with none of the added benefit of the college degree wage premium.
The story is essentially the same for high school graduates. While nine out of ten Americans aged 55 to 64 hold a high school or equivalent degree—far and away the highest percentage in the world—their children and grandchildren have fallen critically behind. Today just 88 percent of 25- to 34-year olds have graduated high school, fewer than ten other OECD countries, including Korea, the Slovak Republic, the Czech Republic, Poland and Slovenia.
It is difficult to draw conclusions from such data. US GDP per capita is higher than all but Norway and Luxembourg among OECD countries, despite its stagnant graduation rates. Germany, another powerhouse economy, also has seen little or no change in its number of high school and college graduates in the last 30 years. And the United States still accounts for over a quarter of the global 25- to 64-year old population with tertiary education—about the same percentage as the next three largest educators combined (China, Japan and the United Kingdom).
Still, these graphs are instructive. America’s economic hegemony in the second half of the 20th century was built on a strong, well-educated middle class, thanks to major investments in higher education like the GI Bill. That commitment has wavered in recent years, as states have cut back their funding for the state and community colleges that educate 75 percent of all US undergraduates, even as the cost of tuition soars. And if a growing number of Americans find themselves financially unable or educationally unprepared to enter higher education, what future can there be for such a middle class? “The net effect,” writes Joel Klein, former Chancellor of the New York City Department of Education, “is that we’re rapidly moving toward two Americas—a wealthy elite, and an increasingly large underclass that lacks the skills to succeed.”
Balancing the Budget on the Backs of the Poor
In recent weeks, Rep. Paul Ryan (R-Wis.) has suggested severe cuts to safety net programs like food stamps and housing assistance, in the spirit of the 1996 welfare reform that moved millions of struggling families off the dole and into poverty. Comparing the safety net to “a hammock that lulls able-bodied people to lives of dependency and complacency,” Ryan has proposed ”welfare reform round two,” which would similarly replace federal funding with fixed grants to states, allowing local politicians to slash poverty assistance programs when the budget is tight and spend the funds elsewhere. “Yes, we divert [welfare funds],” State Representative John Kavanagh, a Republican, told the New York Times, in a recent article about welfare reform in Arizona. ”Divert’s a bad word. It helps the state.” It’s certainly easier than raising taxes.
The practice of diverting welfare funds, and the human tragedy that invariably results, is hardly unique to Arizona. The percentage of families with children living in poverty who received cash assistance declined sharply throughout the United States after the 1996 welfare reform law, which transformed the New Deal-era Aid to Families with Dependent Children (AFDC) into the Temporary Assistance for Needy Families program. TANF, unlike AFDC, was designed to be a transitional program, relying on block grants and lifetime caps on aid to push recipients quickly out of the program. For a few years, the reform seemed to work. The late-1990s economic boom and an unemployment rate below 4 percent helped to reduce welfare caseloads while allowing states to use their TANF funding to plug unrelated holes in the state budget, guilt-free. But when the economy slowed down in 2001, and crashed in 2007, states were unwilling or unable to redirect TANF benefits back to families in need.
“Reformed” welfare—unlike the Supplemental Nutrition Assistance Program (SNAP), or food stamps—had lost its critical counter-cyclical function. From 1995 to 2010, the number of families with children living in poverty rose by 17 percent, from 6.2 million to 7.3 million. But instead of expanding to meet the increased need, as SNAP did, TANF continued to shrink. While food stamps reduced the depth of child poverty by an average 15.5% and its severity by 21.3% from 2000 to 2009, the percentage of families with children living in poverty who received welfare actually declined, from 68% in 1996 to just 27% today. Inflation has further eroded the value of TANF block grants by nearly 30 percent.
Researchers Luke Shaefer of the University of Michigan and Kathryn Edin of Harvard report similar findings: at the same time that the average number of welfare recipients declined from 12.3 million per month in 1996 to 4.4 million today (of whom just 1.1 million are adults), the number of households with children living on less than $2 per day per person has more than doubled, from 600,000 to over 1.4 million.
But for state legislators like the above-quoted Mr. Kavanagh of Arizona, cutting safety net funding has been a no-brainer. “We have reduced our caseload, and we don’t have people dying in the street. There were an awful lot of people who didn’t need it.” Republicans like Paul Ryan and Mitt Romney are likewise on the record in favor of extending the block grant structure for means-tested programs like Medicaid, housing subsidies, job training and food stamps. “Welfare reform showed us how well a state-led approach can work,” Romney told a crowd in Detroit. “Let’s extend that conservative, small-government philosophy across the entire social safety net.”
We already know how that story ends. For the millions of Americans who struggle every day with hunger and poverty, Romney’s “small-government philosophy” is just another way of saying “you are on your own.”
Student Debt and the Middle Class (Part 3)
Part Three of a three-part series on student debt and the middle class. Click here to read Part One and click here to read Part Two.
With the price of a college education rising three times faster than median family income and total student loan debt exceeding $1 trillion, Congress must act quickly to reign in costs if our high-skill labor market is to remain globally competitive. Already, the United States has fallen behind Canada, Japan, and South Korea in the production of college graduates; experts estimate the U.S. must increase postsecondary access and degree production by 4.2 percent annually just to catch up.
The primary obstacle is the cost: a college degree is expensive, and controlling soaring tuition rates won’t be easy. State schools, which educate 75 percent of all undergraduates, including the 42 percent enrolled at community colleges, are largely dependent on government funding to subsidize what is supposed to be a public good. But when the Great Recession forced states to choose between raising taxes and slashing the budget for higher education, the majority of states chose the latter. According to the Delta Cost Project, nearly all public sector tuition increases in 2009 were the result of cost-shifting to replace declining state funding, raising troubling questions for the future sustainability of the entire public education model. At nearly every one of the 2,000 institutions surveyed in Delta’s eleven-year dataset, increased revenues from student tuition were used to offset disappearing subsidies; almost none was spent on the students or the cost of their education.
Both public and private colleges must also find ways to cut costs and increase efficiency. Because student loan money is plentiful—and often guaranteed by the federal government—schools don’t necessarily have an incentive to make tough budgetary choices. Many students readily take on $20,000 or more in debt to pay for an undergraduate degree, making the demand for higher education both high and relatively inelastic (unresponsive to price increases). Research shows that private colleges in particular compete for undergraduates’ dollars by overspending on luxurious athletic facilities and residential amenities, helping students relax while the interest on their loans grows higher and higher. Absent government intervention, it is not clear what might change these market forces, which are pushing colleges in the direction of rising tuition, greater inequality, less efficiency, and higher student debt.
President Obama has advanced several policies that could break that cycle. One proposal would divert federal aid from colleges that raise tuition excessively, and would include performance reviews of schools’ success at enrolling and graduating low-income students, their job placement rates for recent graduates, and students’ ability to repay their loans. At the same time, the president would expand funding for Federal Work Study, Supplemental Education Opportunity Grants, and the Perkins loan program by $10 billion, increasing the incentive for colleges to comply with the new standards. “You can’t assume you’ll just jack up tuition every single year,” Obama told a crowd at the University of Michigan in January. “If you can’t stop tuition going up, your funding from taxpayers will go down. We should push colleges to do better; we should hold them accountable if they don’t.”
Plenty of questions remain. Would the policy punish public colleges that hike tuition rates to compensate for reduced state subsidies? Could the plan end up hurting the low-income students it is designed to help, or lead to even greater disparities in quality between rich and poor institutions? It’s even less clear how the private market for student lending should be reformed. Virtually unlimited private loans ensure broad access to higher education for students willing to take the risk, leaving few incentives for colleges to increase productivity and reduce costs.
The president’s carrot-and-stick approach may increase experimentation and yield results. But in the short term, the fundamental question is whether the public is willing to consider increasing spending on higher education as a matter of civic duty. State tax revenues account for the majority of subsidies for the public and community colleges that educate three-fourths of all U.S. undergraduates. Until congressional legislation reforms the market for higher education, funding these programs remains the surest way for us to sustain the vibrancy of our nation’s middle class and invest in its future.
Student Debt and the Middle Class (Part 2)
Part Two of a three-part series on student debt and the middle class. Click here to read Part One.
A trillion dollars of student loans may not be the next subprime crisis, but it is delaying traditional middle-class aspirations like home ownership. Around one million students will graduate college in debt this spring, with an average $23,000 to be paid off over a period of ten to twenty years; more than enough to discourage young people who might otherwise have taken on a mortgage on their first house.
According to Census data, less than half of those aged 25–34 years old are homeowners today, the lowest percentage since 1999. Despite a brief upsurge in young homeowners signing subprime leases during the heady days of the mid-2000s, on net nearly all of the 11 million unit household growth of the last ten years occurred among older households, while Millennials—children of the Baby Boomers born between 1982 and 2000—are now overwhelmingly choosing to rent or move home with their parents. That’s problematic because first-time buyers are critical to the health of the housing market, which depends on new blood to finance older sellers’ movement into the higher ranges of the market. It’s also a major contributing factor in the continued weakness of the construction sector: single-family housing starts for February were down 12.5 percent from the same time two years ago, while renter-friendly housing was up 197.5 percent.
Although housing prices have fallen by about a third from their 2006 peak, and interest rates are near historic lows, just 9 percent of those aged 29–34 years old got a first-time mortgage from 2009 to 2011, compared to 17 percent a decade earlier. Of course, much of the slowdown in Millennial’s household formation is due to the recession: their employment-to-population is near 45 percent, the lowest it’s been in sixty years, and many of those with jobs are working part-time or at jobs that don’t require a college degree. But a trillion dollars in student loans has added an unprecedented debt overhang to the mix, worsening generational problems such as underemployment and low consumer spending. Those loans will be “a drag on the economy for the foreseeable future,” according to National Association of Consumer Bankruptcy Attorneys vice president John Rao. ”Just as the housing bubble created a mortgage debt overhang that absorbs the income of consumers and renders them unable to engage in consumer spending that sustains the economy, so too are student loans beginning to have the same effect.”
Century Foundation Fellow Dan Alpert also worries that student loans, which act as a tax on future wages, will cost the economy down the road: “Just as during the mortgage crisis, the increases in consumer debt—assuming limited growth over the next few years—is pulling forward consumption from future periods that will not be repeated because of the increased debt load.” Unfortunately, Americans have done a poor job of deleveraging since the recession; total consumer credit has actually increasedabout 9 percent since this time last year. But much of the increase in outstanding consumer credit has been driven by the outsized rise of student loan debt, which last year surpassed total credit card and auto loan debt. Experts believe this confluence of factors—debt overhang, high unemployment, changing patterns of consumer behavior—may lead to a “spending void” that Millennials will be unable to fill as their Baby Boomer parents retire. So while a trillion dollars of student debt may not be enough to topple Wall Street, the impact of Millennial debt on traditional middle-class consumer behavior—purchasing a home, buying a car and starting a family—may be more insidious and long-term than we yet realize.
Student Debt, the Trillion Dollar Threat to the American Middle Class
Part One of a three-part series on student debt and the middle class. Click here to read Part Two and click here to read Part Three.
Although the American love affair with easy credit hit a rough patch during the recession as families delayed the purchase of new cars and ever-larger flat-screen TVs to collectively pay down nearly a trillion dollars in outstanding household debt, one sector of the credit market continued to grow unabated. Total student debt is up over 500 percent since 1999, and is predicted to reach $1 trillion this year, surpassing both total credit card debt and auto loans. By 2020, it could be as high as $1.4 trillion, leading some experts to warnthat student loans “could very well be the next debt bomb for the U.S. economy.”
Not all forecasts are so dire. Moody’s Analytics expects that “despite its rapid growth… student lending is not likely to turn into the next subprime crisis.” That’s because the student loan market is less than one tenth the size of the mortgage market that tanked the economy in 2007. And unlike residential mortgages, 90 percent of student loans are federally guaranteed.
Still, the incredible growth of student debt has sobering implications for the future of the middle class and the U.S. economy. Last year, approximately one million students graduated a four-year college in debt—more than $23,000 on average and nearly $35,000 for those attending a private school. That’s one million young people whose entry into the middle class will be delayed by a decade of debt servicing. Unlike the baby boomers, who spent their 20s and 30s buying homes, creating families and investing in the economy, today’s youth face a trillion dollars in loan repayments, two-thirds of which is held by people under 39. It’s enough to discourage an entire generation.
A weak economy and tough job market have made the situation even worse. Close to 25 percent of recent college graduates are unemployed, up from 19 percent in 2000. Of those employed, less than half work at a job that actually requires a pricey college degree.
The delinquency rate, too, has skyrocketed. Although the number of graduates behind on their payments was initially estimated to be around 10 percent—in line with the delinquency rate for other kinds of debt, like mortgages, car payments and credit cards—a new study by the Federal Reserve Bank of New York puts the true number at 27 percent, far higher than in other sectors of the credit market. As many as 47 percent of student loan borrowers are in deferral or forbearance while they wait for their luck to change.
But it’s not just recent graduates who are struggling to repay their loans. Three-quarters of past due student loan balances—$85 billion in total—now belong to people over thirty, many of whom chose to go back to school and learn new skills during the recession. And while investing in an additional degree typically yields high returns in terms of future wages, a greater debt load also means delaying savings and putting normal patterns of consumption on hold. With close to $700 billion of student debt held by people over the age of 30, it may be a long time before we see middle class consumer behavior return to normal.
Part of the problem is that tuition rates have grown much faster than median family income, a trend that has accelerated in recent years. A lesser known problem, as noted in the Atlantic, is that too few students actually graduate on time, if at all. According to the National Center for Education Statistics, just 60 percent of undergraduates seeking a bachelor’s degree complete their education within six years. The other 40 percent still have to repay their loans—but with none of the added benefit of the college degree wage premium. Creating education policies that encourage these students to graduate on time could go a long way towards lowering the socioeconomic cost of their debt burden.
