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Friday, February 17, 2017

Are We Heading Towards the Next Financial Crisis?

A recent report by the New York branch of the Federal Reserve Board indicates that the total household debt balance is approaching the record peak of $12.68 Trillion, reached in Q3 of 2008. The Q4 2016 number is reported at $12.57 Trillion.

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The most alarming fact coming out of this report is that student loan 90+ day delinquency is rising sharply and consistently over the last two decades. The current student loan outstanding balance stands at approximately $1.3 Trillion. 

The following table (source: FRBNY), clearly shows that student loan default rate leads household debt-component delinquency by far. Note that FRBNY has warned in its previous reports that though the current delinquency rate is alarmingly high, the actual delinquency rate, as an indicator, is quite understated, since many student loans payback terms are deferred, while students attend school. Once the deferral period is reached, it is highly likely that we will notice a much more significant rise in the delinquency rate.

90+ day delinquency rates (known as "seriously delinquent")
CATEGORY1Q3 2016Q4 2016
1Delinquency rates are computed as the proportion of the total outstanding debt balance that is at least 90 days past due.

2As explained in a previous report, delinquency rates for student loans are likely to understate effective delinquency rates because about half of these loans are currently in deferment, in grace periods or in forbearance and therefore temporarily not in the repayment cycle. This implies that among loans in the repayment cycle delinquency rates are roughly twice as high.
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While students' inability to pay back their loans in a timely manner, affects their credit scores as well as spending ability, in many cases this delinquency affects the economic reality of their parents, when parents co-signed as guarantors on their children's loans. Unlike other types of debt, this type of situation has the "passing-the-buck" effect that binds multiple generations together into Indentured Servitude. The economic impact on households that have a high debt to income ratio could have very dire consequences, as both parents and their children are forced into default. Since our government precluded student loan debt  from personal bankruptcy protection, there is currently no mechanism that could prevent a debt crisis.
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Perhaps it is time to call out our government policies for a major review, regarding investment in education in general and the cost of higher education in particular. It is unclear why we have the most expensive higher education in the world, while other developed countries make higher education completely free for their citizens and permanent residents. With many countries in Europe (Germany, France, Scandinavian countries, etc.) offering free university education, at top universities (see references below), to foreign citizens (including U.S. citizens) are we going to begin shipping our young population abroad to seek debt-free destiny?

With hundreds of thousands of H1B visas granted to foreign workers every year and with even greater number of F1 visas granted to students who enter the U.S. workforce through "Optional Practical Training" (OPT) arrangements, U.S. Employers receive the short-term benefit of cheaper labor, all at at the entry level. However, by undercutting citizen children of the middle class in the U.S. from a chance to receive higher education, due to affordability issues, any short-term gain in worker supply will be replaced by a massive downfall and screaming shortages of well educated workforce in the long term.

Is it not the time to demand a major revision of the "for profit" approach in higher education? This system went overboard over the last 30 years, making college-level education un-affordable for so many people and enslaved those who received financial support for their education to a lifetime of debt. With the financial sector taking over every aspect of our lives and dominating the political system, are we going to sit at home and see this, once great country, going to the dump, while enriching the top 0.1 percent of the population?

Your comments are welcome.


Since the original date that this article was written the picture became even worse. The latest FRBNY report indicates a significant increase of ongoing consumer debt, as quoted below:
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  • Aggregate household debt balances rose to a new peak in the second quarter of 2017. As of June 30, 2017, total household indebtedness was $12.84 trillion, a $114 billion (0.9%) increase from the first quarter of 2017 (the original article reported 12.57 Trillion, or a change of 270 billion since Q4  2016). This increase put overall household debt $164 billion above its peak in the third quarter of 2008, and 15.1 percent above its trough in the second quarter of 2013.
  • Mortgage balances, the largest component of household debt, which stood at $8.69 trillion as of June 30, saw a $64 billion uptick from the first quarter of 2017.
  • Balances on home equity lines of credit (HELOC) were roughly flat, and now stand at $452 billion.
  • Non-housing debt rose in the second quarter, with increases of $23 billion in auto loans and $20 billion in credit cards; student loan balances were roughly flat.

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