Student Debt Woes Could Magnify Economic Problems

This burden, along with a poor job market, could impact the economy decades down the road.

Graduate students should consider paying off interest while still in school before taking out Graduate PLUS loans.

Graduate students should consider paying off interest while still in school before taking out Graduate PLUS loans.

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Americans are getting their debt under control...that is, unless you count the pesky little problem of student debt. Since household debt peaked in late 2008, student loan debt has grown by $303 billion to $914 billion, while other types of household debt fell by $1.6 trillion, according to data released today by the New York Federal Reserve Bank.

[Read the latest news about U.S. economic growth.]

Student debt is not a large portion of household debt—as of the second quarter of 2012, student loans made up 8 percent of household debt, compared to the 72 percent contributed by mortgage debt—but it could pose widespread economic problems both now and in the future for a generation that's already struggling.

"Even if the economy recovers, students graduating now or a couple years previous to this, as well—their earnings potential has been hit by the lackluster employment situation," says David Nice, associate economist at Mesirow Financial, a Chicago-based financial services firm.

People under 30 account for nearly one third of all student debt in the U.S., and younger workers are having an especially difficult time in the job market, with an unemployment rate of 13.5 percent for workers ages 20 to 24, and 9.3 percent for workers 25 to 29 (only unadjusted numbers are available for 25-to-29-year-olds). When these workers are unemployed now or underemployed, working in retail or waiting tables out of college, it means a lifetime of lower pay, says Nice.

"Each raise is impacted even for those who do find a job, starting off at a lower wage. Then over time, their earnings potential is always tied to that salary," he says.

So even when people currently in their 20s now are in their 40s and settled into more secure jobs, their salaries will be lower than they could have been. Couple that with ongoing student loan payments, and it makes for persistently lower disposable income, meaning lower spending and slower economic growth.

[See where the money you pay for textbooks is going.]

For now, some people weighed down by student debt are already struggling to stay afloat. The share of student loan balances 90 days or more delinquent grew from 8.7 to 8.9 percent in the second quarter. Meanwhile, overall household debt delinquency rates improved. Nine percent of all debt was in some way delinquent in the second quarter, down from 9.3 percent in the first. Earlier this year, the National Association of Consumer Bankruptcy Attorneys issued a report declaring the student loan situation an emerging "debt bomb" that could eventually rival the home mortgage crisis.

William Brewer Jr., president of the NACBA, foresees broader economic problems attached to high student borrowing. Student debt is yet another drag on an already sluggish housing market, he points out, as heavily indebted people find it difficult to get financing to buy homes.

But he also sees it having potential implications for U.S. competitiveness. The growing cost of higher education may make for a less educated workforce as college is disincentivized for poorer potential students.

[See one estimate of how many jobs the U.S. has lost to China.]

"If the financial risk is too great, then you don't do it, and if you don't do it, then as the U.S.A. tries to compete with other countries around the world, we suffer," says Brewer.

In addition, he fears that it could further entrench economic inequality.

"The people who of course have to get student loans are those who don't have wealthy families," says Brewer. "To the extent that education is a great equalizer between the haves and the have-nots, that will suffer as well."

Danielle Kurtzleben is a business and economics reporter for U.S. News & World Report. Connect with her on Twitter at @titonka or via E-mail at dkurtzleben@usnews.com.