Student Debt May Hurt Economy As Record Levels Dampen Other Loans

BOSTON -- The overhang of student debt on young workers may inhibit consumption and future borrowing, researchers at the Federal Reserve Bank of New York warn, potentially imperiling the economic recovery for years to come.

In a new study, New York Fed researchers said Wednesday that younger workers with student debt are less likely than their unburdened peers to have home mortgages or auto loans -- the first time that has been observed in at least 10 years and a worrying development for policymakers who have traditionally associated student debt with college education and higher incomes.

Borrowers with student loans also shed other forms of consumer debt at a much higher rate than borrowers without educational debt, the researchers found, in a sign that consumers with student loans may have lowered their expectations for higher future earnings and may have less access to loans as a result of rising student debt despite their "comparatively high earning potential."

Student debtors also may have decreased their consumption, the researchers said.

"Lowered expectations of future earnings and more limited access to credit may have broad implications for the ongoing recovery of the housing and vehicle markets, and of U.S. consumer spending more generally," the New York Fed researchers cautioned.

"While highly skilled young workers have traditionally provided a vital influx of new, affluent consumers to U.S. housing and auto markets, unprecedented student debt may dampen their influence in today's marketplace," they warned.

The researchers join a growing group of policymakers who have been highlighting the risk that unprecedented student borrowing presents. Among consumer debt, only home mortgages today exceed the $1.1 trillion in outstanding student loans. That is worrying officials in Washington, who are beginning to question the benefits of a college degree in light of the potentially negative macroeconomic impact of rising student debt levels.

The share of 25-year-olds with student debt has increased from 25 percent in 2003 to 43 percent in 2012, according to the New York Fed. The average student loan balance among 25-year-olds with student debt has grown by 91 percent over the same period to $20,326.

This month, newly released minutes from the March meeting of the Fed's interest-rate setting panel, the Federal Open Market Committee, revealed that some members mentioned "the high level of student debt " as a risk to aggregate household spending over the next three years.

Millions of student borrowers are also paying record relative interest rates on their government loans, according to a Huffington Post review, frustrating efforts by the Fed to reduce borrowing costs for households and businesses.

The Consumer Financial Protection Bureau (CFPB), the Financial Stability Oversight Council and the Treasury Department's Office of Financial Research have all warned about the possible danger that rising student debt levels pose to financial stability and the broader economy. The CFPB has launched a consultation to determine how to stimulate modifications and refinancings of student debt.

As the New York Fed researchers found, consumers with student debt may be less likely to take on additional debt obligations, limiting future credit creation and perhaps hurting financial institutions that rely on making loans in order to stay in business.

"There is increasing consensus that student loan debt is having a broader impact on the economy than we think," Rohit Chopra, the CFPB official responsible for the student loan marketplace, said in a recent interview.

Borrowers without student loans at age 25 on average reduced their debt load by 40 percent from their peak in 2007 through 2012, the New York Fed found. By comparison, those with student debt on average reduced their non-education debt load by at least 43 percent from their separate peak in 2008.

The National Association of Home Builders, a Washington trade group, said earlier this month that "higher student debt loan burdens impair the ability of recent college graduates to qualify for a loan , thereby increasing the time required for such new households to become homeowners."

The New York Fed found that the homeownership rate for 30-year-old student debtors is now nearly 2 percentage points lower than that of those without student loans, a reversal of pre-Great Recession rates.

Student debt burdens may also be affecting access to credit, according to the New York Fed. At ages 25 and 30, borrowers with student loans on average have lower credit scores than their peers without student debt, even though student borrowers are more likely to have better-paying jobs.