Student Debt Malinvestment

Student debt levels continue to soar. In 2012 they hit $1 trillion for the first time ever.

But college education isn’t reaping the rewards it once did.

According to the Associated Press:

About 1.5 million, or 53.6 percent, of bachelor’s degree-holders under the age of 25 last year were jobless or underemployed, the highest share in at least 11 years.

And real wages have fallen for recent college graduates — although this has been part of a broader trend of falling real wages in the general population:

So why is student debt still soaring?

The crucial factor is that student debt isn’t like other debt — it cannot be discharged simply through bankruptcy.

There’s no incentive for private lenders to be particularly careful in who they lend money to, becuase they know that there’s no way that whoever they lend the money to will ever be able to get rid of the debt short of dying.

But just because a loan is nondischargeable doesn’t mean that the loanee will be able to repay. With labour conditions for recent graduates still quite awful, student debt defaults have climbed. The Washington Times notes:

The number of borrowers defaulting on federal student loans has risen substantially, highlighting concerns that rising college costs, low graduation rates and poor job prospects are getting more and more students over their heads in debt.

The national two-year cohort default rate rose to 8.8 percent last year, from 7 percent in fiscal 2008, according to figures released Monday by the Department of Education.

That means that more unemployed former students will end up being hounded for debts that they cannot afford to repay, yet cannot discharge through bankruptcy. If those debts had been accrued at the roulette wheel, though, they could.

It wasn’t always this way.  Until 1976, all student loans could be discharged in bankruptcy. Until 1998, student loans could be discharged after a waiting period of five years.  In 1998, Congress made federal student loans nondischargeable in bankruptcy, and, in 2005, it similarly extended nodischargeability to private student loans.  Since 2000, student loan debt has exploded, and private student loans have grown even faster.

This presents a bigger problem than simply sending people to college who end up unemployed or underemployed. It means that capital is being misallocated. If debt for education cannot simply be discharged through bankruptcy, as other debt can be, private lenders will tend toward offering much more of the nondischargeable debt, and less of dischargeable debt. This means that there is less capital available for other uses — like starting or expanding a business. If the government’s regulatory framework leans toward sending more people to college, more people will go (the number of Americans under the age of 25 with at least a bachelor’s degree has grown 38 percent since 2000) — but the money and resources that they are loaned to do so is money and resources made unavailable for other purposes.

The efficient allocation of capital demands that lending is undertaken based on the real underlying market conditions. To ensure that this is the case, the bankruptcy rules for debt should be universal so that loan applications are considered on merit. This should mean that student loan debt should be dischargeable under the same bankruptcy conditions as other debt. More discerning lenders would likely mean less student lending — but would also mean that potential students would have to think harder about the decision to study, and be able to justify to themselves and to a lender why they are choosing to study (or why they are choosing to study a particular subject), instead of choosing to work, or choosing to start a business.

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Education is a Bubble

A couple of days ago, Zero Hedge reported that a lot of student loans are delinquent:

As many as 27% of all student loan borrowers are more than 30 days past due. In other words at least $270 billion in student loans are no longer current (extrapolating the delinquency rate into the total loans outstanding). That this is happening with interest rates at record lows is quite stunning and a loud wake up call that it is not rates that determine affordability and sustainability: it is general economic conditions, deplorable as they may be, which have made the popping of the student loan bubble inevitable.

The reality of this — like the housing bubble before it — is that a lot of people who borrowed a lot of money can’t repay. That could be down to weak economic conditions. As I wrote yesterday, an unprecedented number of young people are unemployed and underemployed. These circumstances will lead to delinquencies.

But I think that there is a key difference. Unlike housing — which will probably never be made obsolete — it feels like education is undergoing a generational shift, much like agriculture did prior to the Great Depression, and much like manufacturing did prior to the Great Recession.

Venture capitalist Peter Thiel suggests:

Like the housing bubble, the education bubble is about security and insurance against the future. Both whisper a seductive promise into the ears of worried Americans: Do this and you will be safe. The excesses of both were always excused by a core national belief that no matter what happens in the world, these were the best investments you could make. Housing prices would always go up, and you will always make more money if you are college educated.

But earnings for graduates are stagnant, while costs continue to rise:

However, all this really shows is the (quite obvious) reality that colleges — subsidised by Federal student loans guarantees that act as a price floor — can keep raising tuition fees even while in the real world the economy is contracting.

But education is suffering from a much bigger problem: a lot of what it does is gradually (or quickly) being made obsolete by technology.

While college degrees for vocational subjects like medicine, law, architecture and so forth are still critically important (not least because access to such professions is restricted to those who have jumped through the proper hoops), non-vocational subjects have been cracked completely open by the internet.

Why would anyone realistically choose to pay huge amounts of money to go to university to learn mathematics, or English literature, or computer science or economics when course materials  — and much, much, much more including access to knowledgeable experts and professionals — is freely available online?

The answer is for a piece of paper to “qualify” the holder and “prove” their worth to prospective employers. But with earnings for degree holders at roughly 1997 levels, what’s the point? Plenty of people with good ideas, drive and perseverance are living fulfilling and successful lives without a college degree — including me. There are flashier examples like Zuckerberg, Jobs, and Gates, but that is just the tip of the iceberg.

A real estate agent trying to rent me a flat once said:

Why would people want to go to university? All it shows is that you are lazy, and can’t be bothered to find a proper job, and want to spend three or four years getting up late and getting drunk.

A useful (though not universally true) heuristic. “Education” has been turned inside out. To some employers, a degree (particularly one with a weak or mediocre grade) can in fact be a disadvantage. People without a degree can get ahead with three or four years of experience in industry.

So while we wait to see whether or not a student loan meltdown will lead to a wider financial meltdown (a la Lehman), I think we should consider that this industry may well be on the brink of a systemic meltdown itself. With severely decreased demand for education, a lot of schools and courses may be wiped off the map leaving behind a skeleton of only the most prestigious universities, and vocational and professional courses.