There’s a potential time bomb right under our improving economy.

#-ad_banner-#This explosive situation affects over 40 million Americans. You probably know at least one person who is feeling its effects. The silver lining in this problem is that it is creating a limited-time opportunity for investors.

I was first made aware of this quandary several years ago, when a close friend of mine, a former business owner whose business was made irrelevant by changing technology, decided to follow his dream and get a college degree.  

After four years, he graduated with a bachelor’s degree and over $100,000 of student loan debt. He went into the workforce and was shocked that only minimum wage jobs were available to him.

There was no way he could make the payments on his college loans.  He even looked into bankruptcy to lift the burden — but was shocked  to find out that student loan debt is not dischargeable.  

My friend took a low-paying job with the hopes of advancing but was unable to pay back his loans. He’s now living in his parents’ house with trashed credit and little prospects for getting a better job.

My friend is not alone with his crushing student debt. Over 7 million people have defaulted on student debt. These consumers  have seen their credit scores ruined and, to add insult to injury, been saddled with up to 25% in additional costs in the form of fees and late charges.  

Student loans now top $1 trillion and are weighing heavily on the economy, particularly the housing market. “Many recent graduates don’t have the credit score or disposable income needed to buy a house, so they boomerang back home,” said Rohit Chopra, student loan ombudsman at the Consumer Financial Protection Bureau.   

As you can expect, the government is starting to take action — starting with what many consider to be the most egregious abusers of student loan programs, for-profit colleges.

For-profit institutions serve about 13% of total higher education students — but over 30% of student loans go to these types of schools. Half of all student loan defaults are by students from for-profit colleges.

Congressional hearings have been taking place regarding the alleged abuses of such institutions since 2010, and the government has announced new rules, set to take effect in June 2015, to help fight federal student loan fraud at for-profit colleges.

Students at such schools would not qualify for student grants and loans if the default rate in the particular program is greater than 30% or — and this is critical — if loan payments regularly exceed a certain percentage of graduate’s salaries.

The regulations will oversee roughly 8,000 career training programs at for-profit and traditional schools. Most interestingly, schools will also be required to report and disclose the performance and outcomes of their employment programs with information on costs, debt, and completion rates. (For their part, for-profit colleges are calling the new rules unfair and discriminatory, saying they will disproportionately affect low-income students.)  

These new restrictions are aiming at the business model of for-profit schools — and I’m not alone in thinking that stocks like Apollo Group (NYSE: APOL) and DeVry (NYSE: DV) should be sold or shorted.

Taking a look at insider transactions over the past year, DeVry had 32 buys and 73 sales; Apollo had 20 buys and 59 sales. This is certainly not wholesale selling by the insiders, but trading activity is definitely strongly biased to the sell side.

Are insiders selling shares in anticipation of sharply lower future revenue due to the regulations or even public scrutiny of these schools practices? I think it is a strong probability.  

Risks to Consider: Shorting stocks has its own set of risks that include the theoretical potential for unlimited losses. Should these new regulations get shot down, or these schools meet the requirements and definitive efforts be made for improvement, then my short argument holds little water. Always use stop-loss orders and diversify your portfolio.  

Action to Take –> I like Apollo and DeVry as pending short setups right now. Here’s what to do:

Short Apollo when $33 is violated on the downside. I recommend initial stops at $35 and a 12-month price target of $25.

Short DeVry when $40 is violated on the downside. I recommend initial stops at $43 and a 12-month price target of $34.

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