This article is co-authored by Ben Vincent.
In 2008 the prospective career paths for much of America went up in smoke as jobs became more and more sparse. Many, still desperately clinging to the fantasy of the American Dream, are getting money the only way that they know how; borrowing it. What better way to fund your lifestyle and prepare for a new career than getting a loan to go to college right? But what if there’s no one to lend that money? Early this month JP Morgan announced that they will be exiting the student loan market as of this October stating, “We just don’t see this as a market that we can significantly grow,” making it clear that the student loan market is truly dysfunctional. Don’t worry though, the government has come to save us from what Keynesian economists would call this “market failure” by currently issuing over 90% of student loans. Reminiscent of the housing bubble in which there was an underlying societal myth that everyone should own a home and that all houses were good investments, this bubble is fueled by the myth that everyone should go to college and that all college is a good investment. Just like the housing bubble this is believed by just about everyone until it’s not and then it’s too late. The culture, and of course government schools, tell the youth (and older displaced workers) that in order to get a good job one only needs to go to college. Colleges, much like the National Association of Realtors during the housing boom, take advantage of this combination of government subsidies, cheap credit and free marketing (propaganda) to fuel a speculative bubble. In the past decade college debt as a percentage of household debt has exploded becoming the second biggest form of household debt outpacing credit card and auto loan debt. In this article we will go through the perverse incentives that have created this unsustainable boom and put forth some predictions about how the whole thing may play out.
The college debt fiasco we are currently in has nothing to do with the free market and everything to do with government meddling. No one in their right mind would loan money at 2-3% interest to an 18 year old with no collateral or experience to pursue their education in whatever they choose, unless of course you could just create the money out of thin air and had some friends in the university cartel. The GI Bill, federal grants, state grants and government guaranteed student loans have made university tuition prices go into the stratosphere. The once romantic idea of putting yourself through college by waiting tables is now just a memory from decades past. As with anytime that market forces are absent we see not only the price climbing but the quality of the degrees themselves diminishing. The quality of most of the degrees today are so removed from any type of marketable skills that in many cases it could be seen as a negative for someone to have wasted so much time and money to have gone to university at all. This hilarious video by Peter Schiff demonstrates perfectly how utterly worthless most degrees have been to obtain the high paying job that was said to come about by possessing one of these sacred documents.
There have been many factors that have been at play to cause this market to be perverted in such a way. You could more accurately call most degrees “Union cards” as they act as a state sanctioned conditioning seal of approval for the union leader of the specific field the student is entering. Although there are great classes online for free, in order to get an accredited degree you must attend one of the approved Universities. Getting a degree from one of these accredited schools is of course a prerequisite for the next hoop you must jump through; getting a licence to practice. Once the university cartel has been established the only thing left to do is to hand out cheap money. This has been done through a variety of ways but mostly through federally guaranteed or directly issued student loans. Under the old federal lending program loans were made by private banks with federally backed guarantees.
Many financial institutions wanted out of the market so in 2010 President Obama attached an overhaul of the student loan program to the Health Care and Education Reconciliation Act. This overhaul was in essence a takeover of the student loan market by the federal government by stopping the subsidies given to the banks to make the “private” loans and instead have the government lend the money to the student directly. Along with this they increased Pell Grants and allowed students to only be liable to pay 10% of discretionary income for loan repayment, the loan could then be forgiven after 20 years of timely payments. This excess of cheap credit in this specific market has caused college tuition to rise dramatically faster than the rate of inflation.
This has not dissuaded student borrowers however as student debt is now twice what it was in 2007 at just over a trillion dollars, surpassing credit card and auto loan debt.
As the fundamental economic conditions have not improved and with youth unemployment at 20+ percent the delinquency rate of these loans have been on the rise. Some state the rate of loans that are behind 90 plus days are reported as 13% while the Federal Reserve itself admits that the actual number is probably more than double that.
This is a trillion dollar credit market in which the government holds the majority of the loans and to which young people with no collateral who are now mostly unemployed or underemployed in an economy that has no chance of improving are left to hold the bag for. This is not a black swan but rather a giant gorilla staring in the face of the entire nation that most people choose to ignore.
The surge in student loans, which now account for 28% of total non-revolving credit outstanding, has dramatically altered the credit landscape. As you can see, the Federal government, which now originates most student loans, actually surpassed depository institutions in January as a primary holder of non-revolving credit.
It doesn’t take a genius to see that this is an unsustainable boom. As we have shown, tuition rates have exploded dramatically outpacing inflation and wages for many years and as a result student loan debt has exploded over 500% in just over a decade. Student loans now have the highest delinquency rate among all major consumer credit asset classes.
This is ultimately just one more factor in the house of cards that is the US economy. It could be said that this isn’t actually its own bubble just one of the many pieces of the government bubble. It is certainly an unsustainable boom that has been yet another result of artificially low interest rates. As interest rates inevitably rise these debts will become truly unserviceable. However, this bubble cannot pop exactly as a normal bubble would because the federal government is already the majority issuer of this debt and although delinquency rates are on the rise student loans are not dischargeable in bankruptcy. Whereas banks got to cry uncle and discharge their bad investments in bankruptcy court, college students get no such luxury. Interest rates must rise substantially and are already rising even as the Fed’s taper hasn’t become a reality yet. Only a few months ago interest rates doubled for students with subsidized student loans to 6.8% and this will certainly not help the trends in delinquency rates. The government has only been completely shouldering this market for a relatively short time and unless something drastically changes in the job market (which I’m betting against) it is ultimately going to come down to changing regulations including allowing the debtors to default/file bankruptcy on their loans and/or the government performing some type of forgiveness/bail-in (through raising taxes/printing money to pay for losses). This is not good for students, taxpayers or anyone hoping to see an economic recovery anytime soon.
As we’ve entered a new reality where common economic laws of supply and demand and profit and loss no longer apply with the government now serving as the chief creditor, predictions on how the crash will play out are of course highly speculative. You can never know exactly how governments will react to their own follies. Several possibilities include:
- A bail out of the students (if the housing bubble crash is any indication that will not happen.)
- A bail-in in which the government just prints more money to cover the losses of their bad loans.
- A change in policy allowing students to file bankruptcy.
- Government conscription.
With unprecedented monetary easing through the FED’s many QE programs extreme inflation could likely become reality if banks ever start to lend out their excess reserves. High or hyperinflation could be a possible way out of the current debt ridden system. With contracts locked at today’s prices in a hyperinflationary future what you owe on student loans might be the cost of a loaf of bread. Of course, this would cause a huge amount of turmoil and societal unrest but it would also wipe away past debts. The current commitment by the Fed to print unprecedented amounts of money definitely makes this a possible scenario.
Conscription in government service of some sort is also a likely scenario as college becomes more and more socialized. The ones lucky enough to find a job may pay back their loans through the Pay as You Earn program and have them discharged after 20 years but the majority will likely never pay them back. The government could continue to try to hound the holders of the debt through wage garnishments and tax return confiscations but this will inevitably lead the debtors to decide to work strictly in the black market which would mean less money and control for the government. It is more likely that the government will use these debts as a control mechanism. Under the Pay as You Earn program already in effect you will have your loans forgiven twice as fast if you work continuously at a public sector job. Many also forget about the tax implications, the missed payments could be considered phantom income which if over $50,000 would then mean that the federal government could revoke their passport according to Senate Bill 1813, in essence turning the country into one large debtors prison.
While these kids should be saving for their future and building valuable skills by working entry level jobs and apprenticeships in industries with future potential they instead pile on debt for pieces of paper. The effects that this system has on the outlook and mentality of the younger generation is devastating. If jobs are not open in their chosen line of work (which usually they’re not) then they will have to settle for a “temporary” job – more than likely in the service sector – which they likely could have got without a college degree to begin with. As a result students have increasingly been forced to move back in with their parents after college as the reality of their debt to income ratio becomes apparent. If the debt is seen as unpayable this could create a slippery slope where debtors lose all hope of ever repaying and will feel that it is a fools errand for them to go out in the world to actually try and apply them- selves. Let’s face it, no one likes to feel like they’re living in indentured servitude.
Bubbles all have one thing in common – a large misallocation of capital. Unfortunately this bubble is misallocating some of the most precious capital in existence – the minds and lives of the youth. As the US government tries to keep the gravy train going they will keep passing the buck on to the younger and younger generations. I do not see how it can go farther than the millennials, all of the social services for the baby boomers are in the red while those that are supposed to pay for it are entering an overregulated and overtaxed economy with giant debt albatrosses on their necks that if not unpayable now surely will be once interest rates rise. You can’t squeeze blood out of a turnip, but the government will surely try.
[If you’re looking for investment opportunities consider shorting Apollo Group owner of the University of Phoenix (NASDAQ: APOL), ITT Educational Services (NYSE: ESI), and DeVry (NYSE: DV) as public universities (the cartel) are now protesting these schools as taking advantage of the current student loan markets and 80+ % of these company’s revenues come from Federal student aid programs.]