Why Student Loan Forgiveness, Not Prolonging the Payment Freeze Is Needed To Prevent an NPL Crisis

We independently assess all our recommendations. Purchases through our links may earn us a commission.

In this article:

• Today, 45 million borrowers collectively owe $1.7 trillion in inescapable student loan debt, averaging about $37,000 apiece.
• 69% of students today cannot afford to go to college without taking out loans.
• Banks package those loans into Student Loan Asset-Backed Securities (SLABs) and sell them off to hedge funds, investors, and other banks, just as they did with mortgages ahead of the 2008-2009 recession.
• But 7.5 million student loans were already classed as non-performing loans (NPLs), meaning borrowers hadn’t been able to make payments in 90+ days, before the payment freeze.
• When that number climbs after payments resume, banks and investors will lose money on the SLABs they bought and likely come crawling to the federal government for a bailout just as they did after causing the housing crisis in 2008-2009.

A nonperforming loan (NPL) crisis looms on the horizon as 7.5 million borrowers are already in default and millions more could join them this month when the student loan freeze expires.

When collections on NPLs resume, borrowers who are fortunate enough to have a job may see their wages garnished — as this aggressive tactic is a legal means of collecting payments under the Department of Education’s guidelines.

With a housing crisis already underway, borrowers with garnished wages may become unable to afford rent. The result could be a snowballing of multiple financial crises unless the Biden administration or federal legislators take real, long-term action to prevent it.

The Student Loan Crisis That’s Been Growing for Decades

In 1976, a college student at a four-year public university spent $2,600 per year ($13,900 in today’s dollars) for tuition, fees, room, and board. A student working a part-time minimum wage job at $2.30 per hour ($10.98 in today’s dollars) could cover those costs without taking on a single cent of debt.

When that student graduated, they’d leave college unburdened by debt and with a degree that all but guaranteed they’d get a solid, middle-class job and be well on their way to the middle class dream of owning their own home, raising a family, and still having discretionary income for vacations and hobbies.

By the time President Regan took office in the 1980s, significant changes his administration made to the education system came with disastrous consequences.

As states saw drastic cuts to their public education budgets, especially for higher education, universities had to make up the losses by hiking tuition rates.

Tuition hikes began to outpace inflation and the eight-year stagnation of wages imposed by the Reagan administration meant that a gap grew between the cost of a college degree and the amount the average student could afford to pay.

By the way!

Did you know we’re launching a Kickstarter campaign? In the next few months, our campaign for ‘Gentle Jack: The Party Game for Bad Friends‘ goes live! Visit the official website or follow the Kickstarter page to stay in the loop.

Learn more

Similar freezes on federal grants and assistance provided to students exacerbated this trend, leading to the birth of the student loan crisis.

By the mid-1980s, the total amount of student debt rose to $10 billion ($25 billion in today’s dollars), an already panic-inducing amount as college used to be something people could afford without any debt at all.

All of these exacerbating factors initiated by the Reagan administration were allowed to continue or made even worse by future administrations.

This has resulted in the gap that emerged in the 1980s widening into a canyon that is impassable for the 69% of students today who cannot afford to go to college without taking out loans.

If this wasn’t enough, just as college became too expensive to pay for without loans, those same loans students took out to cover the costs became inescapable.

The U.S. Bankruptcy Code was amended in 1984 to exempt all student loans, with a few exceptions, from being discharged if a borrower filed for bankruptcy. That meant that, even if you went bankrupt, you were still on the hook for those student loans.

Over time, exceptions were narrowed further so that it is now all but impossible to escape your student loans, no matter how dire your financial situation becomes.

Today, 45 million borrowers collectively owe $1.7 trillion in inescapable student loan debt, averaging about $37,000 apiece. At the end of 2019, 11.1% of student loans were non-performing loans (NPLs), meaning the borrower was unable to make payments for 90 days or more.

When borrowers default like this, the Department of Education (DOE) will begin pursuing them with aggressive collections tactics including garnishing wages (without a court order or warning), garnishing social security benefits, seizing tax refunds, suing borrowers, tacking on exorbitant collection fees, or simply harassing borrowers by phone, email, and in-person.

There is no statute of limitations either. The DOE can continue aggressively pursuing non-paying borrowers until the day that borrower dies.

This enormous burden has had a domino effect on the rest of the economy. As these 45 million borrowers remain shackled to student debt, they are often unable to save for a down payment, afford the cost of raising children or even just have discretionary income to inject into local economies.

The result: Millions of Americans delay buying a home and starting a family. They don’t dine out or spend money on little splurges like going to the movies or going on trips.

All those reports you see about millennials “killing” an industry are really the consequence of an entire generation being saddled with $1.7 trillion in debt and, therefore, unable to achieve that middle class dream they were promised when they signed those loan agreements at the tender age of 18.

The Federal Reserve Bank of St. Louis found that millennials had the highest debt burden of any generation and struggled to achieve financial milestones — like buying a home or saving for retirement — that previous generations achieved comparatively easily.

As of 2020, the average millennial household has a net worth of $140,600 which puts them just below Generation X’s average of $152,000 and far behind boomer’s average of $221,000. These findings aren’t surprising when you consider that boomers were the last generation to have access to affordable, debt-free higher education.  

While those six-figure amounts all sound perfectly livable, they become less so when you factor in the fact that millennials have the highest debt burden of any generation.

According to the Experian 2020 State of Credit report, the average non-mortgage debt owed by a Millennial was over $27,000 — and just $4,600 of that was credit card debt. The bulk of that amount was student loans.

Burdened by debt and battered by two recessions, this generation has had little opportunity to build even emergency savings, let alone real wealth. With 61% of millennials having less than $500 in savings to help cover an emergency, the generation had no financial buffer to soften the blow of the COVID-19 pandemic.

NPLs and the Makings of a New Recession That Looks Just Like the Old Recession

You may remember 2008-2009, the great recession in which hedge funds and banks caused a nationwide housing crisis through the exploitation of borrowers via subprime mortgages. Essentially, regular people were manipulated and sometimes coerced into taking out high-interest mortgages to buy homes.

Banks then packaged their mortgages into “Mortgage-Backed Securities,” attached “credit default swaps” to them (essentially a promise to pay the value if the underlying loans defaulted), and sold them off to hedge funds, investors, and other banks.

A trading frenzy led to high demand which led to increasing pressure to get more regular people to take out more mortgages.

When interest rates rose and millions of borrowers could no longer afford their mortgage payments, nor find buyers for their homes, defaults skyrocketed, and investors came to collect on their credit default swaps.

This left many of the financial institutions who were gambling with mortgages at risk of bankruptcy — if not for then-President Bush’s $700 billion bailout, which went to these irresponsible institutions rather than to the millions of people forced to foreclose on their family homes.

In a move that demonstrates banks and hedge funds learned nothing from the subprime mortgage crisis, they are now doing the same thing with student loans.

Banks are encouraging teenagers to take on tens or hundreds of thousands of dollars in debt to go to college — where rising tuitions are rapidly outpacing any potential salary increase associated with having a degree.

Then, they package those student loans into Student Loan Asset-Backed Securities (SLABs) and sell them off to hedge funds, investors, and other banks.

With 92% of student debt consisting of federal student loans and all student loan debt unable to be cleared by bankruptcy, investors view these loans as a surefire opportunity to profit. So, the assumption is that the government will be on the hook for the bill if the students should default like their mortgage-borrowing parents before them.

This is driving demand for more SLABs, leading loan providers to encourage even more young students to take on even more debt, regardless of whether they’ll ever be able to climb back out again.

In fact, it was banks who poured millions into lobbying efforts and campaign donations to push for the exemption that blocked students from discharging student loans in bankruptcy.

Without legislative action, this has all the makings of another massive financial collapse where, once again, those most vulnerable will suffer the consequences while those hedge funds and banks who gambled with regular people’s student loans will collect billions in taxpayer dollars to cover the value of the defaulting loans.

The Case for Student Debt Cancelation

While economists estimate that it wouldn’t end poverty, canceling all student debt would inject about $90 billion per year into the economy in the form of added cash flow. It would also likely increase economic output by somewhere between $115 and $360 billion.

Since forgiving $1.7 trillion in debt is not the same as injecting $1.7 trillion in cash into the economy, the initial impact will be relatively small compared to the cost of forgiving that amount.

It will take about 15-20 years for the full $1.7 trillion to flow into the economy — because it will come in the form of spending the few hundred per month that a person was previously putting toward student loans.

However, the long-term stimulus and the ripple effect of these indirect benefits are worth it.

One of those indirect benefits would be an increase in big-ticket purchases. Researchers found that for every $1,000 in student debt an individual had, homeownership was delayed by two and half years.

Eliminate that debt and we’ll likely see a serious uptick in home buying and other big purchases that might have been on the back burner before.

Another consequence of the debt crisis that could be reversed is the rural brain drain. Students from rural areas end up moving to urban areas because they need access to those higher-paying job markets in order to pay off their loans. Between 2010 and 2016, 68% of rural counties saw a net loss in population, particularly a loss of college-educated residents.

If debt were erased, we could see many of those college-educated workers moving back to their rural hometowns, where they could stimulate local economies by working, buying homes, raising families, and using their college education to benefit the community.