September 22, 2023 | 13:57
School’s (Not) Out for Debtors
On top of a potential escalation of the auto workers strike and partial shutdown of the federal government, the U.S. economy will need to fend off one other shock that looms with certainty. Starting October 1, tens of millions of student loan borrowers will resume making payments for the first time in 3½ years (interest started accruing on September 1). Average payments are expected to run between $200 and over $300 per month. Roughly half of 43 million student loan borrowers made regular payments prior to the moratorium on payments in March 2020, with most of the others either delinquent or subject to a grace period while in college. A wide range of estimates suggests total payments will amount to between $5 billion and $10 billion per month, or $60 billion to $120 billion per year.
However, the actual amount could be at the lower end of this range as the Biden administration's new program, Saving on a Valuable Education (SAVE), will allow borrowers to reduce monthly payments depending on discretionary income and family size. Up to 20 million borrowers could benefit from the program, with many seeing monthly payments chopped in half and low-income borrowers (earning less than $32,800 per year) getting exempt from payments.
Using a conservative estimate at the mid-point of the range, $90 billion could be pulled from annual consumer spending (this assumes 25 million borrowers will pay an average of $300 per month). Due to the SAVE program, this figure should be seen as an upper limit. It implies a maximum 0.5% drag on monthly spending in October and, given the consumer’s two-thirds weight in GDP, a 0.3% hit to the economy (slightly allayed by fewer imports). Assuming repayments remain steady thereafter, there would be no further impact on monthly growth rates. For the fourth quarter, the impact works out to a 2.0-ppts reduction in annualized consumer spending growth and a 1.3-ppts drag on annualized GDP growth. Together with other headwinds, this could slow growth in real spending and GDP to around 1% in Q4 from the above 3% pace likely in Q3.
Though mollified by the SAVE program, student loan delinquency rates are expected to gradually normalize in the years ahead. But likely not in the first year, as the Education Department (which grants federal student loans that account for over 90% of the total) will refrain from placing loans into default until September 2024. The current record-low 90-day-plus delinquency rate of 0.6% compares with a much higher, though fairly steady, rate of around 11% in the seven years prior to the moratorium. Since late 2019, outstanding student debt has risen a moderate 4% to just under $1.6 trillion in the second quarter of 2023, according to the New York Fed. That’s similar to the amount of auto loans and represents 9% of total household debt. Interest rates on federal student loans are established by Congress each year based on the 10-year Treasury yield, which is testing 16-year highs. Higher rates won’t be a problem for most current loan holders with fixed-rate terms, but it could create financial stress for new borrowers and current holders with privately issued loans at variable rates.
Bottom Line: Though likely to cause a significant one-time hit to economic growth, student loan repayments are more of a speed bump than a roadblock, especially given the recent resiliency shown by consumers. Discretionary purchases will likely take the brunt of the harm given fading pent-up demand and excess savings. The Fed will largely look past the temporary dampening effect of repayments on the economy, though this is perhaps one more reason (along with a possible escalation of the autoworkers strike) to adopt a more data-dependent approach to assess the need for further rate hikes.