Student Debt and a Broken Financial System

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When the Class of 2009 entered college in 2005, they had good reason to be optimistic. The economy appeared to be healthy, and a college degree commanded higher wages. College, of course, is expensive. And almost 2 out of 3 students entering college took on some debt. They took on that debt believing that it would be easy to pay back any debt given the strong market for those with a college degree.

But then the biggest recession in 80 years hit the United States, leading to a much worse job market for college graduates. Here is the unemployment rate as of October for college graduates who just graduated, by year from 2007 to 2011.

The Class of 2009 had an unemployment rate of 18% — twice as bad as the Class of 2007 had when they graduated. The employment to population ratio also shows how bad the market was:

This was horrible luck for students graduating in 2009 and 2010 — in some sense they were being punished for being born 22 years earlier in 1987 or 1988. You might guess that the punishment was short-lived — eventually these students would find good jobs once the economy recovers, right? Wrong. Research shows that there are long-run, persistent negative effects of graduating from college in the midst of a severe recession.

As mentioned above, many of the students in the Class of 2009 took on student debt. What happened to those interest payments? Unfortunately, the debt contracts taken on by the students didn’t care what the economy looked like upon graduation. Students had to either make the payments, or default and suffer the consequences.

Does this make any economic sense? The financial system is supposed to help the most vulnerable members of society insure themselves against unforeseen risks. But in this case, the student debt concentrated risk on young Americans trying to get ahead with a college degree.

The Great Recession was a completely unforeseen event, as unforeseen as an unexpected fire, storm, or car accident. A properly functioning financial system would help protect young Americans suffering from a horrible recession that was completely outside of their control. Instead, it actually hurt them even worse! And we all bear the consequences. It is quite likely that excessive student debt burdens are holding back the recovery.

We must rethink the financial system, which is a major theme of our book coming out next week.

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