Writing by Tom Wileman. Illustration from Unsplash.
The Western world has recovered remarkably well from the Great Recession of 2007-09. It took just five years for economic indicators such as unemployment and Gross Domestic Product to return to pre-recession levels, and largely continued to trend upwards before the impact of the coronavirus pandemic. However, with student debt, the British economy may be sowing the seeds for a similar disaster in the years to come.
In brief, the Great Recession largely sprung from a collapse in the US housing market. Over $1 trillion worth of ‘sub-prime’ (high risk of default) mortgages were awarded, and NINJA loans (no income, no job or assets) became increasingly popular. These loans were awarded with little to no provision around the ability to repay, and from 2006 onwards millions defaulted, especially as the interest rates were adjusted upwards. Furthermore, subsidiary financial industries emerged as banks, pensions and hedge funds across the world traded ‘packages’ of mortgages and loans. This process is known as ‘securitisation’ and was a major contributor to the massive growth of banks in recent decades. As author Michael Lewis states, ‘it’s what allowed a housing crisis to become a nationwide economic disaster.’ These packages are known as Collateralised Debt Obligations (CDO) and Asset-Backed Securities (ABS). As defaults increased, these CDOs and ABSs lost billions in value, and subsequently, investors and banks across the world (including Britain) who had purchased these packages en masse did too. The UK banking sector had exploded in value since the 1960s, and thus these losses penetrated into most parts of the wider British economy. (1)
Low-interest student loans were introduced in Britain in 1990. Back then, the average loan was just £390. Tony Blair’s Labour government introduced tuition fees (of £1000/year) and largely replaced maintenance grants with maintenance loans. Tuition fees famously rose to £3000/year in 2005, and to £9000 for full-time students from 2012. Whilst the devolved Scottish, Welsh and Northern Irish governments have largely reduced student fees for their own residents, the increase in loans and fees, combined with soaring numbers of students enrolling at university, means UK student loan debt has exploded in the last decade. The value of outstanding student loans in 2019 totalled £121 billion. Currently, two million UK students are studying at university, as both application and acceptance rates have almost doubled in the past 25 years. The government expects total UK student loans debt to reach £450 billion (in 2019 prices) by 2050.(2)
The similarities between the US mortgage boom of the early 2000’s and the UK student loan enterprise do not stop there. The ‘Dearing Report’ (the report which recommended the introduction of tuition fees to the Labour government) advised against the idea of ‘securitisation’ of student loans, and the British government did indeed listen to this advice. For a while. Both Gordon Brown’s administration and subsequent Conservative governments have quietly announced their intention to sell off pre-2012 loans, and in 2017, the process began. £7.4 billion of student debt was sold for £3.6 billion to various banks and pension funds, and thus the first CDOs of the UK student debt industry were born.
Now this alone is no cause for concern; these figures are a drop in the ocean compared to the figures of a decade ago. Additionally, pre-2012 debtors will have a smaller loan than post-2012 debtors, theoretically making it more likely a large percentage will be repaid, due to the lower gross figure of the debt, lower nominal amount of interest, and less competitive graduate market.
In reality, student loans are a more stable investment than a standard mortgage. Many do not like to consider tuition fees and loans as ‘loans’ at all; (as of 2020) these loans are income-contingent, and most are paid off at a rate of 9% on income over £26,575. Furthermore, these loans are written off after 30 years. The UK securitisation market for student loans has also barely gotten off the ground, compared to the trillions in value of CDOs flying around the world’s investment funds before the Great Recession.
But just because there are distinct differences between the tinder box of the Recession and the UK’s student debt economy does not mean we are not treading a similar path. Most of the world’s economists saw mortgages as the among the safest investments one could make (‘because who doesn’t pay their mortgage?’). The phrase ‘as safe as houses’ took quite the hit in 2007. So we should be wary about considering student loans to be structured too stably to fail. The British government has also not sold off the large majority of these loans i.e. the post-2012 loans, and likely will not for a few years yet despite their stated intention to. But whilst I may be speculating prematurely, I don’t believe I am wrong. These early loans will likely be a success, and may convince the government to push forwards with the securitisation of the much different post-2012 loans. The United States has a much more developed student debt securitisation market, and thus we can follow in the footsteps of America as we seem increasingly keen to do in many aspects of policy at present.
If real wages continue to stagnate across Britain, and an increased volume of graduates are unable to pay off a large percentage of their loans going forwards, the returns on investment in these student debt CDOs could turn out to be much lower than predicted, much like in 2007 when millions defaulted.
Securitisation is a solid idea in theory, and there is certainly a pathway for the government to use it pragmatically - but do you trust them to? If the Treasury continues to suffer liquidity issues as we navigate a post-Brexit, post-pandemic, more unstable economy, it is likely the government’s demand for instant liquidity may push them into further privatisation of Britain’s debt. Suddenly we find ourselves repeating the steps of the Great Recession. Putting the repayment of student debt into the hands of banking institutions and hedge funds also indirectly increases private influence in Britain’s Higher Education policy. Is it inconceivable to believe these banks would not lobby the government to lower the repayment threshold going forwards, ask for an increase on the 9% payback rate, or further the period of time before loans are written off if the returns on their CDOs look to be lower than they predicted?
If Britain’s student debt crisis were to materialise, it will likely be over decades rather than years. It may even be avoided entirely if we are pragmatic. But this requires forward-thinking and sensible policy, combined with learning the lessons of the Great Recession, and I am not sure I have faith in either of those conditions being met.
1. Haldane, A. 2010. The Contribution of the Financial Sector – Miracle or Mirage? Available at www.bankofengland.co.uk (speech 442)
2. The House of Comons Library (available at; https://commonslibrary.parliament.uk/research-briefings/sn01079/#:~:text=Currently%20more%20than%20%C2%A317,the%20middle%20of%20this%20century.)