With student loan debt officially reaching the trillions, the U.S. Executive Branch, the Consumer Financial Protection Bureau and the general public are worried about the effect of this massive debt on the American economy — and they should be.
This marketplace propels itself forward by issuing more and more student loans, both federal and private, that lead to ever-increasing tuition costs and, in turn, a higher risk that student borrowers will be unable to satisfy their debt. I often see this crisis compared to that of the 2008 subprime mortgage meltdown, but the truth is the student loan crisis has the potential to be far worse.
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Because the majority of these loans are non-dischargeable in bankruptcy court, these students have walked straight into a debtor's prison — a prison fortified with the long-term trend of tuitions rising faster than inflation, lowering employment rates for graduates and stagnant real wage growth.
It goes unsaid that these combined factors carry severe macro-economic implications, as President Barack Obama implied when he announced a student loan relief plan expected to affect 5 million borrowers. While the plan will help alleviate debtor pain in the short term, the long-term implications could cause future students to believe that student loan debt can be taken lightly, leading to even more loans issued and, in turn, higher tuitions due to inelastic demand.
Instead of limiting relief to short-term subsidies, I believe that holistic financial planning would provide more benefits in the long term. Indebted young professionals require an integrated approach that addresses both assets and liabilities, focusing specifically on the critical decisions and strategies that will have the greatest financial impact. Provide advice and support to minimize the cost of student loan debt, increase liquidity through payment relief as needed and save clients time so they can focus on their careers are critical. On the other side of the balance sheet, these clients need help determining if they are in a position to utilize discretionary funds for investments, savings or paying down premium debts.
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It is disingenuous to compare student loans in aggregate to other securitized products, such as subprime or credit card debt, because there are vastly different categories within this asset class, from federal loans to floating rate private loans to fixed rate consolidation loans. They are also made up of very different types of borrowers. The only comparison I could draw to the subprime crisis is the borrower behavior in that the vast majority of borrowers still view this as an easy way to finance education without fully understanding the potential ROI (or lack thereof).
INVESTOR OPPORTUNITIES
While certain aspects of the student loan marketplace are not directly available to individual investors, there are viable opportunities for investors if approached in the correct manner.
Due to the nationalization of federal loans, private loans make up the bulk of the investment universe for recent vintages. Private student loans provide a premium over LIBOR or prime in both fixed and floating rate structures. They also may give some prospective investors a potentially false degree of confidence because they offer full recourse and are not dischargeable through bankruptcy.
Investors may participate in the space by investing in funds holding student loan assets but these vehicles are typically reserved for institutions or accredited investors. Another more recent opportunity is lending directly to students and graduates through peer-to-peer and community-based models. That said, investors need to complete their due diligence and vet borrower profiles, vintages and the loan servicing company track record prior to investing. The student loan crisis is far from being eradicated or even mitigated on a macro-economic level, but the marketplace can be beneficial if navigated correctly.
John Collins is the managing director of GL Advisor, a Boston-based financial advisory firm that addresses the needs of young professionals with advanced degrees.
