Predicting the next debt bubble burst
As of June 30, total household indebtednesswas $12.29 trillion, 10.2 percent above the recent lowof 2013, but 3.1 percent belowthe peak seen in 2008.
But not all debt is created equal. In fact, every time the Federal Reserve Bank of NewYork releases its quarterly report on household debt, various media outlets report on the findings with scary headlines suggesting that a new bubble has inflated around a different type of debt, and that bubble is about to burst.
The most obvious candidate for the next bubble is student loan debt, which has ballooned to $1.26 trillion. To put that in perspective, federal student loan asset levels stayed at about $100 billion from 1995 to 2010. But as college costs soared, more families turned to debt to finance their coveted degrees. That’swhy the total amount of education debt has soared.
The large outstanding balancewould not be such a big problem if everyone who took out a loan completed his or her studies and then got a job, allowing for adequate servicing of the loans. But that has not been the case, especially after the recession andweak recovery. As theWall Street Journal reported in April, more than 40 percent of Americans who borrowed from the government’s main student loan program are either not making payments or are behind in making them.
As of the beginning of this year, about 3.6 million borrowerswere in default on $56 billion in student debt, and about 3 million who owe $66 billionwere at least a month behind.
Those numbers look scary and lead many toworry that the next debt meltdown will occur in the student loan market. However, there are big differences between the mortgage and student loan markets. The biggest, according to a report from Vanguard, is size.
When the real estatemarketmelted down amid the financial crisis, mortgage debt represented the equivalent of nearly two-thirds of the country’s gross domestic product. That’s huge, especially compared to student loan debt, which is equivalent to less than 10 percent of GDP.
Size also matters in the amount of debt being carried by the borrower. Despite horrible stories of six-figure education loans, most students carry $25,000 to $35,000. According to the Brookings Institution, median student loan debt is much lower—$13,000. Compare that with the average mortgage debt of nearly $100,000 at its peak in 2007.
So while more than a trillion dollars of student loan debt is massive, it pales in comparison to the mortgage bubble.
Another area of concern is the rise in subprime auto debt. Auto loan debt has been rising at an annual rate of around 10 percent for the past three years, and subprime loans (i.e., loans to borrowers with credit scores below660) are the fastestgrowing segment of the market, accounting for about 35 percent of all new originations. Nevertheless, analysts at Capital Economics, an independent macroeconomic research firm, have found that “subprime auto loan origination is still lower than itwas in 2006.”
And although $1.1 trillion of total auto loan debt is above the previous peak of $820 billion in 2006, interest rates are a lot lower than theywere a decade ago.
Being on the lookout for debt bubbles is natural considering the economy is still absorbing the aftermath of the mortgage meltdown. So while the two leading contenders for future problems— student and auto loans— are not in the same realm as mortgages, they bear scrutiny.