By Michael S Derby and Dan Burns
(Reuters) – The US Supreme Court's reversal of President Joe Biden's student loan forgiveness plan will put nearly half a trillion dollars of debt back on household balance sheets, a strain that coincided with the end of a pandemic-related payment pause for student loans could accelerate the expected economic slowdown at the end of the year.
The court's 6-3 ruling on Friday, which is widely expected to be against Biden, comes just weeks after the White House and congressional Republicans reached an agreement to raise the federal debt ceiling that would ban more Extensions to the student debt payment pause included in early 2020, at the onset of the COVID-19 pandemic. The Department of Education said last week loan payments would resume in October.
That means US households, which have a total of $1.6 trillion in educational debt, are finding themselves making hundreds of dollars a month in loan payments for the first time in more than three years. Research by the New York Fed earlier this year found that about $440 billion in loans were eligible for relief, and if they had been permanently eliminated, 40% of student loan borrowers would have been out of student loan debt.
Economists expect the resumption of payments will have a significant impact on consumer spending but disagree on how severe the strain will be.
So far, consumer purchasing power has defied popular forecasts that it will fall sharply amid the sharp rise in interest rates sponsored by the Federal Reserve to curb inflation. In the 12 months to May, consumer spending had grown 5.9% on an annualized basis, almost 2 percentage points above the prevailing pre-pandemic growth rate.
However, questions remain about the resilience of consumer spending, a key driver of economic growth, especially given the prospect of further rate hikes.
“I expect quite a significant impact on consumer spending once payments start up again,” said Thomas Simons, US economist at investment bank Jefferies. “My suspicion is that most people who have to pay back will have limited ability to cope with the increased expenses” while tackling other financial challenges.
“I expect this to be the tipping point that will plunge the economy into recession,” Simons warned.
Morgan Stanley economists, meanwhile, are forecasting that the reintroduction of loan repayments will have a noticeable, albeit modest, impact on growth in the final months of the year. Unlike Jefferies, the bank doesn't expect a US recession but agrees that personal spending will take a tumble and the country's gross domestic product growth is likely to be between 6 and 9 basis points lower than it would otherwise be.
Morgan Stanley pointed out that the typical monthly interest payment that would be required to be made would be between $200 and $300, meaning that affected individuals' disposable income is likely to increase by 0.3 to 0.5 percent each year compared to the what they would have had to reduce The deferral of student loans remained in place.
CARRY THE LOAD
Still, there is still significant uncertainty about how all of this will play out and how it will play out in the economy. Part of that depends on how the Biden administration deals with the aftermath of the verdict.
There is some dispute as to who should bear the burden of the resumed payments. Some economists who opposed the loan moratorium viewed the effort as a gift to wealthy Americans, arguing that large amounts of credit are a sound investment to bolster future returns.
However, researchers at the New York Fed have dismissed that assumption, and analysis by the bank in recent months suggests the resumption of payments will weigh most on those who may be struggling to cope.
A January New York Fed newspaper said those who would benefit most from the debt grace period “are younger, have lower credit ratings and live in lower-income neighborhoods.” It said signs that some student loan borrowers are struggling to manage credit card and auto loan debt “might indicate that borrowers' payment difficulties will continue to worsen if payments resume without relief.”
Another challenge for at least some of those faced with student loan repayments: dealing with new debt incurred after student loan payments were off the table. The New York Fed concluded that the debt-repayment holiday boosted the creditworthiness of student borrowers and opened the door to other borrowing.
A University of Chicago article earlier this year even pointed out that those who benefited from the moratorium did not use the extra money to pay down existing loans, instead spending what turned out to be a temporary fluke, with some of those spending not more available debts were fueled.
Default rates on student loans fell from about 10% before the deadline to under 1% at the end of the first quarter of this year. A White House official said the government is concerned about the ability of some borrowers to repay their loans and there is very good reason to be concerned about defaults and defaults.
Fed research released in May suggested that a return to credit payments could lead to some credit strain, noting that those who enjoyed the relief “were able to improve their credit ratings.”
(Reporting by Michael S. Derby and Dan Burns; Editing by Andrea Ricci)