Economic Impact: Repeal of Student Loan Forgiveness and Resumption of Payments
We spoke with New England Asset Management to review and discuss the implications for the consumer and the economy, as well as long-term effects that insurance companies should be mindful of.
SAA: Was the U.S. Supreme Court decision to strike down the loan forgiveness plan a surprise?
NEAM: Ahead of the decision, indications were that the Biden Administration’s student loan forgiveness would not pass muster with the Supreme Court. The court determined that the Biden administration had overstepped its statutory authority, indicating that the executive branch can make “modest adjustments and incremental additions to existing statutory or regulatory provisions” but that the Heroes Act of 2003 does not allow the Biden administration to make dramatic transformative changes to the Higher Education Act of 1965. There was also a question of legal standing of the plaintiffs (states involved needed to demonstrate harm), but in the end the court determined that the state of Missouri had successfully proven legal standing, and the case proceeded from there.
It was probably a surprise and obviously huge disappointment for over 16 million student loan borrowers who had already been approved for the forgiveness program, along with millions of others expecting relief. Looking at the composition of the federal student loan universe by number of borrowers (about 44 million), it is heavily skewed (over 50%) toward those with $20,000 or less in outstanding loan balances. Those are the folks who would have potentially seen their debt completely forgiven.
SAA: There are other changes afoot for student loan borrowers; loan payments are set to restart based on legislation passed to address the debt ceiling. What effect will that change have?
NEAM: With the passage of the Fiscal Responsibility Act (the debt limit deal), Congress agreed to end the student loan payment moratorium. For the borrowers who had not made a student loan payment for over 3 years, this amounts to quite a large payment shock, especially for those who expected their loan to be cancelled.
There are approximately 44 million government student loan borrowers in the U.S., ~26 million of which have been in forbearance since April 2020 (60% of all borrowers). With an estimated average monthly payment of $250, that has provided a meaningful boost to borrowers’ monthly cash flow for over three years, beyond the billions of economic impact payments (stimulus checks).
SAA: What is the net impact for the consumer and to the economy because of these changes?
NEAM: For student loan forgiveness, it is difficult to assess how borrowers may have changed their spending or savings patterns based on the expectation of their student debt being partially or entirely extinguished. The restart of student loan payments is easier to quantify. The annualized impact based on the estimated monthly payment and number of borrowers equates to about $80 billion or 0.40% of U.S. consumers’ annual disposable income on a nominal basis.
However, the effect will be lessened by proposed measures to the student loan rules governing income-based repayment plans and other changes. Newly proposed measures cut loan payments on undergraduate debt from 10% to 5% of discretionary income, increase the income threshold at which that percentage applies, reduce the period after the debt can be forgiven for certain borrowers (from 20-25 years to as little as 10 years), and provide a 12-month “on ramp” period whereby delinquent borrowers would not be reported to the credit bureaus. This all suggests that the ultimate impact on the restart of student loan payments will be diluted and delayed. Nonetheless, it will create incremental strain for some consumers and could contribute to modest declines in consumer discretionary spending.
SAA: For insurance companies, where might they see these effects/impacts flow into their portfolio(s)?
NEAM: For insurance companies, the impact would flow through to consumer related corporate and structured securities. For example, we could see pressure on credit card and consumer loan delinquencies that could negatively impact corporate credit profitability and loss reserves. Collateral performance for structured securities backed by auto, consumer and credit cards could also see deterioration, though structured securities are designed to withstand high levels of credit stress depending on the position within the capital structure.
SAA: As you noted, the ultimate impact may be delayed and diluted until further into the future. As insurance companies typically have longer-term horizons/perspectives for their portfolio, are there any sector opportunities or portfolio positions you are being mindful of?
NEAM: Taking a longer-term view, we should recognize the tremendous support provided to the consumer through cumulative fiscal stimulus through the pandemic resulting in excess savings, along with the benefit of lower rates and consequent historic wave of mortgage refinancing activity in 2020 and 2021. Those stimulus measures enabled consumers to significantly improve both their household balance sheet and monthly cash flow. As those positive effects recede, and as higher interest rates potentially persist, the combination of higher monthly payments and resumption of student loans can weigh further on the consumer and broader economic activity.
The NEAM responses herein are not an offer to provide investment management services and do not constitute investment advice or a recommendation to buy or sell a specific security or adopt a specific investment strategy. Future results may significantly differ from any forward-looking statements made herein depending on factors such as changes in securities, financial markets or general economic conditions. Investing entails risk, including the risk of loss. In no event shall NEAM be liable for any damages, losses or liabilities in connection with the use of this information.
Source: Strategic Asset Alliance, New England Asset Management The information contained herein has been obtained from sources believed to be reliable, but the accuracy of information cannot be guaranteed.