College tuition is rising at an alarming rate. It has outpaced inflation for a number of years now. And with the economy still in a weak recovery period many students are graduating without having jobs. Everyone has all this debt but no way to pay it off. Some variation of the chart below is everyone’s favorite now. Student loan debt is now greater than credit card debt.

Graph of student loan debt and credit card debt over time

And it’s a good chart. Of course this means we’re in a bubble now too. So says a large proportion of the media so it must be true. And to a degree, I agree with them. There is a problem with many schools promoting all the career opportunities they provide while saddling students with enormous loads of debt. For profit schools advertising on TV and lower tier law schools are two very good examples. But are they the rule, or the exception?

Part of the problem with all the attention student loans are getting is few are looking for real causes of the problem to see if it’s a real one or not. Thankfully some are now. Some professors and Michigan and Virginia dug a little deeper and pointed out a few stats that might put people to ease (linked below). Fewer than 1 out of 30 students have debt greater than $100k. That makes them an outlier. And you don’t want to break the system because there are outliers in trouble. You may want to look into reforming the system though.

How do you do that? If you don’t know much about student loans, there’s basically two types: federal and private. Federal loans are either held by or guaranteed by the government (all new loans are issued directly from the government now). Private student loans are provided by banks and lenders and are not guaranteed by the government. This is important because the private loans are often packaged up and sold as investments. Investors buy packaged student loans and collect the interest on the payments. They are called SLABS (student loan asset backed securities). Yes, this is similar to what was done with mortgages. But, despite a “bubble” that market is considerably smaller than the mortgage market.

But there’s one key item about even private student loans that make them attractive investments. There may be no government guarantee, but there’s something just as good. You can’t bankrupt student loans of any kind. Not even private ones. This was made law in 2005 and was considered one of the greatest wins for the banking lobby in history. As the nice economists point out, this has created a new moral hazard.

Moral hazards are pretty much any system where one group collects income on the risk, but another actually bears the risk. If you’ll remember, banks had a moral hazard before with mortgage lending. They got so big it would be impossible for them to fail. So the taxpayer bears the risk. But not having to worry about losing loans in bankruptcy, banks can lend as much as they want in student loans. And with abundant cash resources, schools can continue to raise tuition.

No one is focused on the ability to pay 4-6 years in the future. The school doesn’t care. The student isn’t thinking about it. And the bank knows the student can’t dump the loan in bankruptcy.

You can say we’re in a bubble, but that argument doesn’t quite flesh out yet. Growth has been linear and other loans balances have been decreasing. We’re borrowing less on credit and even getting rid of car debt, and of course the downward trend for housing continues.

If anything that’s good. If you had to pick one loan type to be increasing, I’d go for student loans. But if you want to reform the system start with allowing people to bankrupt their loans. If lenders and investors effectively bear little risk then the potential exists for a rupture in the system. We’ve seen it once.

By bankrupting student loans private rates will get higher, and students will be able to borrow less. Schools won’t be able to name their price for tuition and look for other ways to pay for college or reduce the cost. But don’t believe the hype on a student loan bubble just yet.

Read: Ignore the debt hype. College is a great investment

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categories: banking, education, government, loans, personal finance