Student Loans Targeted by the Biden Administration

Jacob Hess

August 24, 2022

• Fiscal Policy
• Inflation

The calls to act broadly on the student loan issue have finally been answered by the Biden administration. On Wednesday, August 24th, President Biden moved to cancel $10,000 of student debt for borrowers with income of $125,000 or less. Individuals who received a Pell Grant are eligible for student loan forgiveness of up to $20,000 with the same income restrictions applying. It is made clear that “No high-income individual or high-income household – in the top 5% of incomes – will benefit from this action.”

In the same executive order, President Biden announced two other actions:

• One final extension of the pause on federal student loan repayment through December 31st, 2022.
• Protection for low-income borrowers through a cap on monthly payments for undergraduate loans at 5% of discretionary income.

The executive order appears to be one final move in providing student loan relief for the hardships associated with the COVID-19 pandemic. The student loan repayment moratorium will have lasted almost three years when it reaches its end in December after several extensions across the Biden and Trump administrations. The $10,000 loan forgiveness for most borrowers follows some targeted action that the Biden administration enacted.

The Economic Implications

The economic implications are not insignificant. Wells Fargo discussed what was on the table for student loan policy back in June, and it outlined the economic implications of different options. The report points to a New York Fed analysis which suggested that the plan to erase $10,000 worth of loans per borrower (with no income cap) would disappear a total of $321 billion in student debt and eliminate the entire balances of 31% of borrowers. This is about what one could expect the effect of Biden’s forgiveness program will be since the income cap of $125,000 is pretty high.

While it’s not new, it’s also worth noting the effect of extending the moratorium on loan repayments. The Wells Fargo commentary estimates that households not having to make payments on student loans has freed them from debt interest payments worth “approximately $3.2 billion per month, which amounts to just 0.2% of monthly personal income.” This effect will be extended four more months, though it might not be as potent with many balances being wiped out completely.

The net impact of both measures is positive for consumers. This will free up thousands of dollars in cash for households who were eyeing the looming repayment relief deadline, and others who were patiently waiting on Biden to make a move on student loan forgiveness. The disappearance of uncertainty alone is enough to inspire consumers to spend more and feel less bad about the impact of inflation on their wallets.

Additionally, it should be a positive on credit scores in general as delinquency was becoming an issue in the pre-pandemic period. According to data from the New York Fed, 15% of borrowers were either 90+ days delinquent or in default accounting for almost 7 million borrowers. While the pandemic halted the growth in those categories, millions more borrowers faced unchanged or larger loan balances in 2021 as they waited for the moratorium to end. Lowering the debt load of these individuals allows them more options in seeking credit for large durable goods purchases.

Expansionary Fiscal Policy and Inflation

It’s hard to be a critic of student loan forgiveness. The $1.59 trillion behemoth sitting on US consumers’ balance sheets has been a glaring issue since the Great Recession. The path in delinquency rates over the past decade was troubling before finally levelling out in 2018 and 2019. Student loan forgiveness is also a relatively effective way to target low- and mid-income households who are disproportionately affected by high debt levels. About 55% of the total student debt load is held by individuals younger than 39 years old who are likely to have lower-paying jobs.

Indeed, expansionary policy is typically a good thing and looked at as a way to expand economic growth and prosperity. This also means it tends to have an inflationary effect on the economy in the general sense that it increases the amount of money available to the public if not paired with policies that are disinflationary. Because of this, critics will point out that the timing of student loan forgiveness is unfortunate considering the level of US inflation (the annual growth of the US CPI is at 8.5% as of July).

In particular, the relief from Biden’s executive order will likely support goods consumption which had been declining in the first half of 2022. Real goods personal consumption expenditures fell -0.3% QoQ in Q1 2022 and -4.4% QoQ in Q2 2022, but this wasn’t necessarily a terrible thing as the Fed was looking for demand for goods to weaken so that inflation could ease. Reversing this trend puts upward pressure on inflation, or it forces the Fed to be more aggressive in tightening.

The housing market, which has shown signs of weakening in Q2 and Q3, is another area that could benefit. New home sales were just reported to be down -12.6% MoM and -29.6% YoY in July with inventory expanding 18.5% MoM and 81.7% YoY. With new homebuyers suddenly $10,000 in their pockets (and for couples, it could be as much as $20,000), saving for a down payment on a house becomes a lot easier. Mortgage rates will still make affordability an issue for many, but larger excess cash balances can provide support for home prices.

It’s certainly an interesting time with the Fed engaged in an aggressive tightening cycle while the federal government toys with fiscal policy through the Inflation Reduction Act, which includes infrastructure spending and a corporate tax hike, and now student loan forgiveness. The combination of these policies will make it hard to anticipate the effects on the economy which increases the likelihood of a Fed policy error. Nevertheless, it is still irresponsible to try and make federal student loan forgiveness at any level a completely bad thing. Many will be granted much needed relief from debt that limited their opportunities.