Is the rapid expansion of student loans, now over $1 trillion in the United States, a bubble? This question came to the fore again today after JPMorgan Chase announced it was winding down its student loan business. The bubble question is one that can be debated endlessly, since bubble is not a precisely defined term of art in economics. The way I think of a bubble, though, it occurs when a wide range of people are making excessive purchases in a related class of assets because they have an exaggerated idea of what the assets are worth. Further, a bubble carries with it the risk of a sudden adjustment in values in the future as people come to realize that the previous consensus of value was mistaken.
In one sense, student loans could not be a bubble because it is impossible to have any kind of rapid exchange of the underlying asset, the college degree. It takes years to purchase a college degree, and once acquired, it is not able to be resold. Perhaps you could argue that accredited institutions of higher learning are essentially reselling the education their employees have previously received, but even if you see it that way, it is a limited and slow process.
You could quibble, too, about whether education can really be seen as an asset. Yet for more than a lifetime people have bought into the idea of investing in a formal education, so it is at least very much like an asset.
Setting these two objections aside, it is hard to point to any operational difference between the current student loan situation and a bubble.
Are a wide range of people buying assets with an exaggerated idea of their value? In the case of student loans, it would seem so. We see students pursuing a formal education with the assumption that it will boost their lifetime earnings, when the statistics of the last ten years show that this is often not the case. Parents, lenders, fund managers who buy the resulting securities, and government bodies who issue and guarantee loans may make the same mistake about the student’s future earning potential. It is the classic mistake of a bubble, of viewing the asset being purchased as being more valuable than it actually is. And just like in a classic bubble, public opinion plays a key role in reinforcing this misperception. Employers, for their part, often pay an excessive premium for degree-holding workers — a premium not fully justified by the greater productive power of workers holding degrees.
There are signs now that this whole system could come, if not crashing down, then at least drooping down. One change already taking place this year is banks’ new reluctance to make car, home, or business loans to applicants who have unpaid student loan debts. If you may now have to pay off all student loans to prove you are creditworthy, it reflects the opinion of banks that the student loans and accompanying higher education do not, in combination, give college graduates any extra financial capacity. Meanwhile, many employers have become much less strict about the requirement of a college degree for a wide range of jobs. They’re happy to consider equivalent study or experience instead. This is potentially a game-changer in an era where it is suddenly no trouble at all to piece together the equivalent of a college education, or a more focused education in a specific field, online at minimal expense. Of course, the fewer jobs there are that require a specific degree, the less financially valuable the formal course of study that leads to a degree becomes. At the same time, there is growing political pressure to change the student loan system so that the financial arrangements for a college education do not have such a strong resemblance to a financial death sentence. Put this all together and extrapolate by five or ten years, and it’s easy to imagine a decline in value of all of the assets that cluster around student loans.
So is student lending a bubble? That is, at least, the right way to think of it. Could it lead to a new round of trouble for the financial system? Possibly. If a Wall Street bank is willing to come out and say that student lending is a little too risky for their taste, it ought to tell you something.
