For at least two reasons, the U.S. student loan market bears watching. The first reason pertains to recent headlines about predatory subprime student loans originated by Sallie Mae. These loans have certainly left many people having to bear a heavy debt burden for years, threatening their long term financial health. Years ago, my late colleagues Larry Olson and Hal White, and I, analyzed the risks of investing in education; and those risks have only increased. The second reason, as we all learned from the financial crisis, is that subprime loans can have much wider impacts, because of the potential to destabilize the entire financial system.

Two years ago, I gave a keynote address about the root causes of financial instability at the annual Global Derivatives Trading and Risk Management Conference. During the question and answer session that followed my address, one of the conference participants asked about the destabilizing properties of U.S. student loans. At the time, I said was more concerned about destabilizing elements in China, and even today China continues to be something of a powder keg. However, the U.S. market for student loans also qualifies as a powder keg.

A recent article appearing in The New York Times compares today’s subprime student loans and the prior subprime mortgages which fueled the bubble that precipitated the global financial crisis. The article notes that the two subprime markets are similar in scope and in the nature of misdeeds associated with predatory lending.

Economist Hyman Minsky’s financial instability hypothesis provides an important lens with which to examine the way in which financial markets create economic instability. Minsky warned that excessive leverage and excessive Ponzi finance underlie the conditions that give rise to financial fragility. Excessive leverage is clear enough. Ponzi finance refers to the practice of structuring loans for which both interest and principal can only be fully serviced if the asset being financed appreciates in value.

In the leadup to the global financial crisis, option adjustable rate mortgages provided a primary example of Ponzi finance. Many people who took out these mortgages simply deferred payment of interest and principal in the hopes that their homes would appreciate in value by enough to keep them out of trouble. However, when housing prices stopped rising, they instead found themselves in great trouble.

Some student loans qualify as Ponzi finance, especially for the type of private loans discussed in recent media stories. Interest is deferred and added to principal, applying financial pressure to borrowers to the point where they become unable to comply with the terms of their loans, or do so only at great personal hardship.

The student loan market is large. According to the Federal Reserve Bank of New York, student loans are the second largest category of household loans, after mortgages. At the end of 2016, the size of the U.S. mortgage market was $8.5 trillion, while the size of the U.S. student loan market was over $1.3 trillion.

The financial system becomes fragile when default rates begin to climb. In the third quarter of 2012, the percentage of student loans that were delinquent by at least 90 days increased dramatically. Since that time delinquency rates have remained high and now are higher than any other loan category. At 11.7 percent, student loan delinquency rates at the end of 2016 far exceeded credit card default rates, whose corresponding rate in second place was 7.1 percent.

According to the financial instability hypothesis, increased Ponzi finance contributes to asset bubbles such as the housing bubble associated with the financial crisis. If something similar is going on with student loans, then increased Ponzi finance is contributing to escalating costs of higher education in the U.S. Those costs have been growing faster than the rate of inflation, even though academic salaries have not. The link from student loans to rising costs of higher education is known as the “Bennett Hypothesis.” The hypothesis was first proposed by former Education Secretary William Bennett in 1987, and in 2015 received support from a study conducted by the Federal Reserve Bank of New York.

A ramping up Ponzi finance does not immediately create a financial crisis. It simple adds powder to the powder keg, making it more volatile over time. It is difficult to predict when someone is going to walk by that powder keg with a match, but the bigger the keg, the bigger the resulting explosion will be when it happens. For those eager to mitigate financial crises, Ponzi finance bears watching, no matter what its form. That is the first step in the prudent management of systemic risk in the financial system.