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If you’re looking for a new economic doomsday scenario, U.S. student loan debt default is probably a solid choice. The country’s student loan debt now sits north of $1.3 trillion, according to the Federal Reserve Bank of New York. As of 2012, U.S. Department of Education data show that 48 percent of students were taking out loans for their education, up from 33 percent in 2002; more and more members of that group are going into default.

Students who are behind on or have defaulted on their loan debt take a major hit to their credit scores, which can limit their ability to find jobs and buy cars and homes. Also, parents who have cosigned on loans may become the target of debt collectors and see their credit suffer too if they’re unable to pay. Economists and regulators have drawn parallels to the mortgage crisis, and some investment managers predict that taxpayers may be on the hook for a bailout when the rising default rate becomes too much for the economy to bear.

Players in the credit markets have long traded in securitized baskets of student loans, with some shorting their imminent demise, but the student loan–backed securities market is somewhat illiquid. Now equities traders are getting in on the act with a group of stocks that represent the business end of the American collegiate system, and they’re betting that the college industry will feel the heat. Companies on their list range from debt collectors and loan servicers to textbook publishers and student housing builders.

So how did we get here? Rapidly rising college tuition has been a problem for U.S. students since before the financial crisis, and it has only been exacerbated by a tepid economy. If you went to school in 1976, the average yearly cost of tuition, room and board was $2,275, according to the Washington-based National Center For Education Statistics, a branch of the Department of Education. Today out-of-state tuition, room and board at a public four-year institution cost $32,762 per year on average, the New York–based College Board reports.

Just as going to school was getting more expensive, employers shifted their expectations. A bachelor’s degree is required for even the most basic employment, and when the financial crisis hit, many students opted to stay in school longer to pursue advanced degrees, in the hope that having an extra level of education would make them stand out in the fight for the few available jobs that pay a living wage.

On average, new graduates make $48,707 — not much more than one year of school — according to the Bethlehem, Pennsylvania–based National Association of Colleges and Employers. Upward mobility remains elusive: Data from the Bureau of Labor Statistics show that on a seasonally adjusted basis and before taxes, hourly wages rose just 2 percent in the 12 months ended this August. Starting salaries do go up for those with advanced degrees, given that such programs typically require specialization.

Meanwhile, new types of schools have emerged that operate on a for-profit model, often appealing to low-income students and offering online access for a high price with little in the way of postgraduate job placement. All of this means that America’s students have more debt, fewer prospects and a higher debt default rate than any previous cohort.

The table below from a recent report by Washington-based think tank the Brookings Institution shows the growth in debt per school from 2000 to 2014. The highest default rate comes from attendees of for-profit and two-year colleges. But the debt load at many other institutions is equally significant, as is the potential for default.

 
Institutions Ranked by Accumulated Federal Loans
of Their Students, 2000 and 2014
Rank   Institution TOTAL DEBT ($1,000s) Total Borrowers   Institution TOTAL DEBT ($1,000s) Total Borrowers   5-Year
CDR
%
Balance Repaid
2000 2014 2009 Cohort in 2014
1   New York University $2,184,601 72,650   University of Phoenix–Phoenix Campus $35,529,283 1,191,550   45% 1%
2   University of Phoenix–Phoenix $2,099,828 103,475   Walden University $9,833,470 120,275   7% 0%
3   Nova Southeastern University $1,736,919 34,900   Nova Southeastern University $8,748,887 94,350   6% -3%
4   Pennsylvania State University $1,710,951 123,800   DeVry University–Illinois $8,249,788 274,150   43% -4%
5   University of Southern California $1,609,511 51,525   Capella University $8,043,635 104,450   19% -5%
6   Ohio State University–Main Campus $1,533,954 82,250   Strayer University–Global Region $6,693,570 144,400   31% -6%
7   Temple University $1,531,762 59,900   Kaplan University–Davenport Campus $6,664,067 220,125   53% 0%
8   Arizona State University–Main $1,385,858 70,675   New York University $6,307,264 110,775   6% 34%
9   Michigan State University $1,321,997 65,650   Argosy University–Chicago $6,179,207 104,325   15% -7%
10   University of Minnesota–Twin Cities $1,289,873 66,675   Ashford University $5,891,799 205,000   47% 2%
11   Boston University $1,289,257 50,850   Grand Canyon University $5,881,420 145,850   36% 0%
12   University of Texas at Austin $1,264,226 64,650   Liberty University $5,678,555 142,875   14% 14%
13   University of Florida $1,186,645 52,050   University of Southern California $5,340,123 83,400   5% 20%
14   University of California–Los Angeles $1,159,430 54,975   Pennsylvania State University $5,310,636 210,125   14% 21%
15   University of Michigan–Ann Arbor $1,126,159 44,725   Arizona State University–Main Campus $4,928,019 158,800   17% 12%
16   Columbia University $1,120,001 31,225   ITT Educational Services Inc System Office $4,618,538 191,225   51% -1%
17   University of Pittsburgh–Pittsburgh $1,106,448 48,925   Ohio State University–Main Campus $4,362,143 132,725   12% 19%
18   Indiana University–Bloomington $1,101,234 53,225   Temple University $4,251,334 100,500   12% 13%
19   Rutgers University–New Brunswick $1,077,418 60,150   DeVry University's Keller Graduate School $3,900,283 49,375   13% 1%
20   University of Pennsylvania $1,033,615 33,300   American InterContinental University–Online $3,735,319 129,850   41% -3%
21   University of Arizona $983,809 45,975   University of Minnesota–Twin Cities $3,679,264 101,650   7% 18%
22   University of Wisconsin–Madison $981,553 45,050   Michigan State University $3,596,661 99,925   11% 14%
23   Florida State University $976,114 49,125   Rutgers University–New Brunswick $3,436,474 116,925   9% 19%
24   Virginia Commonwealth University $965,668 39,425   Colorado Technical University–Colorado Springs $3,300,070 114,000   47% 1%
25   University of Washington–Seattle $954,589 51,625   Indiana University–Purgue U.–Indianapolis $3,141,584 74,500   15% 10%
Notes: This figure ranks institutions by student loans outstanding in 2000 and 2014. For each year, the first column shows the institutions name, the second column shows the total volume of student loans outstanding and the third column shows the number of outstanding borrowers. Dollar values are in thousands of 2014 dollars. 5-Year CDR is the fraction of the 2009 repayment cohort that had defaulted by the 5th year (2014). % Balance repaid is the fraction of the total balance of borrowers who entered in 2009 that had been repaid by 2014 (1-[total balance 2014]/[total balance 2009]). Negative numbers indicate balance has increased.

Source: U.S. Treasury tabulations of 4 percent NSLDS sample.

Source: Brookings Institution.

Changes in the way that debt is managed first attracted investors in the bond markets. Newark, Delaware–based Sallie Mae, the federal government’s biggest student loan organization, has been offering securitized baskets of student loans since the 1980s. Then in 1998, Congress opted to make it impossible for students to discharge their student debts in personal bankruptcy. Since 2010, when the government ceased the origination of federal student loans by private lenders, the DoE has provided all such loans, with a Department of the Treasury guarantee. Even if borrowers quit paying, creditors have a golden parachute — or so they think.

The current default rate hovers around 17.9 percent, up from 13.9 percent at the end of 2007, according to Juan Sánchez, senior economist at the St. Louis Federal Reserve Bank. There is also a group of students known as shadow defaulters who haven’t yet defaulted but are 90 or more days delinquent on their loans, making the probability of default much more likely.

Taylor Mann, CIO and founder of Pine Capital, a boutique research and hedge fund firm in Larue, Texas, has emerged as the go-to resource for many investors — including other hedge funds — on how to short the student loan market. He says the bond market for student loans and the equities of the publicly traded companies that handle the debt are inextricably linked.

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