With the return of student loan payments just weeks away, the implications of a new financial burden hitting an already sensitive U.S. consumer base are in focus. According to one “exquisite” analyst, student loans may even lower home prices.
Economists have long expressed concerns over the return of student loan payments. Indeed, student debt payments have been on pause since the start of the Covid-19 pandemic. After a slew of last-minute extensions to the moratorium over the past year and a half or so, alongside short-lived aspirations of a debt-forgiveness initiative, the debt-ceiling deal signed earlier this summer locked in student loans’ comeback.
Student loan interest will start accruing in September, with the first payments due in October. For some businesses, like SoFi (NASDAQ:SOFI), which made its bones off the back of student loans and student loan refinancing, this is a win. For the more than 44 million Americans whose net student loan debt exceeds $1.6 trillion, however, the end of the federal moratorium marks the return of a potentially debilitating financial obligation.
A recent Credit Karma survey shows that 56% of student loan borrowers stated they’ll have to choose between loan payments or bare necessities like rent and food. This isn’t just low-income households either. In fact, 45% of borrowers with household incomes more than $100,000 say they will be forced to make the same concession. Perhaps even more concerning, 45% of borrowers surveyed expect to go delinquent on their loans when payments resume.
Now, President Joe Biden’s administration has implemented a 12-month grace period allowing borrowers to miss or make late payments without any delinquency or credit penalty. But that won’t stop interest from accruing.
With consumers still reeling from elevated inflation and still-rising interest rates, student loans present a unique threat.
Will Student Loan Payments Cause a Housing Market Crash?
According to Michael A. Gayed, publisher of the Lead-Lag Report and portfolio manager at Tidal Financial Group, the return of student loans represents a bearish catalyst for the U.S. real estate market. In an interview with InvestorPlace, Gayed offered some insight into the interconnected nature of consumer activity as it pertains to housing:
“It takes time for people starting to realize that, wow, now their interest rate on their credit card went from 20% to 25%, then maybe 30%. Who knows after that, based on where rates are going. So under that setup, it’s only a matter of time until consumers start to realize that they have to cut back on their discretionary spending. Now, if I’m right about that too, combined with the student loan payment resumption, very suddenly then, I suspect you’re going to have consumers really pulling back almost all at once, because they start realizing that their cash flow is not what it once was. You get that, I promise you, unemployment rises. You get that, I promise you housing prices start going down.”
To Gayed’s point, the state of the U.S. consumer is tenuous at best. While consumer spending has held strong the past year, this is likely a product of rampant credit spending. In fact, earlier this month U.S. credit card debt exceeded $1 trillion for the first time ever. As much as the Federal Reserve loves to describe the healthy and resilient consumer base, holes are clearly starting to form in the central bank’s narrative.
Consumer spending is often referenced as the engine of the U.S. economy. What happens when the engine starts to falter?
Student Loans May Lead to Housing Selloff
Housing inventory has long represented one of the major barriers to sweeping home price corrections across the country. It varies by region, but generally, there’s a shortage of available homes for sale in the U.S. The pinched housing supply has made it such that, even as 30-year fixed mortgage rates soar over 7%, home prices have held on quite well.
Gayed believes, however, the return of student loans may rebalance the disjointed housing market:
“So you have the student loan repayments. That probably hurts the hospitality side because now there’s less cash flow to go around for traveling. That hurts the Airbnb players, the owners, because now they’re not getting income from their second, third, fourth properties. That might result in some selling of those second, third and fourth properties. And that then maybe sparks a broader inventory unleash in the housing market.”
Gayed’s thesis is relatively simple: as bubbling financial concerns like student loan and credit card debt increasingly weigh on consumers, spending on luxuries like travel — and thus, rentals — will decline. This will bear down rental property owners, likely forcing some multi-property real estate investors to liquidate their tertiary properties. As a result, this will ease the supply tension for homes in the country. As inventory returns, prices will inevitably fall as a function of the general decline in the demand for homes, facilitated by historically high mortgage rates.
It’s hard to argue with the logic.
Credit Event on the Horizon?
Gayed’s debt-driven housing pullback is part of a wider theory surrounding an impending “credit event.” Anyone who has spent any time perusing Gayed’s humorous and informative platform on X, formerly Twitter, will have noted the frequency with which the fund manager notes the presence of a looming credit event.
A credit event refers to a sort of margin call that results in an inability for both corporations and consumers to refinance their debt, leading to an influx of defaults that destabilize financial systems.
Earlier this summer, in a Seeking Alpha article, Gayed wrote:
“If corporations start to default on their debt due to difficulties in refinancing, this could lead to a contraction in credit availability, a common precursor to a recession. In such a scenario, we would likely witness higher unemployment rates as businesses cut costs in response to the economic downturn, and an increase in housing inventory as construction slows and foreclosure rates rise.”
It’s hard to imagine the potential repercussions of such an intrusive and historically rare occurrence, but to keep it simple: a credit event would be bad. Optimistically, such an event would result in a massive loss in consumer confidence, reflected in reduced spending, and a potentially brutal reversal in equities. Pessimistically, a credit event would plunge the world into a historic recession.
We are on the verge of a global margin call.
The path is all we can hope to manage.
This is an extremely dangerous environment for stocks.
I expect Treasuries will counter to reset the flight-to-safety trade that was my hell last year.
Good luck to all.
A credit event nears.
— Michael A. Gayed, CFA (@leadlagreport) August 14, 2023
With credit card debt hitting new highs, the Fed continuing its unprecedentedly quick rate-hike campaign, and Fitch’s recent downgrade of U.S. credit, the return of student loan payments may end up being the straw that broke the consumer’s back.
On the date of publication, Shrey Dua did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
