Hurricanes, Interest Rates And Student Loans

How the Hurricane Season Makes College More Expensive

The next time a hurricane blasts ashore somewhere in the United States, turning homes, businesses, and landscapes into an oversized game of Pick Up Sticks, keep in mind that the damage can go far beyond the visible spectrum. In particular, these mighty gusts of wind tend to set in motion a chain of events that can drive up interest rates upon which Federal student loans are based. You read it here first and, no, we haven’t been smoking the funny weed. This is dead serious. A hurricane can make it more expensive to attain that college education you’ve been dreaming about. Here’s how.

Making the Student Loan Sausage

Conventional wisdom says you don’t ever want to watch your local butcher make sausage or you’ll never eat the stuff again, on account of the (perhaps) revolting array of substances that goes into the mix. Though the analogy may be flawed, the interest rate on new student loans is based on a convoluted financial process that takes into account the supply and demand of treasury bonds. Without offering a treatise on the micro and macro economics behind the rise and fall of bond prices, we need only note that the Department of Education (DOE) reviews interest rates for new student loans each May when the Federal government holds a treasury bond auction. Increased economic activity means less bond demand and a higher interest rate., which winds up tacked onto the next round of fresh student loans.

Reasoning With the Hurricane Season

One consequence of a major hurricane landing is that there is a lot of rebuilding that has to be done. Both the government and private sector throw all they have into bringing the ravaged region back functional again. The result is that economic activity increases. Considering we’ve just had two major hurricanes, Harvey in Texas and Irma in Florida, expect a whirlwind of recovery in the coming months and years. Expect the result to be that the student loan interest rates will be nudged higher when it comes time for the DOE to readjust them in July of 2018.

A Storm of Statistics

You might not have realized it, but there are people who study this kind of stuff. In fact, John R. Mousseau and Gabriel Hament have done just that, putting their thinking caps on to review the past 30 years of storms to ascertain whether or not a big blow is correlated to more expensive debt for prospective students. United States history is replete with examples of the impact of storms on other areas of the financial industry. Like bonds, equity markets tend to recover and move higher with the wave of rebuilding economic activity in the aftermath of a big storm. So what did these two gentleman learn from studying 12 of the largest hurricanes spread over three decades?

It seems to make a difference on how far removed from the storm you want to look. Three months after landfall reveals more of a mixed message, while six months after landfall presents a more clear cut story. In the case of the former, the bond yield market was lower after three months with six of the hurricanes (by an average of 2.9 percent) and higher for six of the hurricanes (by an average of 4.45 percent). Keep in mind we’re exempting Harvey and Irma here, though it will be interesting to see how the bond market reacts in the near future.

The Six Month Story

Once Mousseau and Hament moved their analysis out to a six month time frame, a clearer picture began to come into focus as a bias towards higher yields emerged. At the six month mark, only four hurricanes showed a yield drop (average of 7.18 percent), while eight storms saw bonds move higher (average of 8.7 percent). Even more interesting is that the last six storms were followed by higher bond prices. It’s not a stretch to say that there’s a good chance that Harvey and Irma will boost bond prices upward and that student loans next year will likely be more expensive as a partial consequence.

Blame it on the Economic Environment

Obviously, student loan interest rates aren’t at the complete mercy of capricious storms that roll in from the Atlantic. The overall economic environment has something to do with it. For example, the Federal government has been in a process of slowly pushing short-term interest rates up already, especially as we move out of the calamitous recession that peaked in 2008 and was characterized by a meltdown in mortgage industry. We don’t want to say that the tail is wagging the dog. There are a myriad of factors that go into interest rate pricing and catastrophic storms are but one factor, though one very interesting factor.

When reflecting on the factors that spawn recovery to a hurricane impact zone, we should also acknowledge that, in recent years, the Federal government has responded faster and with more money in efforts to repair storm damage. This cranks the economic activity engine just a little faster. Keep in mind that FEMA resources aren’t a bottomless well, though. We’ve begun to see news stories wondering if the agency isn’t tapped out by efforts to deal with the fallout from Harvey and Irma simultaneously? Then there’s Maria out there stirring around the Caribbean and threatening to perhaps impact the U.S. northeast.

The Bottom Line

We should keep in mind that actions by the Federal Reserve to boost or slow growth is far more impactful on economic activity and the resulting interest rates than even the largest of storms. It is interesting, though, to throw this research into the hopper along with all the other factors and concede that one marker indicating the possibility of higher new student loan interest rates could indeed be the next big hurricane on the horizon. After nine years of relative peace from these kinds of storms, Harvey and Irma reminded us forcefully how devastating one of these monsters can be. With a little over a month left in the official hurricane season, let’s hope we don’t receive any more reminders this year.