How Student Debt Is Slowing the Recovery

Economists are noticing new problems that could delay prosperity for younger workers.

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Most Americans agree that education is a good thing. But its cost is a growing problem that may now pose risks to the broader economy.

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During the recession, many people who couldn't get a job they wanted did a rational thing: They went back to school or extended their academic career. More education, they reasoned, would enhance their job prospects and maybe lead to a bigger salary down the road.

But the bill for that extra education is arriving before many graduates have anything to show for their schooling. At a minimum, the added financial pressure on young workers is cutting into spending that would otherwise be boosting the housing market, retail sales, and other key parts of the economy. Some analysts are even starting to worry about a student loan bubble that could burst and bring a damaging wave of defaults, similar to the subprime meltdown that helped cause the recent recession.

Americans now owe more than $1 trillion in student loans, which exceeds the total amount of credit card debt or loans for automobiles. Since 2009, Americans have been paying down most types of debt, but piling up student loans at record rates. At least 37 million Americans owe money on a student loan, according to the New York Federal Reserve. The average borrower owes about $23,000. About 10 percent of borrowers owe more than $54,000.

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Money borrowed to pay for education has long been considered "good debt," since it's an investment that often produces sizeable returns. Incomes rise and unemployment rates decline based on education level. But the heavy burden of student debt in a chronically weak economy is generating some troublesome new trends that economists have only recently begun to think about.

The most obvious problem is that recent graduates are having a tough time finding good jobs in an economy in which the unemployment rate is 8.6 percent for 25-to-34-year-olds, and 13.2 percent for 20-to-24-year-olds. With a shortage of income to make loan payments, the default rate on federally guaranteed student loans has nearly doubled, from 4.6 percent for loans originated in 2005 to 8.8 percent for loans granted in 2009.

The student loan market is smaller than the subprime mortgage market that blew up in 2008, and student loans are far less complex. But rising defaults could still generate taxpayer losses and cause collateral damage elsewhere in the economy. "A wave of defaults could have a crippling effect on the ability of many households to access credit in the future," writes economist Christian deRitis of Moody's Analytics. Millions of Americans, ultimately, could begin their working lives with wrecked credit.

The infuriating prospect of so much unmanageable debt has helped fuel the "99 percent" movement. Last year, the Obama administration passed new rules limiting student loan repayments to 10 percent of income and easing other repayment rules. But that may do little to offset the unintended consequences of mushrooming student debt that economists are beginning to notice.

It's well known that many "boomerang kids" are moving back in with their parents after graduating, for instance. Among other things, that's depressing demand for housing. It could also end up causing a long-term slowdown in the economy. Younger adults are marrying and having kids later, which in turn has pushed the rate of population growth to the lowest level since the 1940s. "These trends are worrisome since population growth is a strong driver for consumer spending, housing demand and household formation," writes Chris Christopher of forecasting firm IHS Global Insight.

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The easy availability of student loans may even be contributing to escalating college costs, which are rising faster than inflation. Loans basically subsidize the cost of education, making it easier for colleges to raise tuition at a time when demand is increasing as well.

At some point, jobs will return, incomes will rise, and twentysomethings (or thirtysomethings) will leave the nest for good. That could unleash pent-up demand and other economic forces typically associated with the improving fortunes of a new generation. For many of tomorrow's earners, however, prosperity may come later in life than expected. Maybe patience should be a new addition to the college curriculum.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success, to be published in May. Follow him on Twitter: @rickjnewman.