How US student loans could cause the next share market crash
By David Taylor
An accounting professor at the University of Sydney's Business School says a dip in the share market is now imminent.
"World financial markets could be facing a major correction possibly leading to another global financial crisis," Dr Stewart Jones said.
So is he right?
Let's go back to September 15, 2008. That's when one of the world's biggest investment banks, Lehman Brothers, collapsed.
The bank had been trading a huge portfolio of CDOs (collateralised debt obligations). They're what's known as "derivatives" — meaning their underlying value is based on another security which is connected to a real asset, in this case a house.
Basically, when house prices plummeted, and the subprime mortgages related to those houses became worthless, the CDOs were also worthless and so the bank collapsed.
Read the discussion in the comments to see whether our readers thought US student loans could cause another global financial crisis.
New game in town
Now, said Dr Jones, there's a new game in town. Investment banks and hedge funds are currently chasing US student loans.
There are two main types of student loans: federal loans and private student loans. They're distributed to roughly 43 million students.
Some students, years after graduating, have loans in the hundreds of thousands of dollars, but an average loan is about $30,000.
The interest on these loans keeps accumulating, making the asset — the loan itself — worth more and more to creditors.
Data from the New York Federal Reserve shows the total value of US student loans has risen to about $1.3 trillion. It's now the second highest consumer debt category in the US, after mortgages.
EMBED: US student loan debt
A new target for profit
There's a thriving over-the-counter derivatives market worth $US500 trillion globally and now it wants to suck up these student loans and make them tradeable securities.
Dr Jones said investment bankers on Wall Street are once again "cutting and dicing up these loans into collateralised loan obligations", the market for which has been dubbed the "student loan asset back security market" and is currently about $200 billion.
Just like before the financial crisis when unemployed Americans defaulted on their mortgages, now graduates, overwhelmed by their debt, are beginning to default on their loans.
"With default rates on student loans at around 11 per cent, and with a much higher number in a deferral or repayment program, it's looking like an overvalued market," Dr Jones said.
There could now be billions of dollars on Wall Street that are backed by — you guessed it — nothing.
A girl in a graduate gown holds the bars of a cage with protest signs about student debt
PHOTO: The rising level of student debt has attracted protests in the US, (Reuters: Randall Mikkelsen)
Is there smoke?
The ABC asked Westpac's head of market strategy Robert Rennie if he knew of any evidence at all if there was another CDO-type market linked to student loans. He declined to comment.
NAB's chief economist Alan Oster said he simply doesn't know if the derivatives market for student loans has ballooned into the billions of dollars.
He said the only way to know for sure is to comb the balance sheets of Wall Street hedge funds.
Perpetual's head of investment strategy concedes "it has the potential" to cause a crash, but that the probability's very low.
The other market wild card
There's also growing consensus that the recent rally on Wall Street — pushing the S&P 500 to regular record highs — is backed largely by hope that President Donald Trump will make good on his tax plans and infrastructure spending.
Wall Street has always been a buyer of his economic plan. In fact the stocks of companies with the highest tax bills are currently being hoovered up by Wall Street investment bankers — keen to get in before the tax changes announced last week become law.
If a company like Exxon Mobil for example, which forked out $31 billion in tax last fiscal year, pays 10 per cent less tax, its stock price should rise.
As Mr Rennie pointed out, if you believe Mr Trump can get his economic reform policies through Congress, you'd be optimistic about the market, but if you don't think he can that's another story.
Analysts estimate "Trump trade" or the "Trump bump" accounts for between 20 to 50 per cent of the market's recent gains.
That's a lot of money to be unwound if the President disappoints the market.
Implications for Australia
The Australian stock markets is often referred to as the "sheep market" by market veterans. That means more often than not, it follows Wall Street's ups and downs.
If stocks on Wall Street were to crash, the Australian market would most likely follow. And of course your superannuation is tied up in that.
AMP's chief economist Shane Oliver estimates that if the Australian market fell 20 per cent, 10 per cent of the nation's super would disappear. Currently superannuation assets total $2.3 trillion, so we're looking at about $230 billion.
There would be other consequences too. As paper wealth evaporated, it would be tempting to liquidate property assets, which could cause that market to falter.
Ultimately business confidence would be affected, as would hiring intentions and the unemployment rate.
What's the take-away?
This is a warning from an academic who has spotted a growing market that he believes has the potential, if it falters, to spark another stock market crash.
Combine that will what some argue are loft stock market valuations from the "Trump trade", and you have the potential for a crash.
However, Dr Jones said laws brought in after the financial crisis of 2008 mean corporations are now better placed to handle a financial storm. So stock losses next time around may not be as large.
Indeed, stockbroker James Rosenberg argued that given current lofty market valuations, a dip in the market might make for a great buying opportunity for investors.
Unless there is a complete collapse of the global financial system, history shows the next crash will be followed by another bull market — in time.
Whether or not you want to ride the waves though is an entirely different story.
courtesy of ABC News ( although it feels like a Motley Fool article )
the US ?? not closer to home where i notice ads for 'double degrees' ( because one is nearly worthless ???? )
*** The Australian stock markets is often referred to as the "sheep market" by market veterans. That means more often than not, it follows Wall Street's ups and downs. ****
excuse me ??? the US markets are continuously making record highs yet Australia can't get within 700 points .(. more usually 1000 points below) ( pre GFC ) records