Resumption of Student Loan Service to Have Limited Macro Impact

Summary

• Only one in six American adults has a student loan, representing about 1% of total household net worth.
• After the administration’s new income-driven repayment plan, debt service could represent less than 0.5% of all household income.
• With excess savings still substantial, the resumption of debt service payment does not appear a major source of downside risk to growth.

Market Implications

• The Fed and markets are overestimating 2024 rate cuts.

Only One in Six Americans Has a Student Loan

Recently, there have been two student loans-related hits to household wealth and disposable income. First is the Supreme Court striking down the administration’s debt forgiveness plans. Second is the debt ceiling agreement stipulating that servicing of student loans must restart in October.

These have received much publicity, possibly because of the borrowers’ demographics (skewed young and educated). Since about 75% of college graduates take on Federal student loans, the share of professionals, including media professionals, who are indebted is likely high.

The data, however, shows the macroeconomic impact will likely be limited. Only one in six adult Americans owes student debt (Table 1). The Fed SHEDs (Surveys of Household Economics and  Decisionmaking) shows only 15% of households report having student loans!

Student Debt Equals 1% of Total Household Net Wealth

The 2022 Fed SHED revealed that 55% of the respondents expected their student loans to be forgiven. Also, 83% of the respondents planned to use the proceeds of any forgiveness to repay debt or save. Only 10% planned to use the proceeds to buy a house, and 7% planned to spend ‘on other things’.

Furthermore, student debt represents only 9% of all households’ debts and 1% of all households’ net worth (Table 1). And since the GFC, the positive relationship between household net worth and the propensity to consume (the ratio of consumption to income) has broken down (Chart 1).

This suggests only a limited wealth effect from cancelling the administration’s planned debt forgiveness.

That said, debtors must resume debt payments in October and, for many, it will be painful.  On aggregate, though, we expect limited macro impact.

Student Debt Service Under 0.5% of Income

Fed data shows consumer debt service represents 6% of disposable income and student debt a third of consumer debt (Chart 2). 

Assuming student loans carry the same interest rate and maturity as other consumer debt, this suggests average annual debt service of about $370 for all households and $2,500 for households that have student loans (15% of all households).

In reality, student loans carry different terms from other consumer debt. For instance, non-student consumer debt is a mix of revolving and non-revolving credit. Revolving credit has no set schedule for repayment. Also, interest rates on student loans, equal to 10yr yields plus a margin of 2.0-4.6%, tend to be lower than on other forms of consumer debt.

However, an alternative estimate of debt service payments, based on the Fed SHED survey, yields annual payments of roughly the same order, $2,650 (Appendix details the calculations; Table 2).

Regardless, following the Supreme Court cancellation of debt forgiveness, the administration has announced a new, income-driven repayment plan (IDR) that is likely to halve debt service payments. The CBO estimates the cost of this program at $230bn over 2023-33.

The new IDR is likely to be challenged in court but is less vulnerable than the debt forgiveness plan. This is because the forgiveness plan was based on the HEROES Act, a 9/11 era law that allowed the administration to cut student debt during a national crisis. The Supreme Court felt using the law in the current circumstances was an overstep. 

By contrast, the new IDR is based on the Higher Education Act, which successive administrations have used for years to build and modify various IDRs without legal challenge.

Based on the above analysis, I expect the resumption of federal student loan repayments to represent less than 0.5% of all households’ disposable income.

Its economic impact will depend on whether households decrease consumption by the full amount to be repaid or instead reduce their savings.

Payment Resumption to Have Limited Impact on Consumption

The data does not show a negative relation between debt service payments and consumption (Chart 3). The positive correlation up to the GFC reflected households’ rising leveraging, which sustained both rising propensity to consume and rising debt service payments.

The post-GFC decline in debt service payments and consumption reflected much lower interest rates as well as household deleveraging.

Recent data shows that, relative to income, consumption is much higher than before the pandemic. This suggests excess savings have not been exhausted yet. I estimate households have about $400bn in excess savings left, or about 25% of monthly disposable income (Chart 4).

Overall, the small size of the repayments relative to total household income and the weak relation between propensity to consume and debt service suggest only a limited impact on consumption.

Market Consequences

GDP growth is accelerating, which supports continued growth in labour demand well exceeding labour supply. A tight labour market in turn suggests upside risks to wages, which the Fed views as inconsistent with a return of inflation to target. 

The above analysis suggest that the resumption of student loan payments is unlikely to bring about the cooler growth the Fed needs to proceed with 100bp of cuts in 2024.

Appendix Estimating Debt Service Payments

Notes

1. Data in table is annualized.
2. I have used the 2020 SHED because I was not sure how to interpret the debt payments reported by the respondents in the 2022 SHED against the backdrop of a debt moratorium.
3. I have assumed conservatively that no student would be delinquent on payments. In reality, the delinquency rate prior to the pandemic was 10%. It could rise given the administration’s efforts to forgive the debt.

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed, the IMF, and the World Bank. She joined Macro Hive soon after its inception.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)