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 One Word Every IPO Investor Needs to Know

Jonas Elmerraji

When a big company IPOs, investors can hardly contain their excitement. In a flash of exuberance, they throw money at a company they've already decided is worth something... even if the market hasn't made up its mind yet. Today, Jonas Elmerraji explains how one simple word can change the fate of every IPO investor. Read on...


5 Min. Forecast
How to Spend $5.5 Million on a War You Already Won

Dave Gonigam

Baltimore was abuzz this weekend with parades, festivities, tall ships and air shows... And it only cost $5.5 million of taxpayer money! Yes, Saturday marked the bicentennial of a critical moment in the War of 1812 - the battle of Fort McHenry. And if you know of a better way to celebrate a war, Dave Gonigam is all ears...


The First Step to Self-Publishing Your Book

Chris Campbell

Want to self-publish a book? You can't afford to miss out on this series. Chris Campbell promises to deliver a step-by-step guide to self-publishing that leaves nothing out. Today, you'll learn how the most successful self-published book got to where it is today - and how you can use the same strategy to make your own book a success. Read on...


One Commodity Worth Buying Right Now

Greg Guenthner

While most of the commodity sector is getting beaten down right now, there's one commodity that's been on an uptrend since early 2013. And you're in luck... It's on a two-week dip in price right now, that could turn around any minute. Today, Greg Guenthner explains why this could signal a solid buying opportunity. Read on...


3 Things Driving the Biggest Investment Story of the Decade

Ray Blanco

Forget about the new iPhone or the Apple Watch. They may create a huge frenzy right now, but they don't have any staying power. In fact, as Ray Blanco points out, these new products are just fads, especially when compared to one incredible story that's poised to be the biggest technology trend of this decade. Read on...