The hidden reason for the student loan crisis

It's no secret that the United States is slogging through a national student loan crisis. Of the more than $1.2 trillion worth of student debt, fully one third of the borrowers are in either default, deferment, or having payments postponed, according to a recent analysis by the Consumer Financial Protection Bureau.

The conventional wisdom is that mounting student debt loads will unleash an avalanche of bankruptcies for Generation Y. Sen. Elizabeth Warren (D-Mass.) — the architect of the CFPB — has been sounding the alarm for awhile, saying that it's morally wrong for the government to profit from its student loan programs.

"In other words, the game is still rigged to make the rich and powerful even more rich and powerful," Warren wrote in a Wednesday letter to her constituents. "And that means we've got more work to do to help make sure the next kid can get ahead and the kid after that and the kid after that."

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But much of the public debate — as framed by Warren and others — has revolved around a simplistic reading of a much more complex problem. The general assumption is that those who owe the most money are most likely to default. However, that stereotype gets undermined when the debt is examined state-by-state.

Buried in a May congressional report by the Joint Economic Committee was a largely overlooked analysis of student loans in different states. It found that recent graduates living in Vermont shouldered staggering debt loads equal to 82 percent of their average income. Their odds of spiraling into delinquency were almost half the national average. In Oklahoma, total student debt equaled just 55 percent of incomes, but amazingly one-out-of-five recent graduates are delinquent.

So, here's the theory on what's going on:

Student debt generally gets treated as an albatross on economic growth. When much of a paycheck goes to servicing a college education, there is less money to invest for retirement, save for a home down payment, or splurge on, say, a leather couch. More young people stay at home with their parents, or delay starting a family of their own.

This is how President Obama portrayed the danger recently, after signing a bill that ties interest rates on future loans subsidized by the government to the 10-year Treasury note.

"The cost of college remains extraordinarily high," Obama said. "It's out of reach for a lot of folks, and for those who do end up attending college, the amount of debt that young people are coming out of school with is a huge burden on them; it's a burden on their families. It makes it more difficult for them to buy a home. It makes it more difficult for them if they want to start a business. It has a depressive effect on the economy overall."

Obama essentially sees student debt as a problem that must be addressed to maximize economic potential years from now. His administration has offered plans to minimize the impact of debt for future borrowers, but not those who were unfortunate enough to graduate into the financial meltdown during 2007 and 2008.

But the political conversation about student debt only looks at half of the bigger picture, judging by the state data.

The bizarre nature of the student loan crisis is that — per Obama — it drags down future growth, but the chances of delinquency increase in the here and now because of the absence of rising wages and viable careers. It's a two-way street, a self-feeding cycle toward economic disaster. A stagnant local economy — where jobs options are sparse — appear to be driving the delinquency rates higher, which also constrains growth years from now.

Consider Vermont, the relatively happy chapter in this story.

For graduates in the class of 2011, 63 percent living in the Green Mountain State have loans. Their debt averaged $28,860. Incomes for Vermont graduates younger than 30 years old average a modest $35,074. Just 9.8 percent of recent graduates are delinquent, compared to a national average of 15.9 percent, according to the JEC report.

So Vermont grads owe more, earn less, but somehow are more likely to repay their debt. Here is the big wild card factor: the unemployment rate in Vermont is 4.4 percent, compared to 7.4 percent nationwide.

That same pattern can be found in Minnesota (5.2 percent unemployment), Montana (5.4 percent), North Dakota (3.1 percent), South Dakota (3.9 percent), Utah (4.7 percent), and Wisconsin (6.8 percent).

By contrast, California looks like a state where defaults should be rare based on recent graduate data. Slightly more than half of the class of 2011 graduated with debt that averaged $19,271 or $9,589 less than in Vermont. Golden State incomes for recent grads average $53,766, or $18,692 more than in Vermont.

But the delinquency rate in California is 16 percent among this group. Not surprisingly, the unemployment rate is 8.5 percent. A similarly raw deal exists for Mississippi (9 percent unemployment), Nevada (9.6 percent), and Rhode Island (8.9 percent).

Congressional staff economists pointed toward the unemployment rate as the likely deciding factor behind this phenomenon. But the conclusion is far from definitive, as other cultural forces may be at work.

Scott Giles, the executive director at Vermont Student Assistance Corporation (VSAC) offered several explanations for the paradox, starting with the obvious: past tuition expenses.

"The cost of college has always been higher here so students tend to have higher debt," Giles said.

Indeed, Vermont's public and private universities are some of the most expensive in the country. Just last month, U.S. News ranked the University of Vermont — which charges $35,582 per year — eighth on its 10 highest-priced public schools list.

What does seem apparent is that the federal government has yet to fully tackle the economic threats stemming from the dependence on student loans, particularly on the repayment issue. Its top program to reduce the monthly burden of student debt has gone unused.

Less than 10 percent of federal borrowers — about 40,000 — are enrolled in the federal income-based repayment plan, "Pay as You Earn," which, according to the CFPB, can lower payments to just 10 percent or less of annual income.

"If borrowers were aware of and able to easily enroll in income-based plans through their servicer, many federal student loan defaults could have been avoided," CFPB student loans ombudsman Rohit Chopra said in a blog post this month.

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