Toxic Student Debt Might Blow Up Our Economy -- Why the Fed Must Bail Out the Millions of Young People Crushed by Student Loans

Among the many ideas posed by different groups of protesters on Wall Street and around the nation is student debt forgiveness—a debt “jubilee. Occupy Philly has a "Student Loan Jubilee Working Group," and other groups are studying the issue. Commentators say debt forgiveness is impossible. Who would foot the bill? But there is one deep pocket that could pull it off - the Federal Reserve. In its first quantitative easing program (QE1), the Fed removed $1.3 trillion in toxic assets from the books of Wall Street banks. For QE4, it could remove $1 trillion in toxic debt from the backs of millions of students.

The economy would only be the better for it, as was shown by the GI Bill, which provided virtually free higher education for returning veterans, along with low-interest loans for housing and business. The GI Bill had a sevenfold return. It was one of the best investments Congress ever made.

There are arguments against a complete student debt write-off, including that it would reward private universities that are already charging too much and it would unfairly exclude other forms of debt from relief. But the point here is that it could be done and it (or some similar form of consumer "jubilee") would represent a significant stimulus to the economy.

Toxic Student Debt: The Next "Black Swan"?

The Occupy Wall Street movement is heavily populated with students. Many without jobs, they are groaning under the impossible load of student debts that have been excluded from the usual consumer protections. A whole generation of young people has been seduced into debt peonage by the promise of better jobs if they invest in higher education, only to find that the jobs are not there when they graduate. If they default on their loans, lenders can now jack up interest rates and fees, garnish wages and destroy credit ratings; and the debts can no longer be discharged in bankruptcy.  

Total US student debt has risen to $1 trillion - more than US credit card debt. Defaults are rising as well. According to Department of Education data, 8.8 percent of recipients of federal student loans defaulted in fiscal year 2010, up from 7 percent the previous year. With an anemic recovery from a severe recession and a difficult job market, the situation is expected to get worse. The threat of massive student loan defaults requiring another taxpayer bailout has been called a systemic risk as serious as the bank failures that brought the US economy to the brink of collapse in 2008. To prevent another disaster like the one caused by the toxic debts on the books of Wall Street banks, we need to defuse the student debt bomb before it blows. But how?  

The Federal Reserve could do it in the same way it defused the credit crisis of 2008: by aiming its fire hose of very low interest credit in the direction of the struggling student population. Since September 2008, the Fed has made trillions of dollars available to financial institutions at a fraction of 1 percent interest; and in audits since then, we've seen that the Fed is capable of coming up with any amount of money required or desired. To the Fed, it is all just accounting entries, available with the stroke of a computer key.

The Fed is not allowed to lend to individuals directly, but it can buy Treasury securities; and with the Student Aid and Fiscal Responsibility Act (SAFRA) of March 2010, the Treasury is now formally in the business of student lending. It can also buy asset-backed securities, including securitized student debt; and there is talk of another round of quantitative easing aimed at just that sort of asset.

After QE3: The Market Wants More

When the Federal Reserve announced its plans for another round of quantitative easing in August 2011, the sums and terms were so tepid that the stock market reacted by plummeting. To appease investors, Chairman Ben Bernanke then assured them that the Fed was "ready to do more." How much more and in what way wasn't specified; but Alan Blinder, former vice chairman of the Federal Reserve Board of Governors, suggested some possibilities. He wrote in The Wall Street Journal on September 28: