The US can avoid an economic crisis on student loans

Student loan repayments, which resume this month after a more than three-year pause, are unlikely to push the U.S. into recession because the debt is concentrated in a small number of households, Wells Fargo economists said Monday. But the payments will create additional costs for borrowers that could make unnecessary spending more difficult for consumers and contribute to a slowdown in the economy.

Consumer spending remained robust even as the Federal Reserve raised interest rates to two-decade highs to curb rising inflation. The price increase is due in part to Americans’ willingness to empty their pockets as the country reopens following lockdowns due to the COVID pandemic.

Recent data shows that personal spending is beginning to decline. In August the core personal consumption expensesa key Fed measure, rose 3.9 percent for the year, falling below 4 percent for the first time in two years.

Economists at Wells Fargo expect student debt repayments will put pressure on individual households, but they alone will not lead to a collapse in overall consumer spending and a recession in the economy.

Nevertheless, the crisis will be felt by households that have to make repayments.

“When you add that in with some other factors like dwindling liquidity and higher borrowing costs, I think it’s another factor that will lead to a slowdown in consumer spending back in terms of the consumer,” said Shannon Seery, Economist at Wells Fargo Newsweek.

Student loan debt has been on hold for the past three years as policymakers look to provide relief to Americans during the economic crisis caused by COVID. An attempt by the Biden administration to cancel up to $20,000 in tuition payments has been thrown out by the Supreme Court.

In August, the White House unveiled the SAVE plan, which aims to help borrowers pay the amount they need to pay and get them on the path to debt relief more quickly. On Friday, the Education Department said a newly formed Student Loan Relief Committee would meet on Oct. 10 and 11 to discuss new proposals focused on those who most need help paying off their debt.

Last month, student loan interest rates began rising again and some borrowers began paying off their loans by transferring billions of dollars to the U.S. Treasury. In September, nearly $7 billion in cash was received by the Treasury Department from the U.S. Department of Education, according to a Wells Fargo analysis.

The average payment for households is about $200 to $300 per month, which is about 5 percent of the average U.S. annual salary.

As households continue to make these payments, the next few months will provide more insight into their overall impact on consumer spending, Wells Fargo’s Seery said Newsweek. Any decline in spending could add another factor to the Fed’s efforts to slow the economy to bring inflation to its 2 percent target.

“If consumers scale back their purchases, particularly discretionary purchases, that could help the Fed bring inflation back toward target as the economy slows,” she said. “This could be a factor causing households to withdraw their discretionary purchases.”

The number of people who owe at least $100,000 in student debt represents about 7 percent of borrowers, about 3 million people, and less than 1 percent of the population. The repayments will reduce about 0.4 to 0.6 percent of total U.S. annual consumption, Wells Fargo said.

Despite it, Data shows that 60 percent of borrowers are 40 or younger, a demographic that typically earns less than their older counterparts, potentially exacerbating the impact of the payments they may feel. While the impact on the overall economy may be manageable, there are still risks for households.

“As households become more reliant on credit or start to pull back on spending, not just because of student loan debt, but because credit is more expensive or because they don’t have as much liquidity. I think so.” “The crisis is happening at a pretty bad time in terms of the recovery and the evolution of fiscal balance sheets,” Seery said.

There were at least two findings, she added.

“People who have student loan debt either cut back on their spending, which would be negative in terms of how it would show up in the spending data, or they continue to spend and either save less of their monthly income or they take out more credit, which is what they do financially more vulnerable,” Seery said Newsweek. “I don’t think either outcome is great.”

Looking at the broader economy, the question is whether households without student debt would offset the downturn with those having to repay their loans, or whether there will be a compounding impact on spending.

“You’re seeing a slowdown in consumers overall because conditions are becoming more worrisome for households overall and you’re starting to see weakness and spending,” Seery said.