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Janet Yellen warns student debt may be holding back housing recovery

Federal Reserve Chairwoman Janet Yellen speaks during a Financial Stability Oversight Council meeting May 7 at the Treasury Department in Washington. (Alex Wong/Getty Images)

Appearing on Capitol Hill for the second time in two days, Federal Reserve Chairwoman Janet Yellen warned Thursday that mounting student loan debt might be holding back the housing market. Slowing housing activity, she also said, could in turn pose a threat to the continued economic recovery.

"The debt loads certainly are high enough that they may play a role in, for example, making it hard for people to buy first homes, to build a down payment,” Yellen said in a hearing of the Senate Budget Committee, adding "that may be an effect we’re seeing already in the housing market.”

In her prepared testimony, Yellen drew attention to the risk to the economy in the possibility "that the recent flattening out in housing activity could prove more protracted than currently expected rather than resuming its earlier pace of recovery." Existing and new-home sales, as well as new housing starts, slowed in March.

The Federal Reserve reported Wednesday that student debt increased to $1.25 trillion in March, up from $830 billion. The record amount of student debt has drawn particular scrutiny because it now eclipses the amount of credit card and auto-loan debt.

Nevertheless, Yellen qualified her warning about student loans by noting that it is good for people to be able to finance their educations. "It’s important for us to recognize how important it is to be able to get education and to have access to loans that will improve earning power over time," she explained.

The problem arises, she added, when students don't understand the benefits and costs of the debt they take on, mentioning specifically the need for appropriate information regarding different programs' completion rates and success in placing students in jobs.

Noting that student debt can't be discharged in bankruptcy, Yellen said that "it can represent a very heavy burden for an individual if things don't go well."

President Obama has proposed a rating system for colleges based on affordability and graduation rates. A bipartisan group of senators, including Marco Rubio, R-Fl., and Ron Wyden, D-Ore., have introduced legislation that would require schools to report information on graduates' earnings, graduation rates and average costs.

Yellen, however, stopped short of calling the run-up in student debt an unsustainable "bubble," as some have.

Unlike other popular forms of consumer credit, student debt is countercyclical, meaning that people take out loans when jobs are scarce to return to school rather than take a undesired job or remain unemployed.

Last year, Congress voted to tie the interest rate on federally subsidized Stafford student loans to the rate on 10-year Treasury securities. On Wednesday, the rate for loans for the 2014-2015 school year was set at 4.66 percent, an increase from the year before, because the yield on 10-year Treasuries has risen.

Earlier in the week, Sen. Elizabeth Warren, D.-Mass., introduced legislation that would allow students with higher rates on their loans refinance at lower current rates. Sen. Debbie Stabenow, D-Mich., referred to the bill in asking Yellen about student debt at Thursday's hearing.