Dan Amoss

A hidden time bomb ticks away inside the government budget: Within a handful of years, US taxpayers will be on the hook for over $100 billion in student loan defaults.

Just last Friday, the US Department of Education released new data on student loan defaults. In short: The hissing sounds coming from the student loan bubble are getting louder.

I doubt it’s a coincidence the Department of Education chose last Friday (when attentions had shifted to the weekend) to release new three-year cohort default rate data for federal student loans. The three-year cohort default rate is defined as follows: the percentage of borrowers who enter repayment on certain loans during a particular federal fiscal year (Oct. 1-Sept. 30) and default or meet other specified conditions prior to the end of the second following fiscal year.

The default rate is horrendous, and it’s only going to get worse. These are uncollateralized loans, so losses given default will be orders of magnitude higher than losses on subprime mortgages; in subprime, losses were mitigated by the value of housing collateral.

“More than one in 10 borrowers defaulted on their federal student loans, intensifying concern about a generation hobbled by $1 trillion in debt and the role of colleges in jacking up costs,” a Bloomberg story notes. The story continues:

“The default rate, for the first three years that students are required to make payments, was 13.4%, with for-profit colleges reporting the worst results, the US Education Department said today.

“The Education Department has revamped the way it reports student loan defaults, which the government said had reached the highest level in 14 years. Previously, the agency reported the rate only for the first two years payments are required. Congress demanded a more comprehensive measure because of concern that colleges counsel students to defer payments to make default rates appear low.”

This 13.4% figure will surely go higher. The post-2008 surge in student loan volume won’t season and start defaulting until after the Class of 2013 graduates. Then we will see the real fireworks. This crisis will finally capture the public’s attention.

What are the investing implications of these defaults-in-waiting? An obvious conclusion is to avoid owning the for-profit education stocks, no matter how cheap they may appear. Education stocks including Apollo Group (APOL) and ITT Educational Services (ESI) probably face a surge in legal and regulatory risk once the enormous scale of student loan defaults comes to public attention next year. In fact, even after they’ve suffered large declines, the for-profit education stocks are starting to look like attractive short sales.

Regards,

Dan Amoss,
for The Daily Reckoning

Dan Amoss

Dan Amoss, CFA, is a student of the Austrian school of economics, a discipline that he uses to identify imbalances in specific sectors of the market. He tracks aggressive accounting and other red flags that the market typically misses. Amoss is a Maryland native, a graduate of Loyola University Maryland, and earned his CFA charter in 2005. In spring 2008, he recommended Lehman Brothers puts, advising readers to hold the position as the stock fell from $45 to $12. Amoss is our macro strategist and guardian of The 5 Min. Forecast PRO.

Recent Articles

The US Debt Crisis that Will Never Happen

Chris Mayer

One of the most heated political battles raging across the western world is debt versus austerity. In the U.S. this debate reached it's apex in 2011 when the U.S. credit rating was downgraded by Standard and Poor's. In today's essay, however, Chris Mayer throws the debate out the window, explaining why he thinks a U.S. debt crisis will never happen...


3 Tips to Finding Small Companies With Huge Potential

Matthew Milner

Believe it or not, more capital for a company doesn't necessarily mean better returns for investors. In fact, in a recent study that dug through data from more than 200 acquisitions going back to 2006, they found a "sweet spot" for the most likely acquisition targets. And it's lower than you think. Matthew Milner explains...


Disruptive Innovation Will Change How You View Obamacare

Greg Beato

The Affordable Care Act dumped 2,000 pages of regulations into the health care sector, stifling any innovation that could have brought about real cost savings. But even with these obstacles, there are still people looking for ways to do things better and at a lower cost. These new technologies could be the key to fixing health care in America...


Why Old-School Tech Stocks Are Beating Social Media

Greg Guenthner

While many of the newer social media stocks struggle for gains this year, old-school tech stocks have become some of the best trades on the market. With the rare exception (Facebook is doing well—shares are up 26% year-to-date) the social stocks are in the gutter. They got off to a fast start in January and Februray, but ran out of steam in the spring. Aside from a few feeble attempts, few have posted anything close to a noteworthy comeback. Twitter, LinkedIn, and Groupon are all down double-digits year-to-date. Groupon—the worst performer on this short list—is down 47%. On the other had, the biggest of the big tech stocks on the market are helping traders pile up even larger gains right now. Greg Guenthner explains…


Video
Creditism and the Threat of a New Depression

Richard Duncan

In the 1960s, total credit in the U.S. broke the one trillion dollar mark...and since then, it has expanded over 50 times. But now, as Richard Duncan explains, the explosion of credit that's made America prosperous, threatens to take the entire economy down. And that could mean the return of another depression...