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Are We Facing a Student Loan Bubble?

thebradentontimes.comMay 24, 2012

By Dennis Maley

In Sunday's column, I asked whether a college education was in danger of being priced out of its value, as tuition continues to soar while more and more recent grads remain unemployed or are forced to take low-paying jobs that don't require their degree. But the numbers used to illustrate the point raise more immediate concerns, like whether something similar to the mortgage meltdown is on the horizon as default rates rise, while overall lending continues to expand. How long can that happen before we face a collapse that will surely require another massive taxpayer bailout?

As I noted in that column, employment prospects have been dim, with more than half of students who've graduated with bachelor's degrees in the last two years remaining unemployed or working in a job that does not require a degree. Not surprisingly, there has been a sharp rise in students moving back in with their parents after graduation. Considering that college degrees have become increasingly expensive and more students than ever are borrowing to finance their education, we are entering a new dynamic in which a sizable chunk of American twenty-somethings are up to their ears in student loan debt, without any realistic means to repay it.

However, the lack of ROI isn't the only thing we should be concerned about. A couple of years back, I began mentioning a potential “student loan bubble,” that economists were beginning to warn of. The financial crisis of 2008 focused our collective attention mostly on the housing market, but it also drew a broader picture as to how too much cheap money could destabilize a number of other markets that had some particular things in common. If certain long-held economic beliefs could be distorted – ie. the value of a home never goes down – in order to market poor decisions to people who are emotionally invested in the angle you're selling while other factors serve to delay the negative ramifications until it's too late, cheap money can and will find its way through that market.

It turns out that higher education and home ownership have a lot in common. Just like historical data could be used to suggest that home ownership was almost always among the most sound investments a person could make, lifetime earnings of college graduates over non-graduates made a similar can't lose argument. But historical figures are just that. To assume that being historical and immovable are the same, would clearly be foolish. When factors linked to outcome can change independently, and especially when they can be manipulated for gain, such universal truths go out the window, as we saw clearly with houses once the money supply became loose enough to initially support price increases that supply and demand could never otherwise justify.

Today there is more than $1 trillion in outstanding student loan debt in this country. The real question, however, should be how costs can continue to rise under the dire circumstances I've described. It would seem elementary, as to why people would seek a college education in such a depressed economy. If they are failing to get by without one – the unemployment rate for Americans under 25 regardless of education is thought to be over 50 percent – then they are naturally going to seek any competitive advantage they can find to improve their prospects.

We are socialized as a culture to believe that a college degree is the best way to do that and like I said, there is a historical basis for that argument, as well as the notion that on the whole, college grads across the age spectrum have fared better than their counterparts in the Great Recession, with an unemployment rate roughly half as high. But that's propped up by grads of all ages who were already in the workforce. The data suggests that as the economy contracted, you were more likely to remain employed at some level with a degree, though having one as you attempted to enter the workforce – or going back to get a degree while you were unemployed without one – has not made anywhere near that kind of difference.

But that only explains the demand for the financing – not the supply. If the numbers suggest that higher costs and lower returns are making borrowing for college a risky bet, why would that not be producing a contraction in volume? The answer is quite simple. Just like in the 2000-2006 mortgage industry, there is an almost complete lack of any sort of underwriting to reflect the risks associated with the lending. Qualifying for student loans, whether federal or private, has almost nothing to do with your future ability to repay them.

Ideally, at least from a finance perspective, there might be an underwriter who looks at everything from the prospective student's past academic achievement to the median starting salaries in their chosen field of study in order to decide whether a person should be borrowing a hundred grand to get a piece of paper that may or may not have a significant impact on their earnings – especially since there's no asset that can be foreclosed upon if they default. In previous economies, where unemployment rates were much lower, education cost less and the economy grew at a healthy clip, bad educational decisions could usually be absorbed. Someone who borrowed $30,000 to attend a private college only to flunk out after two years might be resentful of the monthly repayment, but their earnings in a lower-middle class job typically would still allow for it.

Today, when many more students are borrowing and taking out much larger loans, all while the economy continues to sputter along producing less jobs most months than there are new people entering the work force, it only stands to reason that many more loans are going to fail. So how can costs continue to rise under these circumstances? The same as with houses – too much cheap money going to people unlikely to be able to repay it, mostly because the day of reckoning is so far down the road.

ARM and interest-only mortgages allowed poor underwriting to be masked during the early periods of a loan. Default was pushed far enough away that all of the people who were involved in the early profit – builders, realtors, mortgage brokers, loan originators – had already been paid handsomely by the time the problems hit. This scenario, where it was good short-term business for them to get anyone into a new home or equity loan, but disastrous business for banks, bondholders and ultimately the taxpayers to lend money to people who could never repay it, was a recipe for disaster.

The people that held the bag didn't find out what was in it until far too late. In student loan lending, we see a similar situation. Because nearly all student loans are deferred the entire time the student is in college, and even six months after they get out, once again it is years after the schools have been paid that the chickens come home to roost. That's very different from say, financing a new car, where a person's inability to pay the monthly note will likely present itself almost immediately.

As more cheap money pours in, schools use it as a way to increase tuition and fees in the same way the price of homes rose in step with the artificially-increased purchasing power of low-interest and interest-only mortgage products. The marketing efforts are also frighteningly similar. Colleges and universities routinely use confusing and deliberately vague math to distort the value of their product. Because federal loans (which account for around 90 percent of that trillion dollars) are subsidized, they're typically included in the “financial aid” section of marketing calculations and “award” letters. Unlike the housing industry, almost none of the forms and disclosures for student loan lending are simplified or standardized.

But just like home-buying and refinancing, it's a process that taps into a basic emotional narrative, one that Americans are indoctrinated to buy into their entire lives – Home ownership is a cornerstone of the American Dream, the best investment you'll ever make. Graduating college puts one on the path to inevitable success and financial security. Both are outward indicators of success and responsibility. It might be seen as irresponsible to take out a loan and buy an expensive sports car while working at a low-paying job, or while one is saddled with other, more necessary debt. But who would dare tell a prospective college student that it's a bad idea to take on much larger loans to pay for an education? And for the struggling, wayward teen who has perhaps demonstrated the least capacity to endure and prosper through four years of secondary education, wouldn't we be more likely to encourage them to go for it, no matter what it takes?

Just as in the case of the mortgage fiasco, it is cheap money and increased future debt obligations for the buyer which are being used to subsidize artificially-high profits and salaries for everyone involved in the secondary education racket, even after the true market has stopped supporting such rises. And just like in mortgages, all that ends up happening is that an industry accelerates decades worth of demand to extract greater current wealth, while breaking the very market that they're profiting from.

History has already shown that everyone from the Presidents and other lawmakers who continually deregulated finance, to the Fed Chair and his artificially low rates, Wall Street and their bogus debt securitization scams, lenders and their absence of underwriting, realtors who knowingly pushed bad investments and buyers who borrowed more than they could ever repay, and even the municipal governments that continually re-zoned and cut fees for subsidized over-development, were complicit in the greatest bubble of all time.

History is sure to be equally unkind to everyone from the unscrupulous student loan lenders, to the overpaid university presidents earning millions, while putting endowments above all else, to the admissions offices selling unrealistic dreams of prosperity, and the parents and students not taking a hard look at the real math, if the same sort of disaster implodes. And don't get me wrong, I'm not knocking higher education. The best way for a society to ensure a healthy and productive workforce to seed a dynamic and prosperous economy is to see that every member has at least every bit of education that they desire. But what's happening today, as mountains of debt are increasingly taken on by the members of society least likely to be able to repay it, so that a few can profit greatly is a sure road to ruin.

One has to wonder whether this the last grab, the final way for the debt merchants to enslave a generation of Americans who will never be in a financial position to play a role in mortgage scams, or get swindled in the stock market. Suck all of the kids dry with the promise of a ticket out of the financial misery their parents have endured, via a high-priced education. And when there's as many college grads flipping burgers and defaulting on student loans as there were burger flippers defaulting on mortgages, call in the taxpayers for one final, massive bailout to prevent an “inevitable financial collapse."

There were a lot of warning bells sounding years before the finance industry engineered a bubble that managed to shake loose five decades of American mattress money, while blowing a $3 trillion dollar hole in our economy that we've yet to recover from. They're ringing again and I hope that this time we'll listen, because when a bomb drops on an already battered city, it tends to do significantly greater damage. Another meltdown at this economic stage will not be nearly as forgiving as the one we just endured. Americans had best take a hard look at this issue, or else brace for some serious pain.

Back to May 2012 Archive

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