To be clear, I think there are two separate questions here. Are student loans in a bubble, and the more general question about what are the consequences of a system where we can no longer assume that the earnings differential provided by of a college degree (which is real) will be sufficient to pay off the costs of going to college (debt-financed or otherwise). In other words, what happens when the NPV of a college education to the individual goes to 0 or worse.
If student loans are in a bubble, that means that the investors in student loans (i.e. the lenders) stand a sizeable risk of substantial losses in not just interest payments, but also principal. I don’t think this is likely because 1) student loans are heavily protected, and 2) if regulations on these are loosened up, there will almost certainly be insurance, or grandfather clauses, or some system of purchasing existing loans with tax dollars to protect existing lenders as part of the political bargaining process to make it happen. They may get haircuts (i.e. less than they expected), and there may be reschedulings, but they are probably not going to be facing 30%, 40%, or higher losses on portfolios of student loans.
Also, student loans are not nearly as large a segment of the fixed income market as the mortgage market. One problem with the mortgage situation was that foreclosures pushed down the costs of housing which put more people underwater. It constrained the economy rapidly when people could no longer use their homes as an ATM which threw people out of work, leaving them unable to pay their existing mortgages, leading to more foreclosures, and pushing prices down further. The feedback loops in the student loan system are not nearly as vicious. It’s true that if someone sees that their friend got out of a student loan somehow, they might try to do that too, that’s about the extent of the feedback loop. Few people are expecting recent graduates to start spending money with abandon, so if they take longer to start spending, it’s not going to tip the economy into recession the way that home price slowdown (and then contraction) did.
Now, if you have an ABS that is highly leveraged, like some kind of waterfall structure that gets wiped out if default rates creep up a percent or two, those guys are likely to have problems, but no one should invest in a leveraged structure like that if they aren’t prepared for that possibility. That’s caused by the structuring, and not the underlying security.
To the extent that there is a bubble, it is likely in the price of a college education, and not the student debt that is taken on to pay for it. People may simply stop going to expensive colleges or find other ways to get an education. We haven’t figured out the model yet, but it’s clear to a lot of people that another model for education is needed, and there are at least some attempts to set up alternatives. So colleges may slowly find that if they can’t push themselves as an elite brand that funnels to the highest paying jobs, they simply cannot charge what they have been charging.
I personally think what is liekly to happen is that we get a kind of pay-as-you-go a-la-carte online vocational training, perhaps with brick-and-mortar support locations (like kaplan), where companies train people to do the tasks that they need and no more or less; companies then will value experience more than a college degree. This will be a lot cheaper than schools that have to build dorms and gyms and student unions and student health centers.
There are a whole set of issues that are cropping up as one has a generation of students under the current system who can’t pay off student loans because they are just too large. As BS said, they are going to be putting off lots of decisions like buying homes, furnishing them, starting families, etc., and in an economy driven by consumption, that’s going to put downward pressure on economic growth.
There’s also a question about some of the soft skills that are needed to get young adults into the working place. A company might pay for education for a skill they need right now, but things like leadership, how to work in teams, etc., may get pushed further back onto either parents or the public (and private) school system in K-12 or community colleges. There are things that people learn in school that business may benefit from but don’t feel like paying for.
An interesting question is whether it will be possible to refinance student loans in a way that they could be discharged in bankruptcy. For example, if one currently issues a cash-out refinancing of a home, and then pays off student loans with them, you have the same level of indebtedness, but now one can default on it and have a foreclosure. It may be hard to do that with unsecured loans, simply because of lending limits, but this is one thing that might start happening.