What Does Student Loan Forgiveness Mean For Investors?

Key takeaways

• The Biden administration has just a few days left to extend the student debt moratorium or let borrowers restart payments
• The moratorium has sparked debates over how much – or if – student debt the federal government should forgive
• Economists remain divided over the potential impacts of student loan forgiveness at any amounts
• If the government does extend blanket forgiveness, investors could see some ensuing ripples in their portfolios

With the current student debt moratorium set to expire on 31 August, President Joe Biden has just a few days left to release his decision. Will he extend the deadline, or will he let borrowers begin repayments in September – that is the question.

But there is a third option may borrowers and policymakers have pushed for instead: student loan forgiveness. While the jury’s still out on that decision, too, it’s an important one to consider, especially given the potential economic and investment impacts.

What does student loan forgiveness look like?

Federal student loan payments were first paused as part of the original Covid-19 stimulus package to ease borrowers’ financial woes. Since March 2020, there have been no mandatory loan payments, no interest and no collection on defaulted loans.

In other words, student loans have been effectively frozen for over two years – and whether there’s an end in sight remains iffy.

The student debt moratorium and Covid-19 pandemic (and more recently, the prospect of a global recession in 2022) have given more weight to cries for student loan forgiveness. But what that looks like varies widely.

Some proponents argue that everyone should receive student loan forgiveness. While critics argue that benefits higher-earners even more than lower-earners, advocates say it’s the only way to ensure that forgiveness trickles to the people who need it most.

Less extreme measures call for $10,000 or $50,000 in student loan forgiveness. Exact plans vary, but borrowers, economists and Congressional policymakers have proposed everything from a $125,000 income cap to no income caps on these forgiveness measures.

Meanwhile, some members of Congress have opposed any form of widespread forgiveness, or only touted support for far more targeted forgiveness.

Unfortunately for borrowers, there appears to be no permanent relief in sight – just the prospect of another extension in the nearby future.

How student loan forgiveness could affect the economy

Were the student debt moratorium to proceed into full-blown forgiveness, it would mark one of the largest transfers of wealth in American history. Accordingly, the impacts on the U.S. economy could be startling huge – or, by some estimates, remarkably small.

The case for economic shrinkage (or stagnation)

According to the Brookings Institute, Americans hold an estimated $1.6 trillion in student loan debt. That means even a blanket one-time $10,000 payment would cost around $373 billion, more than school lunch programs, SNAP or WIC.

Opponents argue that this bill would cost the federal government substantially in forgone principal and interest payments. The forfeited value would add up to about 0.4% of GDP annually. At the same time, the Committee for a Responsible Federal Budget (CRFB) estimates that GDP would increase just $31 billion over three years, or a mere 1/10th of the actual cost of the initiative.

Additionally, those who oppose the bill argue that widespread forgiveness would not address sky-high tuition costs and could lead to expectations of future debt forgiveness on larger bills, potentially dragging down long-term GDP.

They also argue that the households most likely to benefit would be higher-income households with greater lifetime earning potential.

A study from the Federal Reserve Bank of New York found that the average monthly loan payment is between $200 and $299. While that’s a lot for lower-income households, critics argue that higher earners are more likely to stash the difference in savings, producing no economic benefit.

Adam Looney, a higher education policy expert and professor of finance at the University of Utah, summed it up thusly: “The bang for the buck is quite low.” Because people with student loan debt generally earn more, he noted, “the economic effects of debt forgiveness are exaggerated.”

He proposes that more targeted student loan forgiveness would put money in the hands of the lower-income individuals who need it.

The argument for economic growth and benefit

Broadly speaking, Americans who take on student loan debt have less disposable income and may have credit problems if they can’t repay. Additionally, several recent surveys have found that student loan debt was cited as a top reason for:

Proponents argue that by freeing up even just the $300 a month estimated by the New York Fed, people could have more money to save for a down payment, qualify for a mortgage or start a business. They’d also have more money for nonessential purchases like travel and entertainment.

In turn, the results could ripple through the economy, boosting spending in sectors like construction while potentially adding jobs. Plus, as people owe less debt, they have less reason to default on their loans, potentially spelling good news for their credit scores.

That said, the actual economic impact of student debt forgiveness varies tremendously based on the amount provided and to whom.

For instance, the CRFB estimates that forgiving $10,000 in student debt would eliminate the burden entirely for some 15 million borrowers. Another 28 million would see their obligations reduced. However, these impacts wouldn’t be felt as strongly for new college graduates who haven’t yet started their careers.

But according to Moody’s, student debt relief would act similarly to a tax cut stimulus, breeding a modest increase in household consumption and investment. Long-term, their report finds, reduced student loan burdens could improve household financial independence.

Additionally, because direct loans are funded by U.S. Treasury bonds and already incorporated into America’s debt upon origination, the vast majority of loans wouldn’t increase the deficit.

Student loan forgiveness and inflation

A recent survey from CNBC and Momentive finds that Americans worry that another unpleasant side effect could stem from student debt forgiveness: inflation. Former Treasury Secretary Larry Summers agrees, noting that student loan relief “will also tend to be inflationary by raising tuitions.”

With inflation sitting at a 41-year high of 8.5%, it’s no surprise that Americans (and their policymakers) are worried about this impact. However, experts note that student loan forgiveness would likely hit inflation quite differently than, say, direct stimulus payments.

For instance, Adam Looney believes that student debt forgiveness would have a “small or moderate” impact on inflation. Chief among his reasons is that stimulus checks provide one large, lump-sum payment. By contrast, student loan relief slowly trickles down, freeing up a few hundred bucks a months that make their way into savings accounts, investments or the broader economy.

A recent CRFB analysis supports this view.

Their data indicates that wiping out all $1.6 trillion in debt would raise inflation just 0.1% to 0.5% over 12 months. While that’s significant against the current inflationary environment, it also assumes blanket forgiveness. (Which, according to most experts and policymakers, isn’t currently on the table.) As such, the actual impact on inflation would likely be much lower.

5 ways that student debt forgiveness could affect investors

With the student debt moratorium still up in the air, pinpointing the effects of forgiveness on investors is mostly speculation. However, we can make a few educated guesses about its potential impacts.

More money to invest

Millions of student loan borrowers are also current or potential investors. For those borrowers who also dabble in the markets, a smaller debt load means more to spend, save or invest. (If you’ve been impacted by the recent student debt moratorium, you may have already enjoyed this perk.)

Better bonds performance/yields

Investors who buy bonds backed by student loan debt may also stand to see a slight benefit, as these securities often pay higher yields to compensate for early principal payments. Broad-based forgiveness could flood this market with liquidity and see bondholders enjoy a sudden boon.

If the economy shrinks…

Let’s posit that student loan forgiveness occurs and the economy shrinks in response.

In such an instance, forgiveness may negatively impact portfolio values. This would be especially true if forgiveness occurred during or even sparked a recession, as company growth may withdraw, driving down stock prices.

That said, for long-term investors, a short-term decline is less problematic, as stock prices tend to bounce back during the recovery phase.

If the economy grows…

On the other hand, let’s consider that student loan forgiveness could cause the economy to grow.

In particular, surveys show that Americans see their student loans bogging down homeownership potential. If forgiving student loans led to a spike in homeownership, investors with money in construction or real estate could see their portfolios bloom. The same could be true of venture capitalists putting money into new small businesses.

And, in a broader sense, if student loan forgiveness led to increased consumption and consumer spending, businesses of all stripes could benefit. And when the economy booms, investor portfolios have a chance to boom, too.

A slightly less powerful dollar

Lastly, let’s consider that student loan forgiveness raises inflation even moderately. In this case, investors may see the power of their dollars decline. For investors in cash assets and robust savings, that could mean their accounts become gradually less valuable.

Fortunately, it’s possible to mitigate some of this impact by switching to higher-earning accounts or investing in other assets. (Or you could buy into an inflation hedge like Q.ai’s Inflation Kit.)

Student debt moratorium or no, stay ahead with Q.ai

Currently, the future of student debt remains nebulous. And so, too, does its potential impacts on investors. But no matter what the economy throws at you, Q.ai can help you stay ahead with smarter investments and AI-backed Portfolio Protection.

Download Q.ai today for access to AI-powered investment strategies. When you deposit $100, we’ll add an additional $50 to your account.