DP11938 Students in Distress: Labor Market Shocks, Student Loan Default, and Federal Insurance Programs
The collapse in home prices during the Great Recession triggered a sharp drop in consumer demand by households, leading to massive employment losses. This paper examines the implications of these labor market shocks for the dramatic rise in student loan defaults, which originated during this time period. Linking administrative student loan data at the individual borrower level to de-identified tax records and exploiting Zip code level variation in home price changes, we show that the drop in home prices during the Great Recession accounts for approximately 24 to 32 percent of the increase in student loan defaults. Consistent with a labor market channel, we find a strong relationship between home prices, employment losses, and student loan defaults at the individual borrower level, which is concentrated among low income jobs. Comparing the default responses of home owners and renters, we find no evidence of a direct liquidity effect of home prices on student loan defaults.
Lastly, we show that the Income Based Repayment (IBR) program introduced by
the federal government in the wake of the Great Recession reduced both student
loan defaults and their sensitivity to home price fluctuations, thus providing student
loan borrowers with valuable insurance against adverse income shocks.