This week, the Federal Reserve Bank of New York offered continuing evidence of the student debt crisis. Outstanding student debt again topped $1 trillion in the fourth quarter of 2013, making it the second-largest pool of debt in the nation behind mortgages. This has tripled in just a decade, as higher-education prices increased faster than medical costs, up 500 percent since 1985. While delinquency rates for all loans have trended downward for the past three years, student loan delinquencies have surged; currently 11.5 percent of all student loans are 90 days behind or more.
The recent explosion in student debt—now held by one in five U.S. households—coincided with the Great Recession’s awful job market. Millennials have come of age amid stagnant wages, high unemployment, a lack of quality jobs (44 percent of recent graduates work in positions that don’t require a college degree), and, for those fortunate enough to attend college, an average of nearly $30,000 in debt.
All this has led to what we can call the Great Delay. The normal milestones of adulthood—moving out of the childhood home, buying a car, getting a mortgage—are coming later and later in life. Could the way we finance higher education in America be sucking the vitality out of the economy, digging an entire generation a hole from which they cannot escape?
First-time homebuyers accounted for just over one-quarter of all sales over the past year, far lower than the historic average. That percentage was even lower for households under age 40. All-cash home purchases, by contrast, hit 42 percent of sales last November, according to RealtyTrac. Recent college graduates typically don’t have that kind of money lying around.
While weak wages and high unemployment for young people explains much of the problem, an analysis from the New York Fed offers compelling evidence for the role of student debt. In 2012, 30-year-olds were more likely to have a mortgage if they had no student debt than if they did. The same trend held for vehicle purchases. In one way, this makes no sense—college graduates have much higher average wages than their counterparts, and should have a higher percentage of auto and home purchases. But student debt is holding them back. Indeed, you can say that student debt is crowding out other forms of credit. For example, high student loan delinquencies damage credit scores, often putting access to credit out of reach. Just having a student loan increases overall debt, making it hard to qualify for other loans, especially under new mortgage rules that limit total debt for a would-be borrower to 43 percent of their annual income.
This isn’t just about the housing market; it’s about the entire economy. A struggling student debt holder who can’t afford a mortgage—or find a job—may also have trouble affording rent or passing a credit check from a landlord. They may have to find roommates to bunk with, or move back in with their parents. This leads to a reduction in household formation, one of our most unsung economic indicators.
First and foremost, household formation measures housing demand. “The number of households matters for construction, which is the main way housing adds to economic growth,” says Jed Kolko of housing data analyst Trulia. In addition, if you’re not moving into a new home or apartment, you’re not buying furnishings or appliances or decorations. You’re not buying that container of salt everyone seems to have in their pantry. You’re not paying an additional bill for electricity or cable television or broadband Internet. Demand for a whole range of services goes down. And that’s exactly what we’re seeing in the economy; consumer spending on services has lagged other purchases since the recession, and it may explain much of our listless economic growth. A “kids living in the basement” economy simply has no vigor.
We know that household formation dropped dramatically over the past several years. Research from the Cleveland Fed finds that, while household formation averaged 1.5 million from 1997–2007, from 2008–2010 it bottomed to just 500,000 a year, even as the population expanded. “The greatest shortfall occurred among young adults,” notes the report, with the “headship rate”—the probability that someone is the head of a household—falling fastest for those aged 18–34. Only one-third of all millennials head their own household, a nearly 40-year low, according to analysis from the Pew Center for Research. Similarly, Pew found that 36 percent of millennials, 21.6 million young Americans, live in their parents’ homes. The share of young adults who move is at a 50-year low, an indicator of lack of funds.
Has household formation come back along with the recovery? It’s hard to say. Trulia’s Jed Kolko explains that there are two main measurements of the headship rate: the Current Population Survey and the American Community Survey. And these surveys show different trends. The Current Population Survey, which is more recent, shows an increase in the headship rate for the last three years. But the American Community Survey, which has a much larger sample, shows the headship rate dipping and then flatlining in 2012. “The decline has either slowed or reversed,” Kolko says. This could be attributable to survey assumptions about population growth, but it makes it hard for economists to definitively say whether the household formation crash was just a blip from the recession, or part of a more lasting “kids in the basement” trend. Indeed, even in the more favorable Current Population Survey data, the share of young adults living with parents remains well above pre-recession rates, even for the employed.
Kolko, like many housing analysts, believes that at some point, the economy will return to fundamentals. In fact, the story goes, the low household formation rate today actually signals optimism for the future, since much more housing will have to be built to meet the pent-up demand. Homebuilders are certainly acting like that demand will come back, at least for rentals; apartment construction in 2013 was at a 15-year high. “Builders wouldn’t have done that if they weren’t betting on a strong increase in household formation,” Jed Kolko says. And to be sure, no young adults want to live with their parents forever.
But what if the pent-up demand story is just no longer true? What if the combination of graduating with debt, difficult job prospects, and stagnant wages has created a new normal? What if college graduates simply expect to spend their first decades “in the real world” shackled with debt and struggling to get by? Without clearer data, we won’t know the truth. But there’s no question that the finances of college graduates are more strained now than at practically any point in our history. Forty million Americans start out their working lives with a massive debt burden, and the salary they can earn out of college—if they can get a job at all—simply isn’t enough to keep up. “The combination of more debt and lower incomes means more risk, and many young workers are walking on an economic tightrope,” said Rohit Chopra, student loan ombudsman for the Consumer Financial Protection Bureau, at a recent field hearing.
If the Great Delay persists, it will handicap millennials for decades to come. A student taking out $53,000 in debt will lose $208,000 over his lifetime, according to the think tank Demos, because he will be less able to build home equity or save for retirement early in his life. There are solutions. Giving debt-holders refinancing options, or moving to a more manageable repayment schedule based on income, would certainly help. So would making college affordable, if not free. And of course, a few more jobs would be nice. But if the student debt treadmill really is stunting the growth of the economy, those jobs may never materialize. And without action, we’ll have no answer for a generation of debt slaves.