Are Student Loans The Next Mortgage Debacle?

[RealPerson]

The issue of student loans has been bothering me for a while. Just like mortgages were giving in near unlimited amounts to people who really did not qualify, students are now given loans in near unlimited quantities regardless of the future prospects of the degree.

From The Federal Reserve Website:
The large and sustained increase in student loan balances over the past decade or so has raised concerns that student loan borrowers are incurring debt burdens that will be difficult to repay and will hinder their ability to achieve life goals such as purchasing homes, starting families, investing in small businesses, or retiring from the workforce.

The numbers are staggering: more than $1.2 trillion in outstanding student loan debt, 40 million borrowers, an average balance of $29,000.

There are students who get a degree without employment prospects, students who drop out but still have the loans, students who are underemployed (e.g. Starbucks barista) and gainfully employed students who lose their job (e.g. in the next recession). I know that student loans cannot be eliminated in bancruptcy, but if you can't pay you won't be sending in a payment. Given this situation, how long will it be before this student loan bubble bursts? What would be the impact on the markets? How to manage that risk in your investment portfolio?

In my mind, this is a larger financial risk than whatever happens in China. I am very curious how others see this issue looming and how to prepare for it.

[Ego]

I am seeing incredible resourcefulness in obtaining under-the-table cash income among this cohort. Really mindblowing stuff. They simply don't care about their credit rating. They can play this game as long as they have someone with traditional credit-worthiness to cosign.

They seem to have no real long-term strategy. They are simply playing the cards they've been dealt. I wonder if they expect a crisis to occur and the debt to magically disappear. Funny thing.... that's probably what will happen. A program will be created to eliminate the debt of those most in need and they will qualify thanks to their super-low "official" income and unimaginable levels of debt. hah!

[GandK]

Short answer: yes. This is the next mortgage crisis.

Long answer: if I were High Queen, I would solve this problem by separating higher education into two buckets. One would be job training, the other would be personal interest. Job training, according to one's gifts and talents, and paying for some portion of that, IS in the public interest. But making taxpayers pay for personal interest courses that are unconnected with an identifiable vocation is NOT in the public interest. And given limited public funds, we desperately need to put an end to the practice of paying for whatever classes strike a young person's fancy and calling that vital public spending.

Changing that paradigm will solve the loan problem long term, IMO. When loans for "whatever you feel like taking" become unsubsidized, use of them will decline. And students will begin to choose career paths instead of just majors/interest areas.

But cleaning up the existing mess? I don't have any good ideas. Making student loans bankruptable would discourage banks from lending to unsuitable borrowers. THAT, however, would further divide higher education into haves and have-nots. So I don't think it's a real solution.

I think we have 10 years at best before this becomes a catastrophe... we basically have until these young people try to buy a house and are told no because of their student debt. Their biggest adult purchase may be out of reach, and at a time when the family-sized housing market is glutted due to downsizing Boomers. So I think the effect will show up not in financial institutions (unless a revolt causes these loans to suddenly become bankruptable, in which case dump banks), but in the housing market. And perhaps secondarily the market for new cars. Just ask yourself, "what can't these people buy because of their debt?" And hedge against losses there.

[Peanut]

@ego: Kudos to the kids I say. Credit worthiness is such a scam. Housing needs a correction in many places. A lot of young people aren't interested in replicating their parents' lifestyles anyway it seems to me.

@Gandk: Isn't one person's job training another person's personal interest? How would one know at 20 what different vocations one might have in the future? Idea and purpose of the university is also about much more than job training. The German model of a lot of apprenticeship training and less 'college for all' would probably benefit us here.

[jacob]

I don't think it is.

Mainly because student loans are not transferable or investable like housing (the funky idea of buying equity in individuals aside). To me, this means that student loans are more apt to drive individual students into a new under/upper class than causing any kind of financial crisis. Spending so much money "educating" people in useless skills is more likely to create a general drag of the economy and a benefit for the educating class (college admins, full profs, football coaches, ... )

In particular student loans is a malinvestment in debt that's widespread but hard to transfer. Mortgages were a malinvestment in equity that's semi-easy to transfer and widespread. Dotcom was narrow and equity-based.

[GandK]

@Gandk: Isn't one person's job training another person's personal interest? How would one know at 20 what different vocations one might have in the future? Idea and purpose of the university is also about much more than job training. The German model of a lot of apprenticeship training and less 'college for all' would probably benefit us here.

The German model probably would help the US to a great degree. At 20, I don't think we can prepare one for all future vocations, but if one is on the public dime, one needs to be in an actual career track, IMO. As a parent and step-parent of kids this age, I see way too many young people with no idea what they'll do with their degree once they graduate. And colleges that are happy to lap up an extra year or two of tuition and fees (read: $30,000) while students take more time to figure that out, instead of orienting them toward a specific career from the get-go. And parents that stand by and let this happen... let their children enter the work force at 24 with $200k in student debt and a degree in something like "Women's Studies" that - if they can even find a job - will pay a tenth if that per year as a salary. And then everybody stands around and fusses about loans being the problem! But I say if anyone along the way had applied some common sense (begin with the end in mind, don't act without a plan, don't live beyond your means, etc.) then it would never have happened no matter what the banks did.

[jacob]

The idea behind the US model of "college for all" was that college was intended to create good citizens. Not necessarily good workers.

There's some overlap. The German Arbitur (high school degree) corresponds to about a US associates degree. IOW, US college freshman/sophomore years do essentially the same job as German high schools do in their senior year. This is because the US lets far more people into high school than Germany. In Germany, the split happens much sooner. Make sure to compare apples to apples.

The primary problem in the US is in offering student loans at extremely low rates. This destroys the market pricing system.

Conversely, I note that the pricing system works pretty well for US grad students. American students have realized that advanced education is a losing game in the sense of income. ex-US has not (because they're state-subsidized). This is why the majority of STEM grad students (and postdocs) in the US are "imports".

PS: I know what the best way to run the educational system is. Unfortunately, it's PC-incorrect to the point of being illegal.

[GandK]

PS: I know what the best way to run the educational system is. Unfortunately, it's PC-incorrect to the point of being illegal.

You know I have to ask...

[Dragline]

Going back to the OP, the overhang of student debt seems to most resemble the "zombie banks" and companies in Japan that were kept alive even though they were insolvent. Only in this case, the zombie debtors will be actual people who can neither pay off their debts nor discharge them in bankruptcy.

The result tends to be stagnation and a bias towards deflation. Zombie debtors can no longer expand their credit, which keeps economic activity in check at limited levels.

It becomes like the mortgage crisis if you have student loan-backed securities that become widely traded and levered. I don't know if that is the case now or not -- but I don't think such securities have the same ubiquitous circulation that the mortgage backed ones did.

[jacob]

@GandK -

Ohh... don't get me started ... Okay, that was easy to get me started ...

I'd want the Swedish preschool system. This avoids wasting talent merely because a child was born to poor parents. If I can't get the Swedish one, at least I'd try to get a Scandinavian one.

I'd want the Finnish elementary/middle school system. (No rankings, no standardized tests, highest PISA scores in the world).

Then I'd want the German split (IQ test) early on deciding who gets into vocational/academic tracks. (7th grade) This avoids wasting everybody's time trying to fit square pegs into round holes.

For vocational jobs, I'd want the Japanese system. Long apprentice programs.

For prep-academic work (K-7--12), I'll take Germany or "Scandinavia. (Not widely familiar here except wrt the outcome)

For undergraduate work, Scandinavia or Russia. Both have a strong focus on mastering the fundamentals. Scandi leans towards creative. Russia leans towards technical strength.

For graduate work, the US, because they have the best funding in the world and you're more likely to work with the best [masters] in the field and you have the full run of creativity.

[jacob]

@Dragline - I concur.

[RealPerson]

It becomes like the mortgage crisis if you have student loan-backed securities that become widely traded and levered. I don't know if that is the case now or not -- but I don't think such securities have the same ubiquitous circulation that the mortgage backed ones did.

This is exactly what I was wondering about. Nobody understood mortgage derivatives until the 2008 crisis. Is there something similar for student loans? Are there derivatives? I assume the banks want to package and sell them just like the mortgages. It is like waking up one day and noticing that you are standing in the middle of a minefield. I wonder where the minefields are.

[BRUTE]

brute agrees with GandK that it would be very helpful to separate "job training" from "becoming a well-rounded individual". both are great, but they are also different. the second one is much higher on the maslow pyramid, and confusing the two is bound to create problems.

the split between privately funded education (USA) and publicly funded education (europe) is very interesting. on a principal level, brute likes the individualistic US approach. but on a practical level, US students are scammed into crazy loans to get worthless degrees. european governments are scammed into paying for those same degrees in europe, but the governments end up with that debt, not the individuals. that's good for the individuals (not so much for society?).

while apprenticeship/trades are very undervalued in western society nowadays, brute advises against romanticizing some of the european models. they are mostly leftovers of the mercantilist system, and the aim is to limit competition for master craftsmen. most of these apprenticeship systems lead to vastly overqualified craftsmen who've wasted several years, because they couldn't compete with their teachers on price until they themselves have reached a masters level. it's similar to the US grad school/professor system.

brute would prefer a more linear and modular system. make it very simple and cheap to get enough job training to feed yourself. then if additional job training is desired, enable that. if a human has interest in studying philosophy, that can be an interesting module, but let's be honest, it's a hobby, not job training.

but of course these systems won't change until they crash. there are too many humans invested in the status quo. all those football coaches, professors, teachers, bureaucrats, educated people afraid of competition, licensers, etc. etc. etc.

[Bismarck]

I got excited about shorting student loan debt after reading "The Big Short" (book is interesting, movie looks dumb). I asked around at work (a bank) and people that work with cdos had never heard of packaged up student loans. That's not to say that it doesn't exist, but it is likely rare if it occurs at all.

[thrifty++]

I think the student loan thing is quite unfair. It seems to me like in some countries the system allows young people to be lured into massive debt for educational qualifications which provide a lesser return on investment. Terrible way to start out life. And the people who perpetuate that system (government big wigs and the administration at the educational institutes) got their education for free or at a peanuts price. Another example of intergenerational theft I think

[BRUTE]

other countries enslave their youth via military drafts or crushing tax burden (hello scandinavia!). societies always exploit their energetic young to the extent they can, it just takes on different forms.

[Ego]

societies always exploit their energetic young to the extent they can, it just takes on different forms.

To quote my mother, "If everyone was jumping off the Brooklyn Bridge, would you do it too?" To do it accurately you've got to say it with a Philly accent and give a withering look of disappointment.

Just because everyone does it, doesn't make it right.

[Peanut]

The German model probably would help the US to a great degree. At 20, I don't think we can prepare one for all future vocations, but if one is on the public dime, one needs to be in an actual career track, IMO. As a parent and step-parent of kids this age, I see way too many young people with no idea what they'll do with their degree once they graduate. And colleges that are happy to lap up an extra year or two of tuition and fees (read: $30,000) while students take more time to figure that out, instead of orienting them toward a specific career from the get-go. And parents that stand by and let this happen... let their children enter the work force at 24 with $200k in student debt and a degree in something like "Women's Studies" that - if they can even find a job - will pay a tenth if that per year as a salary. And then everybody stands around and fusses about loans being the problem! But I say if anyone along the way had applied some common sense (begin with the end in mind, don't act without a plan, don't live beyond your means, etc.) then it would never have happened no matter what the banks did.

My point about studying outside of a narrowly defined job training track in college was that a student might study a few areas that all become relevant to their job prospects in the future. A minor in Spanish has gotten a lot of people jobs in fields outside their major, for example.

I'm going to push back on your example: 200k in student debt implies a degree from an ivy level school or similar. These students should be exceptionally bright if they're not from rich parents. If they're majoring in WS and bright they will understand they must excel to pursue a career in the field, the most obvious ones being teaching or non-profit sector. An assistant professor in WS will start at 50k at most colleges and universities. That's an ok payoff.
I definitely agree not all young people and their parents have sufficient understanding of what they are undertaking when they take on debt to go to college, and we should change that. But the fact is one can achieve success in any field no matter how derided by those outside the field if one is driven and smart enough. Abolishing philosophy is not the right answer imo.

[BRUTE]

@Peanut:

of course certain people will excel no matter what debt or major. but it's a bit like smoking. some humans will always do it. some humans would never do it. the majority of humans is influenced by outside factors on the margin: ads, social pressure, social acceptance (of student loans/smoking), ideology ("everybody should go to college"), status..

[jennypenny]

I'm going to push back on your example: 200k in student debt implies a degree from an ivy level school or similar. These students should be exceptionally bright if they're not from rich parents. If they're majoring in WS and bright they will understand they must excel to pursue a career in the field, the most obvious ones being teaching or non-profit sector. An assistant professor in WS will start at 50k at most colleges and universities. That's an ok payoff.

Unfortunately, that $200K number is correct for many private colleges (in the northeast at least) at the level of Holy Cross or Fairfield. Some ivies are actually cheaper than that. The student's attendance doesn't imply that they are overly bright or rich. It just means that they were above average and went where their parents/friends/guidance counselor said they should go. Look at where Zalo is attending. If he wasn't on a scholarship and had to borrow the money, we'd probably be telling him he was crazy even though it's a great school. (from Amherst's website "Cost of attendance: $68,393 - $70,843" -- annually )

There is so much that bugs me about this issue, but the biggest thing for me is the sheer amount of money a student can borrow as an undergraduate. As a society, do we really think an 18-20 year old isn't mature enough to drink alcohol or gamble or even rent a car, yet is somehow magically mature enough to enter into a contract to borrow over 200K for an intangible asset??