U.S. May Avoid a Student Loan Economic Crisis

Student loan repayments, which resume this month after a more than three-year pause, are unlikely to push the U.S. to a recession as the debt is concentrated in a small number of households, Wells Fargo economists said on Monday. But the payments add another expense for borrowers that could stifle unnecessary spending for consumers and contribute to a slowdown in the economy.

Consumer spending has remained resilient despite the Federal Reserve’s moves to hike interest rates to a two-decade high in an attempt to slow down soaring inflation. The rise in prices has been driven in part by Americans willing to empty their pockets after the country re-opened following the COVID pandemic lockdowns.

Recent data has begun to show that personal spending is beginning to decline. In August, the core personal consumption expenditures, a key metric for the Fed, increased by 3.9 percent for the year, the first time in two years it has fallen under 4 percent.

Wells Fargo economists believe that student debt repayments will squeeze individual households but they alone are not going to plunge overall consumer spending and push the economy into a recession.

Nevertheless, the households that have to make repayments will feel the pinch.

“When you put it on top of some other factors, such as dwindling liquidity and higher borrowing costs, I do think it’s another factor that’s going to cause consumer spending to slow. But again, by itself, it’s not the factor that breaks the camel’s back in terms of the consumer,” Shannon Seery, an economist at Wells Fargo, told Newsweek.

Student loan debt had paused over the past three years as policymakers wanted to give Americans relief during the COVID-induced economic crisis. An attempt by the Biden administration to cancel up to $20,000 of student debt was struck down by the Supreme Court.

In August, the White House introduced the SAVE plan that aims to assist borrowers in the amount they have to pay and get them on a path towards debt forgiveness quicker. On Friday, the Education Department said a newly formed Student Loan Relief Committee will meet on October 10 and 11 to discuss new proposals focused on those who are most in need of help with their debt.

Last month, the interest on student loans restarted and some borrowers began paying back their loans, sending billions of dollars to the U.S. Treasury. In September, nearly $7 billion of cash arrived at the finance department from the U.S. Department of Education, a Wells Fargo analysis showed.

The average payment for households is about $200-300 a month, which comes to around 5 percent of the U.S. median salary.

As households continue to make these payments, the next few months will add more insight into their overall impact on consumer spending, Wells Fargo’s Seery told Newsweek. Any decline in spending could add another factor in the Fed’s effort to slowdown the economy to get inflation to its target of 2 percent.

“If consumers pull back on purchases, particularly discretionary purchases, that could help the Fed in terms of the cooling of the economy to get inflation back towards target,” she said. “This could be a factor that does cause households to pull back on discretionary purchases.”

The number of people who owe at least $100,000 in student debt makes up about 7 percent of borrowers, about 3 million people and less than 1 percent of the population. The repayments will reduce about 0.4-0.6 percent of total U.S. annual consumption, Wells Fargo said.

Nevertheless, data shows that 60 percent of borrowers are 40 years old or younger, a demographic group that typically earns less than their older counterparts, potentially compounding the effect they might feel from the payments. While for the larger economy, the impact maybe manageable, there are still risks for households.

“If the households rely more on credit, or if they start to pull back on spending, not only because of student loan debt, but because credit is more expensive or because they don’t have as much liquidity out there. So I think it is happening at a pretty inopportune time, in terms of the resumption and where household balance sheets are headed,” Seery said.

There were at least two outcomes, she added.

“For people who have student loan debt, either they pull back on spending, which would be negative in terms of it showing up in the spending data, or they keep spending and they either save less of their monthly income, or they take on more credit, which makes them more financially vulnerable,” Seery told Newsweek. “I don’t think either outcome is great.”

When it comes to the overall economy, the question is whether households without student debt would offset the slowdown from those who have to repay their loans or will there be compounding effects to spending.

“Where you see slowdown throughout the broader consumer, because conditions are just kind of growing more and more worrisome for overall households, and you start to see some weakness and spending,” Seery said.