There is a major problem brewing in the United States. It is a slow-moving and highly visible disaster, but that doesn’t impair the potential impact of this phenomenon. Like a freight train creaking toward you on the rails, it doesn’t matter if it’s only going five miles per hour if you’re tied down and in its path. Join me in discussing the absurd and dangerous student loan crisis.
In this post, we’re taking a trip. We’ll see some basic facts about student loans, explain how we arrived at this situation, learn the dangers of student loans, and discuss some potential outcomes and ways to fix this Gordian knot.
Student Loan Facts
Before we proceed, we first must set the table with some basic facts about student loans. As of the end of 2019, there are over $1.6 trillion in student loans outstanding. TRILLION. A thousand billion. $1.4 trillion of that is federal student loans.
- There are 44.2 million people with student loan debt
- Student loan debt increased by $41.2 billion in 2018 (as of the second quarter)
- Roughly 10% of aggregate student debt is 90+ days delinquent (2)
That delinquency rate is scary, right? Unbelievably, the real rate of delinquency is approximately twice that, or above 20%. The official figure understates effective delinquency rates because half of these loans are in deferment, grace periods, or forbearance.
A fifth, or more, of the outstanding student loan balance is delinquent. People went to school to gain knowledge and add value, but the delinquency rate starkly shows that this added value is missing. We’ll touch on this again later.
Timeline of Student Loans
In order to try to see the future, we first have to dig into the past. How did we get to where we are today? (3)
1867: The Department of Education is formed.
1944: The G.I. Bill allows veterans to attend college for free or next-to-free. This dramatically boosts college enrollment numbers and vets become ~50% of enrolled students in the years after the passing of the G.I. Bill.
1958: The first federal student loans come into existance through the National Defense Education Act so that the U.S. can better compete against the Soviet Union.
1965: The Higher Education Act is passed to provide Educational Opportunity Grants for students with financial need. The Federal Family Education Loan Program (“FFELP”) enables banks to provide government subsidized and guaranteed loans to students.
1972: The Pell Grant is created to further help needy students attend college.
1992: The Higher Education Amendments create FAFSA, the Direct Lending Program, and unsubsidized Stafford loans.
1993: The Student Loan Reform Act kicks-off the Direct Lending Program, which cuts out the middleman and enables the government to lend directly to borrowers without using a private bank.
2005: The Higher Education Reconciliation Act allows students to take out loans for grad school.
2008: The Great Recession causes hickups in the credit markets and many private lenders ditch FFELP.
2010: Government legislation buried within the Affordable Care Act eliminates FFELP (few were underwriting these loans anyway) and requires all new loans to be Direct Loans, giving the government a monopoly on this type of lending. Remember this date!
The Shocking Truth
Guess what the U.S. Government’s number one asset is? Take a second. What do you think?
Is it land? Military equipment? Taxes receivable? Buildings? The gold in Fort Knox and the New York Federal Reserve?
If you have federal student loans, YOU are part of the government’s biggest asset!
How did this insane situation come to pass? How are more than HALF of the government’s assets student loans?
Carrot or Stick?
Like anything else, look at the incentives. Incentives drive human behavior more predictably than anything else I know.
Student loan debt is almost impossible to shake off; you can’t even get rid of it with bankruptcy. Issuing an almost impossible to write-off bond is a lender’s dream.
The typical student loan has a duration of ten years. The 10 Year Treasury yield, at the time I’m writing of this, is 1.82%. This is what the government owes to people who buy 10 Year Treasuries. The average student loan interest rate is between 4.81% (undergrad) to 7.44% (Direct PLUS loans). This is a spread of ~3-5%, which is absurd. (4)
In my humble opinion, government-backed student loans should have a rate only slightly higher than the 10 Year Treasury yield. If you’re going to socialize loans, be reasonable about it. Or, better yet, don’t have government backed student loans in the first place.
This is not the case, however. This wide spread between what the government owes on its borrowed funds and what it loans out to creates an issue called moral hazard.
The government is making a considerable amount of money from student loan borrowers. This ability to offset increased government debt with an asset at a premium spread to the aforementioned debt only serves to enable the government’s profligate borrowing. While I don’t believe this is some grand conspiracy that was planned at the onset of the student loan explosion, this dynamic exists now and must be questioned.
Related: Social Insecurity
This lending spread would be less of a problem if the cost of education didn’t skyrocket, but it did.
The Rapidly Rising Cost of Tuition
Recently, I wondered about the current tuition charged by my business school. I graduated roughly five years ago and when I attended this school, tuition was approximately $45,000 per year. So, the cost of this two-year degree, not including living costs like room and board, was $90,000.
I thought that was expensive.
Then I looked at what my school is charging now: over $70,000 per year! Almost $150,000 for the full program. Tuition increased by more than 50% in a handful of years.
Including other expenses, getting my degree now costs around $225,000.
But wait, there’s more. The school only lists the expenses during the nine months of the school year. Do you think your landlord stops charging rent during the summer internship? Hopefully you’re making good money during this internship, but usually, it’s just enough to tread water.
While my school is renown for being stupidly expensive, this rapid increase in tuition exceptional. Nationwide, how much has tuition increased?
How does this look when you take into account compounding over time? Ugly.
These are truly worrying statistics. Not only is the interest rate charged on a voluminous amount of student loans higher than it should be, but the cost of college and therefore the total amount borrowed is also compounding at a high rate.
If you thought compounding was powerful, take a gander at double compounding.
Why has college gotten so damn expensive?
Related: Inflation, the Destroyer of FIRE
Colleges: the New Robber Barrons
If you speak to your grandparents or your parents, the costs for a college education were substantially less during their day.
As a prospective student, you had a few options to pay for your education:
- Get mom and dad to pay for it
This list is identical today, with one glaring exception: student loans.
Previously, if you didn’t come from a family with means, you could still go to college without taking loans! People worked summer jobs and the paltry pay was still enough to cover the costs of college. Many people cannot work, even full time, and afford school without loans. Previously, you could go to school for a few thousand dollars a semester, not the cost of a BMW.
What has really accelerated the cost of college is the guaranteed check the government writes for student loan borrowers. There is no scrutiny into the credit history (if any) of the borrower. There’s no concern about the quality of the school being attended, the academic history of the applicant, or their major and future earning prospects.
Prior to the government stepping in, student loans were very rare. Who would underwrite such a loan given the conditions listed above? The inability to get student loan was a damper on the cost of college. If nobody can afford it, nobody will buy it. However, when student loans became federalized, they also became something you couldn’t write-off in bankruptcy. For lenders, that is literally zero-risk. Want to go major in Zero-Gravity Blanket Quilting? Here’s your $200k, have fun!
College is Big Business
What do you call it when the government artificially props up a private enterprise? Corporatism.
The typical complaints against capitalism are actually complaints against corporatism: massive tax breaks for oil companies, taxpayer funded bailouts of airlines, corn subsidies, the list goes on.
Colleges, even state-run colleges, are not non-profits. They often have massive endowments (hello, Yale) and pay the top administrators millions of dollars. The more students they take in, the more money they make.
As the pool of potential students continued to grow, it outpaced the physical capacity of older colleges to expand. This is why so many highly dubious and sometimes fraudulent private universities popped up all over the country.
My business school has a full-time program and a newer part-time program. The quality of the part-time students varies wildly and it is far easier to get admitted through the part-time program, and my school makes a fortune from these part-time students. Since the standards are lower, the sheer number of students my school can educate goes up significantly. Not only are they growing the price every year, they’re increasing the volume of students. The part-time program is equally as expensive as the full-time program.
However, I specifically overheard recruiters from investment banks immediately asking applicants “part-time or full-time?” They screened out the part-time students because they had already perceived the less-vetted nature of the part-time students. So, these additional students, whether they are brilliant or not-so-brilliant, are paying as much for a degree that takes more time to obtain and they aren’t even getting the same access to the “elite” positions they went to business school for.
The government is writing fat checks and it’s a party! Models and bottles for everyone, but it’s “Smart Water” and Excel for most.
The Declining Value of a College Degree
Unless you went to an elite school for undergrad, you likely need another degree to advance your career further. Even Ivy League grads are increasingly feeling the pressure to get a Masters degree or Ph.D. This does not apply at all to entrepreneurs, but more to the check-the-box white collar hierarchy of many large companies.
In 1940, 3.8% of women and 5.5% of men had college degrees. In 2018, 35.3% of women and 34.6% of men earned college degrees. In the span of one lifetime, college degrees went from very rare (< 5% of the population) to common (> 1/3 of the population).
Let’s look at it by generation. (6)
What does this mean?
Instead of only the top students furthering their education, now anybody who graduates from high school can go to college. Public high schools, under immense pressure from the Department of Education, pass almost anybody with a pulse. While I generally believe a better educated populace is better than a less educated populace, is the premise that a college education leads to a better outcome and earning power still true?
Let’s see (6):
The data above is interesting.
In the Silent Generation, the gap between the earnings of college-educated people and high school grads was much less than it is today.
People with a college degree make more money now than they did before, yet people without college degrees are earning even less.
While this may seem somewhat strange, this is a biproduct of the expectation of a college degree for even low-level menial office jobs. No longer are only the top students going to college, now it’s expected of everyone to get a degree.
How much did average earnings grow in fifty years if you have a college degree? Earnings grew a total of 8.7%. This is a compound annualized growth rate (CAGR) of 0.17%. At least they grew, right?
No! This is woefully below even minor inflation. Now compare these earnings to the chart earlier in this post showing the rising cost of education. We have a massive problem here.
While earnings for those with college degrees barely increase, the cost of attaining these degrees is exploding. If you even get a job after college, your personal balance sheet is getting worse. A $50k per year job doesn’t look so hot when you have $150k of debt. People are now resembling private equity-backed companies, with multiple turns of leverage. We’re walking LBOs (leveraged buyouts)!
If you don’t get a degree, however, the data is grim. Most people truly are stuck between a rock and a hard place.
History Doesn’t Repeat, but it Echos
What does this remind you of?
- Loans backed by the government given to questionable borrowers
- Asset value is also questionable
- Product purchased under the assumption that it is an investment
- Massive leverage
Sounds a lot like the 2008 housing crisis, doesn’t it?
In the last few years, private companies like SoFi and CommonBond as well as some of the banks (Wells Fargo, First Republic Bank) have aggressively pushed student loan refinancing.
They ofter dramatically lower rates than the ones offered by the government. The graduates with the best earning potential, highest paying jobs, and best credit scores are almost all refinancing their loans. It’s logical.
However, what does that mean to the pool of student loans that aren’t refinanced? Over time, it is filled with riskier and riskier borrowers! The government’s top asset is getting increasingly unstable. The AAA-rated professionals are leaving that pool, and the government is stuck with people who don’t have the income or the credit rating to refinance their loans.
Uncle Sam has Issues
In the wake of the housing crisis, Freddie and Fannie Mae (the government agencies behind student loans) went bankrupt and had to be bailed out, as did many “private” banks. The damage to the economy and to people’s lives is still felt today.
Today, the government relies on the volume of student loan borrowers. These loans become assets on the books although they’re highly questionable and many will never be paid back. This “asset” empowers the government to borrow more money for other projects.
New graduates are burdened by high debt and shitty salaries. This is preventing people from moving out of their parents house, getting married, or having kids. Immigration is not pulling the slack. This alone is a demographic time bomb.
Related: Social Insecurity
The government, unlike us, has the ability to print more money. When the government takes in less money than the debt payments it owes, do you think they will default?
If social security benefits suddenly stop getting paid, along with many other social programs, there will be massive unrest, riots, and violence. Since the government controls the printing press, I think it’s more likely that the money supply skyrockets and eventually inflation also balloons. The meager wage increases seen by college graduates (or decreases with everyone else) will get curbed even more by the loss in purchasing power of the dollar.
People will see that college is no longer the guarantee for a better life, as it once was perceived, and stop going to college. This decrease in volume will cause many of these newer schools to shutter. Student loan repayments will crumble and the Treasury will be under increased stress with less income to make debt payments.
Student loans are a stealth tax on the middle and lower class. Remove the Government’s power over education
We’re in a bad situation and most people push this to the back of their mind, if they even think about it at all. How do we turn this around? I certainly don’t have all the answers and I’m not an expert on how to implement ANY of these changes. That said, here are some ideas:
- Change Perception: a college degree should go back to being rare. Maybe 10-15% of the population should have one, not 1/3 (or half of Millenials). This will increase competition for degrees, increase the quality of degrees, force bad schools to close, and lower the debt levels of the average person. If you’re not a good student, learn how to code or weld.
- Make High School Great Again: a high school degree is perceived as below a bare minimum for many jobs. It is inconsequential in the white collar world. Reform education so that a high school degree is worth a damn again. Flunk people who don’t meet the standards.
- Remove the Stigma of Blue Collar Jobs: electricians and plumbers often make more than new college graduates and they have no debt. They also enter the workforce at least four years sooner. In a Great Depression scenario, who will be able to continue getting work and put food on the table, a plumber or an investment banker?
- Make Sure Your Major Pays: if you are going to college, take the most challenging courseload possible. You’re not there to party and get wasty-faced every week. You should HATE college because of how hard it is. Ask any engineer. This increases your odds of having a good salary that justifies your new debt.
- Bang for the Buck: if you are going to an expensive school, make sure it is elite. Paying Ivy League money for a shite school is quite possibly the biggest mistake you can make in your life. Go to the least expensive but quality program you can get into. Even if you go to Harvard, make sure your major PAYS. No sane bank would underwrite a hobby/passion so don’t do it yourself.
Do you agree or disagree? What do you see as the best way forward?