Majority Leader Harry Reid’s admission that the Senate is unlikely to pass any legislation to prevent the doubling of interest rates for student loans is bad news . It is also a financial blow against the housing recovery and the economy in general.
How can this be possible, you say? Let me explain and once you see the logic, I hope that you will feel as I do.
The student loan crisis and a sustainable housing policy are inextricably linked. We cannot afford to keep lurching from one crisis, one bubble to another for this very reason. It is bad enough that students who cannot afford to make loan payments will have their credit destroyed. Remember these loans are not forgivable under bankruptcy laws. A pipeline of future homeowners will come to an end.
Second, the credit stability of parents and grand parents are in play as well. Loans in the name of parent(s) and/or co-signed by students’ parents and grand parents that go into default will send shock waves across the economy and housing in particular. Life events can strike at anytime and even if parents are well off financially, anyone can be wiped out.
The consequences for mortgage lending are severe. For starters, parents who wish to retire and sell their homes and move down will be unable to do so. Seniors living on fixed-incomes that have a reverse mortgage may go into default for failure to pay tax or insurance bills.
But what about those student loans that never go into default? Can financial harm can be done by increasing interest rates? Absolutely! Loans that signed or co-signed by someone other than a student will have those debts appear on their credit report. The added payments may well spiral their debt to income ratios so high that they will be unable to refinance or buy a home.
Let’s us not forget that our economy is dependent upon relatively easy access to credit. A combined student loan default-housing crisis would deal a death-blow to the meager economic recovery witnessed to date. It may even throw us into another recession.
Student loans and mortgage loans are both securitized on capital markets. There are likely to be derivatives, those unregulated global financial bets, attached too. Financial risk, in our day and age, is never limited to just the instrument used to own a home, buy a car, or go to college. Even a relatively small number of loans can cause immense economic damage. Witness the original subprime loan defaults that was in the billions of dollars. Student loans now total at least a trillion dollars.
I implore Harry Reid and John Boehner to resolve this short-term issue. More than that, our nation must develop a long-term strategy to limit the risk associated with student loans and mortgages. Waiting will never be an option.