Banking

What Biden’s pledge to forgive student loans means for consumer lenders

If President-elect Joe Biden delivers on his plan to grant blanket forgiveness of federal student loan debt, banks, credit unions and other consumer lenders stand to benefit.

Almost certainly, U.S. consumers saddled with federal education debt would have more money left to make payments to credit card, auto and private student lenders, all of which are bracing for a rise in defaults as the pandemic recession drags on. Americans whose student debts are even partially forgiven would also have more capacity to borrow anew, potentially juicing demand for car loans and mortgages.

“In effect, it is a way to provide stimulus,” said Mike Taiano, an analyst at Fitch Ratings.

Yet the banking industry is not backing the idea. One industry group notes that the Biden plan would do nothing to address the runaway cost of college. More fundamentally, forgiving loans — even those made by the federal government — is not an idea with intuitive appeal to private-sector lenders.

As of the third quarter, Americans owed $1.55 trillion in student debt, with federal loans comprising more than 90% of the total.

Biden is pitching debt forgiveness as a way to offer consumers relief from the COVID-19 crisis, but the effects of his plan would be long-lasting, since federal student loans typically have 10-year terms. Unlike one-time government checks, which provide short-term relief, debt forgiveness would erase or reduce monthly payments over a period of years.

Forgiveness of federal student debt would function somewhat like an extension of the short-term forbearance offer that has been available since the passage of the Coronavirus Aid, Relief and Economic Security Act last spring. According to one analysis, only 11% of borrowers with federal student loans were making their monthly payments in the fall.

The payment pause on federal student loans, recently extended through the end of January, has helped private-sector consumer lenders to weather the storm of 2020. Some 29% of federal borrowers have been using their savings to pay down other debts, according to a recent survey that The Harris Poll conducted on behalf of NerdWallet.

In October, Sallie Mae CEO Jonathan Witter noted that the eventual end of the federal government’s forbearance offer will have negative economic consequences. “This added payment burden may drive some level of increased financial distress,” he said during the private student lender’s most recent earnings call.

Witter estimated that Sallie Mae’s average borrower owes $400 per month on federal student loans. That sum is more than enough, given the ongoing payment holiday, to cover the $277 that the average borrower owes each month to Sallie on private student loans.

A recent poll of more than 58,000 student loan borrowers lends credence to the idea that if Americans resume paying off their federal student loans, they are likely to start missing more payments to private-sector lenders.

Some 77% of the poll’s respondents said that they do not feel financially secure enough to start making their federal student loan payments until at least June, according to the survey by Savi, a startup that helps borrowers reduce their education debt payments, and the advocacy group Student Debt Crisis.

“I still think there’s a lot of anxiety about the payments resuming,” said Aaron Smith, a Savi co-founder.

The economic benefits of Biden’s debt-forgiveness plan would depend on its size. The former vice president has endorsed forgiving $10,000 for all federal student loan borrowers, which would eventually result in total consumer savings of approximately $370 billion. That approach would help many Americans who attended college but did not finish, and therefore have not enjoyed the salary boost that typically comes with a degree.

Borrowers who didn’t finish their education face a predicament similar to folks who take out a car loan, only to see the vehicle stolen, said Chris Keveaney, a former JPMorgan Chase executive who is now the CEO of the education lending startup Meritize.

“You don’t have the car, which was security against the loan, and you still have to pay on it. It becomes a very untenable situation,” Keveaney said. “That’s where I think the focus should be.”

But some Democrats in Congress want to forgive much larger sums of debt. Student loan forgiveness has become a hot topic in progressive circles because it is a form of economic stimulus that could arguably be accomplished by the executive branch alone, without the approval of Senate Republicans.

Sen. Elizabeth Warren, D-Mass., House Financial Services Committee Chairwoman Maxine Waters, D-Calif., and other prominent Democrats want the president-elect to forgive up to $50,000 per borrower. That plan would blast a bigger hole in the federal budget, and its benefits would skew more toward wealthier people. But it would also have a larger stimulative effect than forgiving no more than $10,000 per borrower.

“Canceling student loan debt would help boost our struggling economy and close the racial wealth gap that has persisted for far too long,” Warren said earlier this fall.

The mortgage industry in particular could benefit from large-scale student debt forgiveness. Between 2005 and 2014, more than 400,000 young Americans did not buy homes because they were burdened with student debt, according to Federal Reserve research published last year.

Still, banking industry groups do not support proposals to forgive federal student debt. When Warren and Rep. James Clyburn, D-S.C., unveiled debt-forgiveness legislation before the pandemic, the Consumer Bankers Association blasted the plan as shortsighted and bad for taxpayers.

The CBA noted that debt forgiveness would do nothing to reduce the spiraling cost of college, which has contributed to what recent data from the Federal Reserve Bank of New York shows to be a roughly 100% increase in student debt outstanding over the last decade.

There is also the possibility that forgiveness of federal student loans could pave the way for similar treatment of privately backed education debt. In addition to Sallie Mae, banks in the private student loan market include Discover Financial Services, Citizens Financial Group and PNC Financial Services Group.

In a letter to Biden last week, Waters endorsed large-scale forgiveness of federal loans before adding: “I will work with your Administration to secure similar relief for private student loan borrowers as well.”

The National Association of Federally-Insured Credit Unions has not taken a position on the forgiveness of federal student loans, but a spokesman said that the group would oppose an extension of Biden’s plans to cover private student loans.

Critics of the Democrats’ proposals point out that numerous other forms of stimulus, including cash payments to individuals, would have a bigger short-term impact than student debt forgiveness. Taiano noted that the monthly payment on a $10,000 loan with a 10-year term and a 4% interest rate is only around $100.

The plan’s opponents also argue that forgiving debt would create a so-called moral hazard, encouraging Americans to take out more loans under the assumption that future debts will also be forgiven. “It is a problem that people will expect they won’t have to pay their loans,” said Adam Looney, an economist at the Brookings Institution.



 

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