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As CARES Act Debt Relief Ends, How Bad Will the Hangover Be?

I have no idea how much of Apple's $170B in sales is coming from student loan borrowers with their loans on deferral. But it’s not $0.
CARES Act

In two months, 37 million Americans are in for a rude awakening.

Some know it’s coming. Others don’t. Regardless, reality is about to set in.

Thirty-seven million Americans have student loans on deferral, as in they borrowed money that doesn’t currently require them to make any payments. But on October 1, the deferment period ends, and payments will resume.

The CARES Act, passed in March 2020, put these payments on hold. So, it’s been over three years since student loan borrowers have had to make any payments.

But now, that extended grace period is over. And I’m not convinced today’s market is fully factoring in the implications.

As you’ll see, they’re pretty material. This is trillions of loans and billions of dollars per month…

Goods and Services Will Take a Hit

According to the Federal Reserve Bank of New York, the average student loan payment hovers around $393 per month, which pencils out to $10 billion or more in payments each month.

This is money going toward paying down debt and interest. It’s not going into the economy to buy goods and services.

The largest cohort of borrowers are between ages 19 and 40. This demographic has certain spending habits, such as on clothes, travel, furniture, and electronics. All that money—$10 billion per month—borrowers were spending on goods will soon shift to the unproductive paydown of debt, including principal and interest.

Let’s put this $10 billion per month into context.

According to the Census Bureau (and highlighted by The Wall Street Journal), Americans spend $35 billion per month on clothing and at department stores. Resuming student loan payments will surely take a bite out of this $35 billion.

And how about electronics? Let’s use Apple AAPL as an example.

Apple generated $169 billion in sales in North and South America last year. Let’s say $120 billion of this was sales solely in the United States. On a monthly basis, that’s $10 billion.

Now, I have no idea how much of that is coming from student loan borrowers with their loans on deferral. But I can guarantee you it’s not $0.

From clothing stores to electronics, the resumption of student loan payments will be felt in certain parts of the economy.

What the Academics Say

Now, there’s an argument to be made that student loan borrowers on deferral used the grace period to build up excess savings and can use those savings to pay off their loans. In other words, they “saved” instead of spent.

But that’s not true according to a few academics at the University of Chicago. Michael Dinerstein, Constantine Yannelis and Ching-Tse Chen had this to say in a May 2023 research paper:

We find that, relative to borrowers who had to continue paying their loans, borrowers who had a pause in their payments sharply increased mortgage, auto, and credit card borrowing.

So, borrowers on deferral didn’t save money. They spent it.

The Consumer Financial Protection Bureau (CFPB) somewhat confirms this view. Its recent June 2023 press release indicated that 8% of student loan borrowers are currently behind on their other payment obligations (i.e., credit cards, mortgages, rent, and auto loans).

That’s not good.

The CFPB goes on to say that one in five student loan borrowers have “risk factors that suggest they could struggle when scheduled payments resume.”

That’s not good either.

How It All Shakes Out

I’ve already given readers my take on Apple. It looks overvalued here.

Outside of that, I think we should tread lightly with the stocks we pick. $10 billion per month is a material amount of cash that’ll be sucked out of the consumer economy into non-productive debt paydown.

My guess is that we’ll start to see “resumption of student loan payments” as a callout from public company CEOs in the fourth quarter of this year. It may even result in an impact on their full-year earnings guidance.

Not all companies, though, will be impacted.

But for those that are—again, looking at Apple—I’d be very careful.

Stories like Charlie Munger’s inspire me. It shows why you must live life as an optimist.