Bond Investors Starting to Dump U.S. Student Loan Debt as Too Risky

U.S. student loan debt has now become so risky that some bond traders are starting to dump it. The New York Federal Reserve estimated the amount of U.S. student loan debt at $1.2 trillion and raised concerns that it constitutes a “long-term threat to consumer spending.”

If that was not bad enough, rating firms Moody’s and Fitch are considering dropping the credit ratings on some student loan backed bonds, The Financial Times reported. Those bonds are currently rated at around AAA, but that could change on September 7, when Moody’s will tell reporters whether it will change its ratings methodology for the bonds or not.

The ratings firm of the Big Three, along with Fitch and Standard & Poor’s (S&P), is considering changing methodology because of the greater number of loans with income-based repayments. That means it will take longer to get the loans paid off and increase the chance they’ll never get repaid. That could lead to a downgrading of bonds issued by the Federal Family Education Loan Program, or FFELP.

Student Loans on Shaky Ground

The FFELP loans make up a small percentage of the total amount of student loans, but they show how shaky the whole market is. Part of the pressure for downgrading is driven by uncertainty.

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One creator of uncertainty is the election, in which would-be Democratic presidential candidates Bernie Sanders and Hillary Clinton have proposed schemes for federally funded college tuition and student loan forgiveness. Sanders and Clinton have gotten aggressive on student loans because they both need the votes of younger voters to win the election.

Investors are obviously afraid that some sort of debt forgiveness, which means some of the student loans could never be repaid, is on the horizon. Some protesters are already demanding the forgiveness of all student loan debt.

Private Colleges Make Matters Worse

Another source of pressure is the so-called private universities, which are increasingly being criticized for issuing questionable or worthless degrees paid for by loans. There is growing pressure to crack down on such institutions. Such a crackdown could expose some of them as frauds, leading to even more defaults.

Federal lawsuits and congressional investigations have targeted a number of institutions, including the University of Phoenix and DeVry University, The New York Times reported. The issue has even been raised on the presidential campaign trail; Clinton has promised to crack down on predatory colleges, while Republicans are attacking the Democrat front runner for her husband Bill’s links to a private college operator called Laureate Education.

At least one private college company, Corinthian Colleges, which operated Everest University, declared bankruptcy and imploded in May. The Miami Herald reported that several presidential candidates, including Clinton, Marco Rubio and Jeb Bush, have a history of taking money from private college operators.

Another candidate, Donald Trump, ran his own for-profit business school, the now defunct Trump University. Reuters reported that a number lawsuits, including one brought by New York Attorney General Eric Schneiderman, allege that Trump University was nothing but a scam. Trump contends that the suits were nothing but a scam.

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Loan servicers like Navient are also nervous about the bonds; The Financial Times reported that the servicer has repurchased more than $428 million worth of loans, possibly to boost the market. It could be planning to buy back more loans in the future.

Subprime Student Loans

It looks as if a student loan meltdown could be imminent. That could be bad news for the economy because the amount of student loans in the United States now exceeds the amount of credit card debt.

There is around $1.2 trillion in student loan debt compared to $901 billion in credit card debt, NerdWallet reported. It is not clear how much of that debt is in loans for private college students or questionable degrees, the student loan equivalent of subprime mortgages, but the amount could be high, making the market shaky.

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The situation is particularly dangerous because unlike credit card debt, student loan obligations cannot be extinguished through bankruptcy. That weighs down the entire economy and could lead to a situation in which large numbers of Americans are underwater.

One thing is certain: This crisis is not likely to go away anytime soon and is likely to get worse. Our political leaders are going to have to deal with this nightmare whether they want to or not.