Student loans--another bubble waiting to burst?

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dogmatic slumber
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Student loans--another bubble waiting to burst?

Postby dogmatic slumber » Thu Jul 01, 2010 3:02 am

This topic has been touched on before, notably in a doomsday thread courtesy of TTTGrad, but I just came across a blog post by Judge Posner that got me thinking about it again. While Posner's talking specifically about for-profit colleges (U of Phoenix and the rest), the applicability of the following passage to all graduates ITE seems uncomfortably clear:

An alternative possibility, however, is that most of the people who attend a for-profit college understand the risk of failure but prefer to gamble on succeeding in obtaining a college degree and using the credential and what they have learned to obtain a much better job as a result—a job that will enable them to repay their loan and derive a net benefit from having borrowed it. (This is likewise a theory of why during the housing boom so many people took out adjustable rate mortgage loans, or home equity loans, that they could not “afford”—they were gambling, many with their eyes open.)

I'm struck by the latter underlined phrase because I've used it myself in discussing my law school plans with people. That's exactly how I conceive of what I'll be doing for the next three years: I'm gambling that I'll be good enough at law school exams to snag a $100k+ salary that will justify my having taken out $100k+ in loans. I know full well that the odds are against me, but I'm doing it anyway--gambling with my eyes open. And obviously it's not just law students who are in this boat; students in higher education are generally highly leveraged, and there aren't enough lucrative jobs to go around.

So what happens when, inevitably, a whole bunch of gamblers--law students and others--end up losing over the next few years? From what I can gather, student loans are routinely pooled into asset-backed securities and re-bundled into derivatives, just like mortgages. I'm guessing that a lot of the AAA-rated tranches of these financial products contain student loans, meaning mutual and pension funds (among other systemically important institutions) likely have a stake in our performance. Of course the analogy with mortgages isn't perfect, but still, it seems a wave of student-loan defaults could conceivably send another shock wave through the economy. I'm wondering how big that wave could be. Interested to see if anyone has thoughts on this.

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Kohinoor
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Re: Student loans--another bubble waiting to burst?

Postby Kohinoor » Thu Jul 01, 2010 3:08 am

dogmatic slumber wrote:This topic has been touched on before, notably in a doomsday thread courtesy of TTTGrad, but I just came across a blog post by Judge Posner that got me thinking about it again. While Posner's talking specifically about for-profit colleges (U of Phoenix and the rest), the applicability of the following passage to all graduates ITE seems uncomfortably clear:

An alternative possibility, however, is that most of the people who attend a for-profit college understand the risk of failure but prefer to gamble on succeeding in obtaining a college degree and using the credential and what they have learned to obtain a much better job as a result—a job that will enable them to repay their loan and derive a net benefit from having borrowed it. (This is likewise a theory of why during the housing boom so many people took out adjustable rate mortgage loans, or home equity loans, that they could not “afford”—they were gambling, many with their eyes open.)

I'm struck by the latter underlined phrase because I've used it myself in discussing my law school plans with people. That's exactly how I conceive of what I'll be doing for the next three years: I'm gambling that I'll be good enough at law school exams to snag a $100k+ salary that will justify my having taken out $100k+ in loans. I know full well that the odds are against me, but I'm doing it anyway--gambling with my eyes open. And obviously it's not just law students who are in this boat; students in higher education are generally highly leveraged, and there aren't enough lucrative jobs to go around.

So what happens when, inevitably, a whole bunch of gamblers--law students and others--end up losing over the next few years? From what I can gather, student loans are routinely pooled into asset-backed securities and re-bundled into derivatives, just like mortgages. I'm guessing that a lot of the AAA-rated tranches of these financial products contain student loans, meaning mutual and pension funds (among other systemically important institutions) likely have a stake in our performance. Of course the analogy with mortgages isn't perfect, but still, it seems a wave of student-loan defaults could conceivably send another shock wave through the economy. I'm wondering how big that wave could be. Interested to see if anyone has thoughts on this.
No.

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dogmatic slumber
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Re: Student loans--another bubble waiting to burst?

Postby dogmatic slumber » Thu Jul 01, 2010 3:18 am

Kohinoor wrote:No.


Say more about that.

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Re: Student loans--another bubble waiting to burst?

Postby Kohinoor » Thu Jul 01, 2010 3:28 am

dogmatic slumber wrote:
Kohinoor wrote:No.


Say more about that.

As you noted, mortgages aren't a great analogy to student loans. I'd suggest that they're such a poor analogy that that entire line of reasoning fails. Student loans are typically owed directly to the feds and are nondischargeable. The only way for a student loan to fail is for a bankruptcy court to forgive your loan in extraordinary circumstances or for you to leave the country forever or fake your death. Even if you refused to pay, they would directly garnish your wages. Unless a bill goes through making loans casually dischargeable in bankruptcy, securities backed by student loans seem quite solid.

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Na_Swatch
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Re: Student loans--another bubble waiting to burst?

Postby Na_Swatch » Thu Jul 01, 2010 3:43 am

dogmatic slumber wrote:
Kohinoor wrote:No.


Say more about that.


Translation: Student Loans = Nondischargeable = AAA+ Security for Lenders

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dogmatic slumber
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Re: Student loans--another bubble waiting to burst?

Postby dogmatic slumber » Thu Jul 01, 2010 4:03 am

Kohinoor wrote:Student loans are typically owed directly to the feds and are nondischargeable.


The finer points of student loans are admittedly above my pay grade, but Wikipedia says that Sallie Mae (which had its governmental ties severed in 2004) is the largest originator of federally insured student loans. Other major lenders include Bank of America and JPMorgan Chase. Also, with securitization generally, it's hard to say who's "owed directly," though I don't know how it works in the specific case of student loans. Presumably (as with mortgages) the loans would be bundled into a pool held by an institution like the ones mentioned here, and securities issued whose returns are dependent on the performance of the loans in the pool, thus shifting the risk of default from the holder of the pool to investors in the securities, and allowing the loan-originating institutions to make more loans. That's the magic of securitization. It's a lot more complicated than students making loan payments to the government (though again I do not know the specific details of student-loan securitization and may be missing some crucial ones).

Re: the nondischargability of student loans, agreed, but the issue for securitized debt generally is loan performance, i.e. whether debtors are making their payments. If they stop paying en masse in a doomsday scenario, that security you bought stops yielding anything (which is where credit-default swaps come in, incidentally). So if a bunch of indebted students are unable to make their loan payments, a whole big bunch of debt-market investors (and swap providers) might be on the hook. That is what happened during the housing crisis, at any rate, and I think it's a live question whether something similar, though presumably on a much smaller scale, could happen here.

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Kohinoor
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Re: Student loans--another bubble waiting to burst?

Postby Kohinoor » Thu Jul 01, 2010 5:27 am

dogmatic slumber wrote:
Kohinoor wrote:Student loans are typically owed directly to the feds and are nondischargeable.


The finer points of student loans are admittedly above my pay grade, but Wikipedia says that Sallie Mae (which had its governmental ties severed in 2004) is the largest originator of federally insured student loans. Other major lenders include Bank of America and JPMorgan Chase. Also, with securitization generally, it's hard to say who's "owed directly," though I don't know how it works in the specific case of student loans. Presumably (as with mortgages) the loans would be bundled into a pool held by an institution like the ones mentioned here, and securities issued whose returns are dependent on the performance of the loans in the pool, thus shifting the risk of default from the holder of the pool to investors in the securities, and allowing the loan-originating institutions to make more loans. That's the magic of securitization. It's a lot more complicated than students making loan payments to the government (though again I do not know the specific details of student-loan securitization and may be missing some crucial ones).

Re: the nondischargability of student loans, agreed, but the issue for securitized debt generally is loan performance, i.e. whether debtors are making their payments. If they stop paying en masse in a doomsday scenario, that security you bought stops yielding anything (which is where credit-default swaps come in, incidentally). So if a bunch of indebted students are unable to make their loan payments, a whole big bunch of debt-market investors (and swap providers) might be on the hook. That is what happened during the housing crisis, at any rate, and I think it's a live question whether something similar, though presumably on a much smaller scale, could happen here.
But as noted above, the only doomsday scenario where they could stop paying would be pretty much actual doomsday. I really don't think it's a live question at all. Answer me this. What would you need to do if, tomorrow, you didn't want to pay your student loans anymore?

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Re: Student loans--another bubble waiting to burst?

Postby Na_Swatch » Thu Jul 01, 2010 6:03 am

dogmatic slumber wrote:
Kohinoor wrote:Student loans are typically owed directly to the feds and are nondischargeable.


The finer points of student loans are admittedly above my pay grade, but Wikipedia says that Sallie Mae (which had its governmental ties severed in 2004) is the largest originator of federally insured student loans. Other major lenders include Bank of America and JPMorgan Chase. Also, with securitization generally, it's hard to say who's "owed directly," though I don't know how it works in the specific case of student loans. Presumably (as with mortgages) the loans would be bundled into a pool held by an institution like the ones mentioned here, and securities issued whose returns are dependent on the performance of the loans in the pool, thus shifting the risk of default from the holder of the pool to investors in the securities, and allowing the loan-originating institutions to make more loans. That's the magic of securitization. It's a lot more complicated than students making loan payments to the government (though again I do not know the specific details of student-loan securitization and may be missing some crucial ones).

Re: the nondischargability of student loans, agreed, but the issue for securitized debt generally is loan performance, i.e. whether debtors are making their payments. If they stop paying en masse in a doomsday scenario, that security you bought stops yielding anything (which is where credit-default swaps come in, incidentally). So if a bunch of indebted students are unable to make their loan payments, a whole big bunch of debt-market investors (and swap providers) might be on the hook. That is what happened during the housing crisis, at any rate, and I think it's a live question whether something similar, though presumably on a much smaller scale, could happen here.


lol I guess i shouldn't expect an understanding of economic principles on a law school board but the main cause of the subprime mortgage crisis is exactly the words "subprime":

These loans were given to risky creditors, packaged in ways that supposedly gave them better credit ratings, and then sold to vast amounts of investors (and insured in very sketchy and unrealistic manner)....

What happens? Bubble pops, the truth comes out, defaults start occurring, and the ratings on the loans cave massively leading to a vicious cycle where rapidly dropping assets with declining ratings require larger cash assets to be kept on hand by major financial institutions...

Completely impossible situation for student loans with their permanence and protection against defaults.. theres no way student loans could ever become "subprime" or drop in ratings to junk status.

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Unitas
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Re: Student loans--another bubble waiting to burst?

Postby Unitas » Thu Jul 01, 2010 8:00 am

Na_Swatch wrote:
dogmatic slumber wrote:
Kohinoor wrote:Student loans are typically owed directly to the feds and are nondischargeable.


The finer points of student loans are admittedly above my pay grade, but Wikipedia says that Sallie Mae (which had its governmental ties severed in 2004) is the largest originator of federally insured student loans. Other major lenders include Bank of America and JPMorgan Chase. Also, with securitization generally, it's hard to say who's "owed directly," though I don't know how it works in the specific case of student loans. Presumably (as with mortgages) the loans would be bundled into a pool held by an institution like the ones mentioned here, and securities issued whose returns are dependent on the performance of the loans in the pool, thus shifting the risk of default from the holder of the pool to investors in the securities, and allowing the loan-originating institutions to make more loans. That's the magic of securitization. It's a lot more complicated than students making loan payments to the government (though again I do not know the specific details of student-loan securitization and may be missing some crucial ones).

Re: the nondischargability of student loans, agreed, but the issue for securitized debt generally is loan performance, i.e. whether debtors are making their payments. If they stop paying en masse in a doomsday scenario, that security you bought stops yielding anything (which is where credit-default swaps come in, incidentally). So if a bunch of indebted students are unable to make their loan payments, a whole big bunch of debt-market investors (and swap providers) might be on the hook. That is what happened during the housing crisis, at any rate, and I think it's a live question whether something similar, though presumably on a much smaller scale, could happen here.


lol I guess i shouldn't expect an understanding of economic principles on a law school board but the main cause of the subprime mortgage crisis is exactly the words "subprime":

These loans were given to risky creditors, packaged in ways that supposedly gave them better credit ratings, and then sold to vast amounts of investors (and insured in very sketchy and unrealistic manner)....

What happens? Bubble pops, the truth comes out, defaults start occurring, and the ratings on the loans cave massively leading to a vicious cycle where rapidly dropping assets with declining ratings require larger cash assets to be kept on hand by major financial institutions...

Completely impossible situation for student loans with their permanence and protection against defaults.. theres no way student loans could ever become "subprime" or drop in ratings to junk status.


Student loans are naturally subprime loans. They are given to students who usually have little to no credit history (they don’t even take score into consideration, only no defaults), make no money, and liabilities are much greater than assets. However, this risk is mitigated somewhat by not being able to discharge the loans. However, the subprime mortgage crisis occurred well before most (possibly all) mortgages were discharged in bankruptcy (most were still current also). The credit squeeze (calls for collateral and such) occurred when investors realized the loans were given to subprime borrowers and the risk was much higher than previously assumed (stupid ratings agencies with AA and better ratings). This could occur in private student loans, but the government has taken steps to try and make loans public to ensure effective lending.

What protection against default? Their is a protection against discharging the loans, but not against default.

It should also be noted that there is a good chance of the government stepping in and changing the way student loans work at all levels and making them dischargeable. This is a huge risk for private lenders and holders of student loans. Once that risk is noted it could cause a problem.

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Re: Student loans--another bubble waiting to burst?

Postby Anonymous Loser » Thu Jul 01, 2010 8:05 am

dogmatic slumber wrote:
Kohinoor wrote:Student loans are typically owed directly to the feds and are nondischargeable.


The finer points of student loans are admittedly above my pay grade, but Wikipedia says that Sallie Mae (which had its governmental ties severed in 2004) is the largest originator of federally insured student loans. Other major lenders include Bank of America and JPMorgan Chase. Also, with securitization generally, it's hard to say who's "owed directly," though I don't know how it works in the specific case of student loans.


As the result of legislation passed earlier this year, private lenders no longer originate federal student loans. Indeed, private lenders now play no part in federal student lending whatsoever. These legislative changes to the federal student loan program received significant media coverage. Accordingly, citing to a four-year old wire-service article is not particularly helpful or persuasive.

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Re: Student loans--another bubble waiting to burst?

Postby CG614 » Thu Jul 01, 2010 8:47 am

Equating student loans to the sub-prime bubble is a horrible parallel to draw. First, you have to fully understand this recent crisis to see how it does not work. The mortgages were being collateralized, which means they were being lumped together and sold off to investors as securities. They were being rated as whole package, getting a AAA rating, and then sold off in tranches. The tranches ranged from the solid loans down to the crappy sub-prime ones. Since the sub-prime tranche was part of the greater package, it had the AAA rating. This avenue to sell off the loans, and essentially the risk, allowed the banks to make more and more loans. Once the banks realized that the risk was not wholly theirs, they started making riskier and riskier loans. All this was done with the caveat that housing prices would continue to rise, so if a sub-prime borrower defaulted, the bank and the securities holder would get back most of their money in foreclosure. Well, when the housing market prices stalled, at first there was not much of a drop, it caused this whole model to go out of whack. Things got worse from there and the bubble popped.

Now, student loans have a bunch of features that are very unique and make a similar "bubble burst" unlikely. First, there are a finite number of student loans that can be made. The limit is the population of students. Second, there are no speculators in this market. People cannot take out college loans solely to speculate that the prices of degrees will rise. Calling someone that gets a degree a speculator is highly off base. Now, do some students make bad decisions to take out loans for degrees that will not pay off? Yes. Will this ever come to the point where the market for student loans will collapse. Highly unlikely. Even if someone is straddled with student loan debt and can't find a job, they still have an asset in their degree and they can consolidate loans and lengthen the terms of the loan to lessen their monthly debt burden. Some people will get burned by the bad decisions to take out educational loans, no doubt, but this is hardly a market that will burst.

Note: This is obviously a very brief overview of what happened, there are many more aspects to the crisis.

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Re: Student loans--another bubble waiting to burst?

Postby BaronDetroit » Thu Jul 01, 2010 9:43 am

I think eventually student loans will be dischargeable in bankruptcy. I believe the Supreme Court already made one such ruling.

Mortgages have real collateral and housing is very important to all of society. Student loans are more like credit cards. I think there will be a considerable increase in defaults, but that should not be too big of a deal. When you give a law student 3 years of free tuition, free rent, free food, etc etc- it just seems very risky to give a person like that with no track record 40 or 50 thousand bucks a year.

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Re: Student loans--another bubble waiting to burst?

Postby Kohinoor » Thu Jul 01, 2010 11:21 am

Image
Pretty sure this was a troll thread.

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dogmatic slumber
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Re: Student loans--another bubble waiting to burst?

Postby dogmatic slumber » Thu Jul 01, 2010 3:34 pm

Kohinoor wrote:But as noted above, the only doomsday scenario where they could stop paying would be pretty much actual doomsday. I really don't think it's a live question at all. Answer me this. What would you need to do if, tomorrow, you didn't want to pay your student loans anymore?


...? As Unitas put it, "What protection [is there] against default? Their is a protection against discharging the loans, but not against default." I think that's what's tripping you up, because default is what matters for securitized debt. Granted, as long as I stay in the country those loans will stay with me--but if I can't pay for the next five years for whatever reason, an asset-backed security whose pool includes my student loan loses an incremental piece of its value (because its value, or its return to investors, is based on debtors making their payments). Now, tranching is supposed to insulate AAA-only investors from little blips like this: the "junior tranches" are bought by high-risk investors (hedge funds and the like) and don't yield their returns until all of the "senior tranches" have been paid. So if the senior/junior split of a given ABS is 70/30, then the security would have to lose 30% of its value before holders of senior tranches would be hurt. What happened in the housing crisis was that a whole lot of mortgages stopped performing--more than most risk managers (who believed the tranching system would adequately protect low-risk investors) thought possible--and so mortgage-backed securities and their derivatives started hemorrhaging. How is it not a live question whether something similar could happen with ABS collateralized by student loans?

Unitas wrote:The credit squeeze (calls for collateral and such) occurred when investors realized the loans were given to subprime borrowers and the risk was much higher than previously assumed (stupid ratings agencies with AA and better ratings).


Yes, it became apparent (in fact had been apparent for a while) that the entire financial sector was over-exposed to mortgage-backed securities and their associated products, i.e. was surfing along atop the housing bubble. So one question here is whether there is any kind of similar over-exposure now to student-loan-backed securities. Probably not, but I don't know. There's a lot of student loans out there, and they've been a primary source of collateral for ABS.

AnonymousLoser wrote:As the result of legislation passed earlier this year, private lenders no longer originate federal student loans. Indeed, private lenders now play no part in federal student lending whatsoever.


You seem to be right, and I hadn't heard about this. But private lenders still originate private student loans (as most of us here know very well), and federal loans through private lenders from past years continue to populate (though to what extent, none of us seems to know) collateral pools that underlie various securities. So, going forward, private student loans will continue to be added to the pile of securitized debt, and past federal loans from private lenders will continue to be part of that pile until they're paid off (or not). It's not like the potential problem I'm describing here just evaporated with the new legislation.

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dogmatic slumber
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Re: Student loans--another bubble waiting to burst?

Postby dogmatic slumber » Thu Jul 01, 2010 3:38 pm

Kohinoor wrote:Pretty sure this was a troll thread.


Pretty sure--due respect--you don't really know what you're talking about.

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Re: Student loans--another bubble waiting to burst?

Postby sundevil77 » Thu Jul 01, 2010 4:00 pm

I get what your saying, dogmatic slumber, and I think it's a fair question. However, I think the scenario in which serious economic shockwaves could occur is highly unlikely.

First, jobs would have to be practically non-existent. We're not talking about the current situation in which maybe 20-30% of law students can't find jobs (or choose to not be employed in jobs they don't want). One large class of student debtors, med students, doesn't even have the same problems as law students do. So really, I think jobs for grads would have to cease. Additionally, I think many more students would have to decide to take out these loans. Think about how many people owned a home with a mortgage before this last bubble. Close to 70%? I don't think the percentage of people with student loans will ever approach that number.

At the end of the day, the people left holding the bag are going to be the X% of students ("gamblers") that lose the bet. We have plenty of them that post on TLS. I think most people, at least on TLS, are well aware of the risk involved, but we are all willing to take it. The real people we should pity are the thousands of gamblers that make the bet without knowing what they're getting into.

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dogmatic slumber
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Re: Student loans--another bubble waiting to burst?

Postby dogmatic slumber » Thu Jul 01, 2010 4:07 pm

CG614 wrote:Equating student loans to the sub-prime bubble is a horrible parallel to draw. First, you have to fully understand this recent crisis to see how it does not work. The mortgages were being collateralized, which means they were being lumped together and sold off to investors as securities. They were being rated as whole package, getting a AAA rating, and then sold off in tranches. The tranches ranged from the solid loans down to the crappy sub-prime ones. Since the sub-prime tranche was part of the greater package, it had the AAA rating.

Incorrect. The senior tranches (discussed above) got the AAA-rating and first dibs on the yield; the junior tranches, which contained the riskiest loans and got paid out last (but at a higher yield), did not, and they were supposed to be the cushion that protected cautious senior-tranche investors like mutual funds and pension funds (often required to invest only in AAA-rated products) in the event of a wave of defaults. Unless that wave got real big.

CG614 wrote:All this was done [on the assumption] that housing prices would continue to rise, so if a sub-prime borrower defaulted, the bank and the securities holder would get back most of their money in foreclosure.

And from the home-buyer's perspective, crucially, the same assumption made highly risky mortgages seem sensible, because if the house is going to appreciate by 40% within 3 years (i.e. before funky stuff starts happening with that adjustable rate or whatever), you can take that equity that just landed in your lap and refinance at more reasonable terms. Getting back to the original issue, the logic is similar to that employed by law students and others: "Lucrative jobs will continue to be available to graduates, so taking on this enormous debt load actually makes sense." And there's bound to be a similar fallout when that premise stops being true. Question is what the systemic ramifications will be.

CG614 wrote:Now, student loans have a bunch of features that are very unique and make a similar "bubble burst" unlikely. First, there are a finite number of student loans that can be made. The limit is the population of students.

Okay, but (1) one student may take out multiple loans (trust me), and (2) aren't there also a finite number of home-buyers?

CG614 wrote:Second, there are no speculators in this market. People cannot take out college loans solely to speculate that the prices of degrees will rise. Calling someone that gets a degree a speculator is highly off base.

Agreed on the first part. But I didn't call indebted students speculators; I called them gamblers. And ITE, that's exactly what we are.

CG614 wrote:Even if someone is straddled with student loan debt and can't find a job, they still have an asset in their degree and they can consolidate loans and lengthen the terms of the loan to lessen their monthly debt burden. Some people will get burned by the bad decisions to take out educational loans, no doubt, but this is hardly a market that will burst.

I hope you're right, but these days there are a lot of degrees that are pretty questionable as assets. Also, any debt burden might be too much for someone who doesn't have a job.

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dogmatic slumber
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Re: Student loans--another bubble waiting to burst?

Postby dogmatic slumber » Thu Jul 01, 2010 4:14 pm

sundevil77 wrote:I get what your saying, dogmatic slumber, and I think it's a fair question. However, I think the scenario in which serious economic shockwaves could occur is highly unlikely.

First, jobs would have to be practically non-existent. We're not talking about the current situation in which maybe 20-30% of law students can't find jobs (or choose to not be employed in jobs they don't want). One large class of student debtors, med students, doesn't even have the same problems as law students do. So really, I think jobs for grads would have to cease. Additionally, I think many more students would have to decide to take out these loans. Think about how many people owned a home with a mortgage before this last bubble. Close to 70%? I don't think the percentage of people with student loans will ever approach that number.


Yeah, this is basically my gut feeling too. To the extent that there's a student loan bubble, it's not likely to pose anything like the systemic threat of the housing bubble. I'd like to hear an economist parse the differences though; there's some interesting stuff going on here in any case.

sundevil77 wrote:At the end of the day, the people left holding the bag are going to be the X% of students ("gamblers") that lose the bet. We have plenty of them that post on TLS. I think most people, at least on TLS, are well aware of the risk involved, but we are all willing to take it. The real people we should pity are the thousands of gamblers that make the bet without knowing what they're getting into.


Well, I think we should pity the people who end up losing the bet. Hopefully our knowing what we're getting into makes us less likely to be on the losing side.

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Re: Student loans--another bubble waiting to burst?

Postby Na_Swatch » Thu Jul 01, 2010 4:15 pm

Unitas wrote:
Na_Swatch wrote:
dogmatic slumber wrote:
Kohinoor wrote:Student loans are typically owed directly to the feds and are nondischargeable.


The finer points of student loans are admittedly above my pay grade, but Wikipedia says that Sallie Mae (which had its governmental ties severed in 2004) is the largest originator of federally insured student loans. Other major lenders include Bank of America and JPMorgan Chase. Also, with securitization generally, it's hard to say who's "owed directly," though I don't know how it works in the specific case of student loans. Presumably (as with mortgages) the loans would be bundled into a pool held by an institution like the ones mentioned here, and securities issued whose returns are dependent on the performance of the loans in the pool, thus shifting the risk of default from the holder of the pool to investors in the securities, and allowing the loan-originating institutions to make more loans. That's the magic of securitization. It's a lot more complicated than students making loan payments to the government (though again I do not know the specific details of student-loan securitization and may be missing some crucial ones).

Re: the nondischargability of student loans, agreed, but the issue for securitized debt generally is loan performance, i.e. whether debtors are making their payments. If they stop paying en masse in a doomsday scenario, that security you bought stops yielding anything (which is where credit-default swaps come in, incidentally). So if a bunch of indebted students are unable to make their loan payments, a whole big bunch of debt-market investors (and swap providers) might be on the hook. That is what happened during the housing crisis, at any rate, and I think it's a live question whether something similar, though presumably on a much smaller scale, could happen here.


lol I guess i shouldn't expect an understanding of economic principles on a law school board but the main cause of the subprime mortgage crisis is exactly the words "subprime":

These loans were given to risky creditors, packaged in ways that supposedly gave them better credit ratings, and then sold to vast amounts of investors (and insured in very sketchy and unrealistic manner)....

What happens? Bubble pops, the truth comes out, defaults start occurring, and the ratings on the loans cave massively leading to a vicious cycle where rapidly dropping assets with declining ratings require larger cash assets to be kept on hand by major financial institutions...

Completely impossible situation for student loans with their permanence and protection against defaults.. theres no way student loans could ever become "subprime" or drop in ratings to junk status.


Student loans are naturally subprime loans. They are given to students who usually have little to no credit history (they don’t even take score into consideration, only no defaults), make no money, and liabilities are much greater than assets. However, this risk is mitigated somewhat by not being able to discharge the loans. However, the subprime mortgage crisis occurred well before most (possibly all) mortgages were discharged in bankruptcy (most were still current also). The credit squeeze (calls for collateral and such) occurred when investors realized the loans were given to subprime borrowers and the risk was much higher than previously assumed (stupid ratings agencies with AA and better ratings). This could occur in private student loans, but the government has taken steps to try and make loans public to ensure effective lending.

What protection against default? Their is a protection against discharging the loans, but not against default.

It should also be noted that there is a good chance of the government stepping in and changing the way student loans work at all levels and making them dischargeable. This is a huge risk for private lenders and holders of student loans. Once that risk is noted it could cause a problem.


Yeah it was late and I was being brief, but the basic gist is that subprime mortgages collapsed due to the inherent discrepancy between their ratings and their reality, leading to the cash squeeze.

Bottom Line: this isn't happening to student loans, and won't be happening anytime soon, hence no student loan bubble.

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dogmatic slumber
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Re: Student loans--another bubble waiting to burst?

Postby dogmatic slumber » Thu Jul 01, 2010 4:38 pm

Na_Swatch wrote:Yeah it was late and I was being brief, but the basic gist is that subprime mortgages collapsed due to the inherent discrepancy between their ratings and their reality, leading to the cash squeeze.

Bottom Line: this isn't happening to student loans, and won't be happening anytime soon, hence no student loan bubble.


The initial hiccup in the subprime market was in 2007 when the first significant wave of borrowers started having trouble servicing their mortgages. That's what got the dominoes falling. The "reality" of subprime mortgages was that they were sensible propositions as long as housing prices continued to rise. The analogy with student loans ITE, however imperfect, is clear enough.

maquih
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Re: Student loans--another bubble waiting to burst?

Postby maquih » Sun Jul 25, 2010 5:22 pm

Actually the bubble has already burst. I have a friend who works at Citibank and securitized student loan packages are trading anywhere from 25-50 cents on the dollar.... They prices crashed just like subprime mortgages 3Q 2009.

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chicagolaw2013
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Re: Student loans--another bubble waiting to burst?

Postby chicagolaw2013 » Tue Jul 27, 2010 12:47 am

Kohinoor wrote:
dogmatic slumber wrote:
Kohinoor wrote:Student loans are typically owed directly to the feds and are nondischargeable.


The finer points of student loans are admittedly above my pay grade, but Wikipedia says that Sallie Mae (which had its governmental ties severed in 2004) is the largest originator of federally insured student loans. Other major lenders include Bank of America and JPMorgan Chase. Also, with securitization generally, it's hard to say who's "owed directly," though I don't know how it works in the specific case of student loans. Presumably (as with mortgages) the loans would be bundled into a pool held by an institution like the ones mentioned here, and securities issued whose returns are dependent on the performance of the loans in the pool, thus shifting the risk of default from the holder of the pool to investors in the securities, and allowing the loan-originating institutions to make more loans. That's the magic of securitization. It's a lot more complicated than students making loan payments to the government (though again I do not know the specific details of student-loan securitization and may be missing some crucial ones).

Re: the nondischargability of student loans, agreed, but the issue for securitized debt generally is loan performance, i.e. whether debtors are making their payments. If they stop paying en masse in a doomsday scenario, that security you bought stops yielding anything (which is where credit-default swaps come in, incidentally). So if a bunch of indebted students are unable to make their loan payments, a whole big bunch of debt-market investors (and swap providers) might be on the hook. That is what happened during the housing crisis, at any rate, and I think it's a live question whether something similar, though presumably on a much smaller scale, could happen here.
But as noted above, the only doomsday scenario where they could stop paying would be pretty much actual doomsday. I really don't think it's a live question at all. Answer me this. What would you need to do if, tomorrow, you didn't want to pay your student loans anymore?


I'm waiting for 2012 to make all of my outstanding loans null and void. 8) :mrgreen:

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soaponarope
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Re: Student loans--another bubble waiting to burst?

Postby soaponarope » Tue Aug 10, 2010 3:10 am

If you begin to see the recent J.D.'s robbing banks, then you can worry... Till then, STFU, cause it ain't happenin. "."

Renzo
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Re: Student loans--another bubble waiting to burst?

Postby Renzo » Tue Aug 10, 2010 5:54 am

ITT: a lot of really long posts by people who don't really understand what they are talking about.

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vanwinkle
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Re: Student loans--another bubble waiting to burst?

Postby vanwinkle » Tue Aug 10, 2010 8:17 am

What the hell are people trying to say when they talk about "defaulting" on a student loan? It's not like a mortgage, you can't just stop paying and walk away. They WILL get their money, even if they have to garnish your wages--the only way to avoid paying altogether is to willfully adopt a lifestyle of poverty so you don't earn money for them to take.

The standards for discharging student loans in bankruptcy is pretty high, too; you have to convince a court that you've made all reasonable efforts to pay, you can't afford to pay, AND your circumstances are such that they shouldn't expect you to be able to start paying for a long time. It's an incredibly high standard, and if you can't meet it, you can't get rid of that debt. It stays with you, for the rest of your life if necessary.

Also, failure to pay debts can get you disbarred. Bar associations frown heavily on people who can't manage their own money for a host of reasons, not the least of which is that you can't be trusted to handle other people's money if you can't handle your own.

There's a rather famous example of someone trying to walk away from their debt, and between the loans, late fees, and default charges, ended up owing over $400K. He was denied admission to the bar. So, even if you think "not paying" is a solution, thr legal profession at least has a counteroffer: Fine, but you can't be a lawyer.




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