Among the demands of the Wall Street protesters is student debt forgiveness—a debt “jubilee.” Occupy Philly has a “Student Loan Jubilee Working Group,” and other groups are studying the issue.
Commentators say debt forgiveness is impossible. Who would foot the bill? But there is one deep pocket that could pull it off—the Federal Reserve. In its first quantitative easing program (QE1), the Fed removed $1.3 trillion in toxic assets from the books of Wall Street banks. For QE4, it could remove $1 trillion in toxic debt from the backs of millions of students.
The economy would be the better for it, as was shown by the G.I. Bill, which provided virtually free higher education for returning veterans, along with low-interest loans for housing and business. The G.I. Bill had a sevenfold return, making it one of the best investments Congress ever made.
There are arguments against a complete student debt write-off, including that it would reward private universities that are already charging too much, and it would unfairly exclude other forms of debt from relief. But the point here is that it could be done, and it would represent a significant stimulus to the economy.
Toxic Student Debt: The Next “Black Swan”?
The Occupy Wall Street movement is heavily populated with students—many without jobs—groaning under the impossible load of student debts that have been excluded from the usual consumer protections. A whole generation of young people has been seduced into debt peonage by the promise of better jobs if they invest in higher education, only to find that the jobs are not there when they graduate. If the students default on their loans, lenders can now jack up interest rates and fees, garnish wages, and destroy credit ratings; and the debts can no longer be discharged in bankruptcy.
Total U.S. student debt has risen to $1 trillion—more than U.S. credit card debt. Defaults are also rising; and with a very tight job market, the situation is expected to get worse. The threat of massive student loan defaults requiring another taxpayer bailout has been called a systemic risk as serious as the bank failures that brought the U.S. economy to the brink of collapse in 2008. To prevent a repeat of that disaster, we need to defuse the student debt time bomb before it blows. But how?
The Federal Reserve could do it in the same way it defused the 2008 crisis: by aiming its fire hose of very-low-interest credit at the struggling student population. Since September 2008, the Fed has made trillions of dollars available to financial institutions at a fraction of 1 percent interest; and in audits since then, we’ve seen that the Fed is capable of coming up with any amount of money required—accounting entries, available with the stroke of a computer key.
The Fed is not allowed to lend to individuals directly, but it can buy Treasury securities; and with the Student Aid and Fiscal Responsibility Act (SAFRA) of March 2010, the Treasury is now formally in the business of student lending. The Fed can also buy asset-backed securities, including securitized student debt; and there is talk of another round of quantitative easing aimed at just that sort of asset.
The Market Wants More
When the Federal Reserve’s expected “QE3” turned into the tepid and ineffectual “Operation Twist,” the stock market reacted by plummeting. To appease investors, Chairman Ben Bernanke then assured them that the Fed was “ready to do more.” How much more and in what way wasn’t specified; but Alan Blinder, former Vice Chairman of the Federal Reserve Board of Governors, suggested some possibilities. He wrote in the Wall Street Journal on September 28th:
"To maintain the size of its balance sheet, the Fed has been reinvesting the proceeds in Treasurys. But starting "now" (the Fed's word), and continuing indefinitely, those proceeds will be reinvested in agency bonds and MBS instead. . . . A future round of quantitative easing (QE4?) that concentrates on private-sector securities like MBS, rather than on Treasurys, is now imaginable ... Indeed, if we indulge ourselves in a bit of blue-sky thinking, we can even imagine the Fed doing QEs in corporate bonds, syndicated loans, consumer receivables and so forth."
Syndicated consumer loans include asset-backed securities (ABS) of the sort purchased by the Fed through its Term Asset-backed Securities Loan Facility (TALF) created in November 2008. According to the Fed’s website, that includes securities backed by bundles of student loans.
Quantitative easing is a tool reserved for economic crises, and toxic student debt appears to be the next “black swan” on the horizon. Buying up a trillion dollars in student loans could be a nice stimulus package for the economy.
In July 2010, the New York Fed posted a staff report titled “Shadow Banking,” showing that the money supply had shrunk by about $4 trillion since the 2008 credit crisis. The shrinkage was hidden because it was not in the traditional banking system but was in the “shadow” banking system—an array of non-bank financial institutions including investment banks, hedge funds, money market funds, SIVs, conduits, and monoline insurers. Adding back a trillion dollars in student aid could go a long way toward curing this shortfall.
What this could do for the economy was suggested by the G.I. Bill, which provided free technical training and educational support, along with government-subsidized loans and unemployment benefits, for nearly 16 million returning servicemen. Economists have determined that for every 1944 dollar invested, the country received approximately $7 in return, through increased economic productivity, consumer spending, and tax revenues. The G.I. Bill not only made higher education accessible to all, but it created a nation of homeowners, new technology, new products, and new companies.
Eliminating, reducing, or deferring student loan debt will free up the budgets of millions of students, allowing them to spend more on goods and services, increasing demand and creating jobs, and adding to tax revenues. As long as the money is spent on goods and services rather than on financial money-making-money schemes, the result will not be inflationary. Retailers will just put in more orders for goods, causing producers to produce more and to hire more workers. Supply will rise along with demand, keeping prices stable. Overall prices will not increase until the country hits full employment, which is far from where we are today.
Interest-free Student Loans: Taking a Cue from Abroad
The government of New Zealand now offers zero percent loans to students, with repayment to be made from their income after they graduate; and so does the government of Australia. The loans in the Australian Higher Education Loan Programme (or HELP) do not bear interest, but the government gets back more than it lends, because the principal is indexed to the Consumer Price Index (CPI), which goes up every year. They are contingent loans, payable only if or when the borrower’s income reaches a certain level.
Assume, then, that the Fed bought up $1 trillion in U.S. student debt and waived the interest. With a
default rate even as high as 10 percent, it would get back $900 billion of this money. The $100 billion difference is only one-seventh the bailout money authorized by Congress to rescue Wall Street banks; and if the Fed’s investment generated anything close to the returns from the G.I. Bill, its $100 billion outlay could produce a several-hundred-billion dollar return.
To prevent abuse of the system, colleges should be required to stay within certain well-defined parameters for providing affordable, high quality education; and students should also meet well-defined standards. Properly monitored, a federal investment in higher education can be a win-win-win—good for the economy, the government, and the people. A generous student loan program will create jobs, increase tax revenues, and give young people a fair shot at the American dream, a dream that has become a mirage for 99 percent of the population.
Web of Debt