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D is for debt: U.S. student lending could give growth a failing grade

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Take a U.S. federal government pushing citizens to pursue a social objective, add easy credit conditions, a dramatic build-up in debt, steadily rising prices and a spike in delinquencies. We're talking the U.S. subprime housing meltdown from 2007-08, right? Yes – but the same conditions are at play again, right now – only this time in U.S. student loans.

There are striking similarities between the two situations, but for one: this time, the systemic downside risk isn't a potential meltdown of the global financial system – but bleaker, longer-term economic prospects for the U.S. economy. That's not much of a consolation prize.

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Since the Great Recession U.S. consumers have ratcheted down the size of their obligations for mortgages, credit card debts, home equity lines of credit and, until recently, auto loans. At the same time, however, student loan growth has continued unabated – reaching $966-billion (U.S.) at the end of 2012, almost three times higher than the level in 2004. In fact, the $327-billion increase in student loans outstanding since the end of 2008 is almost equal to the amount ($337-billion) by which Americans reduced their non-housing debts over that time. Excluding mortgages, Americans are no less indebted than they were at the height of the credit crisis – they just owe more toward the pursuit of higher education.

There are several reasons for the rapid climb of student loans. For years, Americans have been encouraged to attend college, since graduates generally do better in the job market, abetted by the U.S. government, which provided or backstopped the vast majority of student loans. Not surprisingly, attendance at colleges and graduate schools has been increasing for years – but so have tuition costs, which have risen four times faster than the rate of inflation since 1980.

Meanwhile the lingering effects of the Great Recession have led to a steep increase in the number of people leaving the job market – and many of them are heading to school instead. The number of people under 30 carrying student debt has increased by 6 per cent since the end of 2008 – but it's up by more than 34 per cent among people from 30 to 60 and by close to 70 per cent among those 60 or older. In total, the number of Americans carrying student debt has climbed by about 70 per cent in the last eight years, to 38.8 million, while the average amount owing has also increased by 70 per cent, to $24,803.

Alarmingly, delinquency rates for debt more than 90 days in arrears have risen sharply in the past year, to 31 per cent, leading to concerns that losses would "be borne broadly by U.S. taxpayers, thereby adding another item to a long list of U.S. fiscal challenges," a team of Credit Suisse analysts said in a recent report.

The longer-term effects are a troubling, toxic mix that could drag down consumer spending prospects in the world's global economic engine. The combination of higher consumer debt, greater defaults, lower entry-level wages and continuing tepid job prospects could add up to dampened consumer spending power over the longer term. And every one of those defaults creates a credit-impaired consumer who will have a harder time buying big-tickets item such as homes or cars.

The effects are already starting to ripple across the economy. Americans who took out loans to go to school are now less likely to have a home mortgage at age 30 than those who never did, according to the Federal Reserve Bank of New York, while credit scores for student borrowers have fallen sharply since the Great Recession. Government could help fix the problem by forgiving loans, but that would only "boost the federal deficit even more," says Credit Suisse. Too bad they don't teach a way out of this mess in college.

Sean Silcoff is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights, and follow Sean on Twitter at @seansilcoff.

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