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 managing editor of the Strategic Short Report.

Recent Articles

Extra!
6 Reasons You’ll Love Being a Late-Stage Investor

Matthew Milner

When investing in a private company, there are two kinds of investors: early-stage and later-stage. And while early-stage investors have more upside potential, they're also exposed to far more risk. Today, Matthew Milner explains how you can be a successful later-stage investor, and still make great gains, with much less risk. Read on...


Video
How to Predict an Economic Collapse

Kate Incontrera

In his recently released book, A Viennese Waltz Down Wall Street, Mark Skousen gives the Austrian School's take on what triggered the 2008 financial crisis - and why you should be wary of the artificial boom that's driving the recovery.


Laissez Faire
Why Heartbleed Will Change the Internet as You Know It

Mike Leahy

The Heartbleed bug is a massive security flaw that could put you and your personal information at risk. And while there are things you can do to limit the damage, you haven't yet seen the ramifications of this security disaster. The Internet in the post-Heartbleed world won't look like anything you've seen before. Mike Leahy explains...


Big Opportunity in the “Baby Bakken” Oil Field

Matt Insley

As the U.S. "shale gale" nears its 10th birthday, it appears the America energy renaissance has outlived its critics. Still, it's natural to wonder whether all the big gains are behind us. Today, Matt Insley reveals the newest shale hotspot, and explains why there's still plenty of opportunity left in the U.S. energy boom. Read on...


Maestro
The Real Reason the US Media Hates Vladimir Putin

Marc Faber

The U.S., Russia, the EU and Ukraine all met in Geneva, where all sides agreed to halt all violence and provocations in Ukraine. But the news media are still taking an antagonistic stance toward Vladimir Putin and Russia. What gives? Today, Marc Faber explains the hypocrisy behind U.S. foreign policy... and the BS the news media are pushing about it...