Since
the housing bubble burst spectacularly in late 2007, many analysts have been
actively seeking out the next likely explosion. Rest assured, it will be
related to debt in some way. US Treasuries, credit cards, and potentially
another disaster on Wall Street thanks to over-leveraging have all been
mentioned as potential leading candidates. However, there is another bubble
out there and it too is debt related. This one, in my opinion, has far
greater consequences because it involves a group that is the least
financially able to deal with the ramifications. I’m talking about
student loans and the massive bubble that has been expanding for at least the
past decade.
I
can remember a time back in the 1980s when I had several relatives put
themselves through state schools by working during the summer and on
holidays. They either didn’t carry student loans, or if they did, they
were exceedingly small. Granted, these were not Ivy League institutions or
anything like that, but it was possible to get an education without going
bankrupt. If parents were able to kick in a few bucks, many kids could walk
out of college either debt free or very close to it. Credit cards for college
students were virtually unheard of.
Fast-forward
a couple of decades and for college students who have credit cards, the
average balance upon gradation is around $4,000
while the average debt of people in the 19-24 age group is nearly double
that. It is not uncommon for a kid to leave college these days with $50,000
or more in student loans. That might not sound like much, but when
you’re talking about people who have nothing in the way of serious work
history or experience to present to potential employers and a job market that
resembles the aftermath of a major hurricane, $50,000 suddenly becomes a lot
of money.
It has been common knowledge for many years now that the cost of a college
education has been increasing at a significantly faster rate than most other
costs. There has been grand speculation as to why this is the case, but
I’m going to use a parallel example and simple economics to explain why
this is so. First, our society has been somewhat conditioned to believe that
a college education is a birthright of every American. Secondly, for years
now we’ve been shown statistics on the lifetime earnings of people with
college degrees versus those without. It is the natural ‘next
step’ if you will once high school has been completed. I have spent a
lot of time over the years working with young people and many have no idea
what they want to do for a career, but are urged by parents, guidance
counselors, and the universities themselves to explore their interests. In
the 80s that might have been reasonable advice. However, now this advice is
not only impractical, it borders on insane.
The Economics of Student Loans - 101
Simply
put, we have a society that by and large feels a college education is both a
necessity and an entitlement. This creates a huge demand. However, much of
that demand would not be satiated were it not for government. The idea of
guaranteed student loans has monetized virtually all of the demand. This
guarantees income for universities and they similarly behave as if their cash
stream is not dependent on performance, market factors or anything else. They
treat their cash flows as an annuity in perpetuity. And unfortunately,
we’ve taught them that they can raise their tuition at double or even
triple the rate of the cost of living and all the seats will be full at the
start of each year.
The
above graphic depicts the cost of tuition versus housing and the CPI. Notice
that housing has already retreated to 2003-ish levels. Notice also how the
CPI is represented by an almost perfect straight line – an almost
laughable impossibility over a 30-year period. Tuition, however, continues to
rise and our kids continue to fall further into debt.
For
comparative purposes, let’s take a look at the situation in housing.
Why did we have a housing bubble? Because mortgages essentially became
guaranteed to virtually anyone that wanted one. We’ve been brainwashed
to believe we’re not living the American dream if we don’t
‘own’ a home. And the government has once again stepped in and
created entities to absorb all this misplaced demand. Where the housing
market has Fannie Mae, the student loan world has Sallie Mae. The parallels
are undeniable. Unfortunately, the dream of home ownership has become a
nightmare for millions of Americans.
Similarly
the panacea of having a college degree has also become a nightmare for
millions of our kids. Many of them have been out of college for several years
now and still can’t find work in their field of study. They’re waiting tables or performing other retail type labor. And with the job market
saturated in many areas, they’re being forced to compete against more
experienced workers, who are willing to work cheap just to have a job to
support their families.
The Implications of Student Loan Debt
What
is likely the worst part of this bubble is that nobody really knows how big
it is. Many private analysts peg the outstanding
debt at over $1 trillion, while the NY Fed
claims the outstanding debt is $867
billion, using Equifax data. While even the larger of the two numbers pales
in comparison to the outstanding mortgage debt from our earlier example,
remember that the debtors in the case of student loans generally have nothing
in the way of savings or assets. For the most part they are 100% dependent on
the labor market to provide a salary that not only covers their cost of
living, but allows them to meet their debt obligations as well.
In
increasing levels, students are finding this to be an impossible task. The
graphics below depict default rates both in the aggregate and by state on
federal loans only. Keep in mind that technically a student loan is not in
default until the debtor is 270 days in arrears. So if a student makes a
payment once every 9 months, the loan is technically not in default, although
from the debtor’s standpoint, it might as well be when penalties and
interest are factored in.
What
are not oftentimes mentioned in the statistics are the implications of defaults
on student loans as well. For all intent and purposes they might as well be
taxes. They cannot be discharged through bankruptcy proceedings like most
other types of debt, and are unsecured as well. The bank (now the government)
can’t repossess your other belongings to satisfy student loan debt. It
is literally an albatross that cannot be escaped. Defaulting will make it
much more difficult to get other types of credit too – at least at a
reasonable rate. And the interest rates on certain types of student loans can
be upwards of 15% if a parent or guardian isn’t willing to cosign the
note.
I
am not an advocate of walking away from debts, so the best advice is to urge
students to become as aware as possible of what they’re walking into
beforehand.
Some Helpful Tips
If
you know of someone who is considering college as an option, there are a
couple of tips you can give them in terms of guidance and whether or not
college is a viable option.
1)
What is the job market likely to be like in the field of study they’re
considering? It is important not to look at the market currently, but rather
what are the medium and long-term prospects? Does it make good common sense
that their career path has longevity? Granted, many folks end up in fields
they never considered when they were 18 – yours truly is a prime
example. However, given the tight job market and the fact that it is likely
to remain so, today’s entrants into the workforce had best be prepared
to find a ‘good job’ and, if possible, stay put.
2)
What type of education is necessary to enter into a particular field? Many
times, students will opt for a 4-year degree when it is only necessary to
have a 2-year degree to get a job. There are still employers who offer help
with tuition. If you’re one of those who only need an Associate degree,
consider getting it and then finishing out your education with assistance
from an employer or even taking a class at a time on your own.
3)
Does the institution really matter? Many students improperly feel that they
need a degree from a prestigious institution to get a job. That may be true
depending on the field, but there are lots of examples where a state school
education will get you a job just as easily as if you went to a private
school. Again, researching your area of career interest will give plenty of
direction in this regard.
4)
A college education is an investment and must be treated as such. I have
talked to many kids who want to chase their dreams and do it as a career. If
it happens to make financial sense, then go for it. However, in many cases it
just doesn’t make sense. I’m not being a hard case here either.
30 years ago it didn't matter as much, but today a decision to embark on the
pathway to a college degree has enormous financial implications. Many kids
have found a career they like that will allow them to be financially secure
while they pursue dreams (such as music or art) outside the work arena.
Until Next Time,
Andrew W. Sutton, MBA
Chief Market Strategist
Sutton &
Associates, LLC
Interested in what is going on in the markets and the
economy? Read Andy Sutton's weekly market and economic commentary 'My Two
Cents' - go to www.my2centsonline.com