Student Loans: Today’s Financial Time BombPerhaps the most important factor in winning the jobs war is building human capital. Human capital is defined by the quantity, age, gender, education, experience, and attitudes of those who make up the workforce. The characteristics that we can tweak at this point are limited to education, experience, and attitudes; and of these, education has the highest leverage.
America’s universities have done a great job of maximizing the capabilities of the top 5 to 10 percent, but that’s not good enough to win the jobs war. Standardized tests say we’ve done a poor job of getting the average American ready for the 21st century job market. Worse yet, we’ve invested trillions in this endeavor and the resulting student loans have only bought us a new financial bubble waiting to explode.
The warning signs of a financial bubble are certainly there, including:
? Cheap money ? Loans that nearly anyone can get
The signs of an impending burst are emerging as well, including:
? Widespread inability to make payments on student loans ? Rising defaults and downgrades for some student loan asset-backed securities
These factors bring back unpleasant memories of the recent housing bust, complete with growing numbers of Americans going bankrupt.
Just how bad is it? Here are some numbers to consider.1, 2, 3
? The average cost of tuition has soared 440 percent in the last 25 years; that’s more than four times the rate of inflation. ? Unable to keep up with rising costs, students have increasingly turned to loans. In 2010, student borrowing surpassed the $100 billion mark. ? In 2011, total outstanding loans exceeded $1 trillion, surpassing credit card debt for the first time. ? Graduating college seniors in 2010 owed, on average, $25,250. That was a 5 percent increase from 2009. ? College loans that parents owe on behalf of their children have jumped 75 percent since the 2005-2006 school year. ? These parents, on average, owe $34,000 in student loans for their children in a climate of stagnating wages. ? College graduates from the class of 2010 were reportedly unemployed at a rate of 9.1 percent
This final statistic has contributed to a growing crisis; 80 percent of bankruptcy attorneys say that in the past three to four years, potential clients with student loan debt have increased “significantly” or “somewhat.”
Another analysis reported that of borrowers from the Class of 2005, 25 percent became delinquent at some point and 15 percent defaulted.
There are two key factors that have inflated this student-debt bubble.
The first is the widely-held belief that a college degree will translate into a higher income. Although this is undeniably true for certain fields, a significant number of graduates are no better off than they would have been with a high school diploma. A corollary of this belief is the notion that our country needs a well-educated workforce to create new opportunities and stay globally competitive. That is definitely true. But this education does not always need to come from expensive colleges. Furthermore, the education received from many expensive colleges is irrelevant to any high-paying career available today. Unfortunately, the collective wisdom perpetuated by the education industry simply reinforces the costly myth that a college degree should be pursued by anyone and everyone.
Harvards Clayton Christensen was one of the first experts to formally analyze the need for disruptive innovation in higher education. His landmark book, The Innovative University, is still the best source for guidance on this topic.
The second factor that is pumping up the debt bubble is the lengths to which families have gone to ensure their children attend college because of the perceived necessity of earning a degree. As college costs have risen, family incomes, available grant aid, and state investments in higher education have not kept up, so families have turned to student loans to make up the shortfall.
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But the unseemly truth is that while the loans have enabled families to close the gap, it is the very availability of these loans that has enabled colleges to raise their tuition in the first place. It’s a vicious circle. Administrators know the gap they cause can and will be covered by loans. So, they simply view these loans as federal subsidies that are there for the taking. Incentives to follow the “lean” production rationale of private industry are totally missing.
As a result, schools are encouraging students to accept a debt burden that will become debilitating to their futures. Colleges are funding building projects, high salaries, and handsome pensions by getting students to mortgage their futures.
The flaw in this system is that colleges have discovered they not only make money on students pursuing serious courses of study, but they can also capitalize on students with no real plan: students who are in college for no other reason than meeting family expectations. Many of these kids simply do not belong in school at all, at this time in their lives. And, while they may emerge from the system with a diploma, they’ll come out with no genuinely marketable skills. Yet, they’ll be saddled with a very real debt load.
Even for middle-aged people going back to school looking for retraining, the outcome may be no more promising than for the directionless 18-year-old. The likelihood of realizing a payout in terms of a better job after taking on so much debt is often quite low or even negative.
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The stark reality is that a large majority of students who are amassing debt at universities, community colleges, and for-profit technical schools today are wasting their money and often their time. For these students, the future looks bleak. They are being burdened with thousands of dollars of new debt each year, leading to significant monthly payments when their earning power will be at its lowest.
Before the recession, the median starting salary for college graduates was $30,000. Today, it’s just $27,000.4
Of course, many graduates can’t even find a full-time job. Almost 2 million Americans with college degrees were underemployed in 2011, an increase of 17 percent in just four years ? and roughly 50 percent of all college graduates are working at jobs that do not require a degree. This includes 80,000 bartenders, 317,000 waiters and waitresses, and about 25 percent of all retail salespeople.
Facing a tight job market with degrees that haven’t prepared them for better-paying jobs, it’s not surprising that recent college graduates often fall behind on their student loans. What happens then?
If they miss just one payment, they are put into a delinquent status. It takes nine months of delinquency before a borrower is in default, but once default occurs, the full amount of the loan becomes due immediately.
When it comes to collecting, the government has powers that far exceed those of most creditors. The list of ways it can collect are extensive, including garnishing wages without a judgment, seizing a tax refund, and seizing portions of federal benefits such as Social Security. It can also sue the borrower to have liens placed on bank accounts and property, and charge collection fees up to 30 percent of the amount due.
Furthermore, using bankruptcy to escape from federally insured student loans is not an option, except in extremely limited circumstances. Unlike other types of debt, a statute of limitations does not exist. Finally, for those with professional licenses, the government can revoke a state-issued license for failure to pay on a student loan debt.
These terms offer borrowers a slim margin for error and can cause them to end up facing a lifetime of debt with little or no chance for relief.
As a result of this debt, many life-cycle events are delayed, such as buying a car, purchasing a home, getting married, and having children. Instead, graduates find themselves trapped in a hand-to-mouth existence ? hardly what they were led to believe by the colleges that recruited them.
Stuck in this situation, with precious little sound economic training, it is no wonder so many disillusioned students are protesting against the system, even though they have a hard time articulating what it is they are for or against.
Whether the government, the schools, or the students are primarily to blame for this situation, it’s clear that it cannot continue. Fortunately, some partial solutions have been offered.
For example, President Obama has proposed a link between federal aid and a school’s success at controlling tuition costs.5 Only schools that limit increases in tuition will see an increase in campus-based aid.
Although encouraging schools to trim budgets is a good step, artificially high education costs would still be propped up with federal aid ? taxpayers’ money. And, throwing more money at the situation is hardly a long-term solution.
Others have called for phasing out the Federal student loan program altogether to get the government out of the student loan business. Instead, it is argued, these types of loans should be reviewed objectively, based on business criteria, rather than treated as a riskless venture for the both the lender and the school.
Considering this trend, we foresee the following developments:
First, in the coming decade, the U.S. economy will be impeded by the mountain of student loan debt.
Like the mortgage foreclosure crisis, the significant share of consumer incomes consumed by student debt loan servicing will cause a drag on the economy for the foreseeable future. These Millennial generation consumers would typically be making purchases that are the lifeblood of our economy, such as cars, houses, and appliances. Similarly, the discretionary spending of Boomer and Xer parents who took out loans will also be curtailed. Parents’ spending will be further constrained by having to support their children even after they’ve graduated from college. A poll by marketing and research firm Twentysomething Inc. found that 85 percent of college graduates now move back in with their parents, up from 67 percent in 2006.6 Without this spending, it will be harder to maintain a growing economy. In the worst case, if the bubble goes on to burst and Sallie Mae bonds are affected the way Fannie Mae bonds were during the housing crisis, the impact will be very far-reaching.
Second, disruptive business models for college education offer a genuine path out of this crisis.
A serious contributing factor in rising tuition costs is a lack of competition. In previous Trends issues, the editors have examined the economics of “distance education,” also known as “online learning.” Accredited online universities, which could be located anywhere in the world, could offer programs at much more reasonable prices than those charged today. Students could benefit from lectures given by the greatest minds in their fields of study, rather than the graduate student who got stuck teaching their class. Students who are simply priced out of the traditional educational system will be the first to support online offerings, followed by those whose high school grades and ACT scores were too low to receive college scholarships. Then, very quickly, as the success and cost savings of online learning becomes more widely known, it will become one of the top choices for students across all academic levels.
Third, Washington is likely to follow rather than lead in terms of proposing real solutions.
Academia, which needs radical change, is a much too important constituency for the current administration, making it virtually impossible for the President to force any substantive changes. It is telling that the reform he is recommending ensures that colleges still get Federal money. It does nothing to address the main issue of whether students are getting an education that is worth the debt they are incurring. Until that happens, reforms are merely helping the educational institutions and the loan originators.
References List :1. Mises Daily, March 8, 2012, "The Higher-Education Bubble Has Popped," by Doug French. ⓒ Copyright 2012 by the Ludwig von Mises Institute. All rights reserved. http://mises.org 2. USA Today, October 18, 2011, "Student Loans Outstanding Will Exceed $1 Trillion This Year," by Dennis Cauchon. ⓒ Copyright 2011 by USA Today, a division of Gannett Company, Inc. All rights reserved. http://www.usatoday.com 3. Townhall, February 12, 2012, "Obama Student Loan Debt Bubble About to Blow," by Mike Shedlock. ⓒ Copyright 2012 by Townhall.com. All rights reserved. http://finance.townhall.com 4. Mises Daily, March 8, 2012, "The Higher-Education Bubble Has Popped," by Doug French. ⓒ Copyright 2012 by the Ludwig von Mises Institute. All rights reserved. http://mises.org/daily/5533 5. The Washington Post, January 27, 2012, "Obama Outlines Incentive Plan to Rein in College Tuition Costs," by David Nakamura and Daniel de Vise. ⓒ Copyright 2012 by The Washington Post. All rights reserved. http://www.washingtonpost.com 6. New York Post, May 7, 2011, "85% of College Grads Return to Nest," by John Aiden Byrne. ⓒ Copyright 2011 by NYP Holdings, Inc. All rights reserved. http://www.nypost.com
