The Student Debt Dilemma

Some predict that student debt will be the next asset bubble that will make the financial markets crash.  That's unlikely, but student debt is a huge and growing problem that gnaw away at economic growth until something changes.

Student debt won't bubble and burst like mortgages because the impact of losses wouldn't be centralized in the financial system.  The reason why mortgages, and their kissing cousins, mortgage-backed derivatives, almost blew up the world's financial system in 2008 is that when the ship hit the sand, the impact of losses was concentrated on the largest financial institutions, in particular an insurance company called AIG.  These institutions would have been rendered insolvent toute de suite, and the financial system would have been engulfed by a roaring flushing sound.

Some 20% or so of student loans are in default, and very possibly many more will never be fully repaid (for various reasons, it's sometimes possible to avoid default by paying small amounts of student loans but not be repaying fast enough ever to fully pay off the debt).  The impact of these losses will be spread out over time, and much if not most of it will fall on the U.S. government.  Which means that taxpayers will bear a lot of the burden, along with private investors.  But it will be a diffuse, albeit large, burden rolling out over years and decades.  There won't be a sharp poke in the eye at a discrete moment in time that will trigger a financial crisis.

But the aggregate amount of student debt keeps growing (it's over $1 trillion now), and the burden of repayment is growing commensurately (especially since interest rates on federal loans will float, and given today's ultra low rates, they can float only in one direction).  The burden of defaults and other nonpayment will also grow.  It's anecdotally said that student loans are holding up everything for many young adults--marriage, car purchases, home purchases, having children, and so on).  Maybe it makes sense that the sharing economy (car sharing, bike sharing, and the various iterations of the rental economy) is booming.  Young people can't afford to buy things, so they purchase the use of things for short periods of time.  This may be good for the environment, but it hinders economic growth.  If the burden of student loans becomes heavy enough, the impact could be lifelong, and entire lives could end partially unlived.

Student loans are almost impossible to discharge in bankruptcy.  It's easy to get federal loans--you just need to be admitted to an accredited institution--so there's an understandable reason for making them hard to ditch.  Otherwise, taxpayers could be asked to give free college educations to vast numbers of people.  And college educations provide lifelong benefits, so it's arguably fair to ask people to repay college loans, even if it takes a lifetime.

But student debt has become a bear trap for those who default.  Of course, their credit scores are knocked down.  That seems fair enough, but that's also where the kidney punches start.  Many employers won't hire a person with credit problems.  If you are laid off and then default on your student loans, you may not be able to get a new job to repay them.  Sometimes, you lose a professional license (like a nurse's license), which makes it even more difficult to find a job to repay the loan.  Defaulted loans continue to bear interest and penalties are imposed for default, thus ballooning the amount you have to repay.  So, if you have significant student debt, here's what you have to do:  (a) never lose a job; (b) never get so sick that you have to take major time off from work; (c) tell your aging parents that you can't help support them in their old age; (d) tell your spouse he or she can never lose a job, get so sick that they have to take major time off from work, and provide no support to their aging parents; and (e) never do anything that would otherwise result in default.  Getting to like rice and beans, network television broadcast to a TV with rabbit ears, and knitting your own socks, would also be good.

What will happen is, eventually, substantial relief will be given by Congress to student loan defaulters.  The exact scope and terms of the relief aren't easily predicted.  But it will happen.  Why?  Because the problem has become too big, and full repayment is increasingly unlikely for too many borrowers.  Since students from middle and lower income classes are the most likely to take out loans, the burdens are distributed in a regressive way.  Sooner or later, that will find expression in the ballot box.  When too many people labor under the burden of student loans, their combined political voices will overwhelm the lobbyists and influence peddlers employed by the student loan industry and the educational institutions that free-ride on easy educational credit.

There's a precedent for allowing student loans to be discharged in bankruptcy--that's bankruptcy itself.  When Lord Cornwallis' Redcoats surrendered at Yorktown in 1781, there was no such thing as bankruptcy.  Debtors were not only expected to repay their debts in full, but could be imprisoned until they did so.  As one might expect, the use of debtors prisons wasn't always fruitful.  A debtor in prison couldn't work or otherwise do much to repay.  But debtors were commonly imprisoned in the belief that the world was a better place for it.

However, as America grew into a bustling, vibrant industrial nation, voices of reform argued for giving debtors a chance for a fresh start.  Freed from old debt, individuals could more fully participate in the economy and provide for their families, thus strengthening future generations.  Creditors pushed backed, contending that a man's word should be his bond and that shiftless, lazy and prevaricating deadbeats shouldn't be able to hoodwink those that extended credit in good faith.  But the voices of reform won the debate, and America became one of the early adopters of the concept of bankruptcy.

Permitting bankruptcy shifts risks, placing more of the burden of default on creditors and less on borrowers.  As a consequence, market forces led creditors to adjust their practices, raising interest rates on all borrowers and eventually adopting the credit scoring system.  In effect, all borrowers pay for the defaults of some, but all borrowers have the option of bankruptcy.  Since you never know when life may blow up in your face, this may not be so bad.

The student loan crisis will eventually impel something similar. The sheer, growing size of the problem will force change.  Student loans increasingly are no longer just the problem of some, but the problem of many, most and perhaps even all. Of course, if student loans become dischargeable in bankruptcy, other changes will result.  Interest rates on the loans would likely increase, so that all borrowers cover the costs of defaults.  And educational institutions may be required to pay a portion of defaulted loans--at least for those students who don't graduate, so that colleges don't accept applicants who are unlikely to graduate and then free ride off the loan revenues from those students.  These changes would be appropriate, since taxpayers shouldn't have to fund handouts for the educational sector. 

The current student loan crisis is yet another illustration of the problems of easy credit.  Easy credit at first seems like a bargain, and everyone loves it.  But there's no free lunch, and the costs of easy credit will eventually emerge.  When the problem becomes so severe that it cannot continue in the present form, then it will change.

The Online Challenge For Higher Education

Higher education is moving online, and that's a trend that will continue and expand.  The costs of college degrees have risen sharply over the past 40 years and this trend shows few signs of abating.  Cost considerations alone will force many students to look for online alternatives.  It doesn't matter that physical institutions offer the benefits of face-to-face classroom interactions and social opportunities that could create lifetime friendships.  When college costs continue to rise 5% or more a year, and incomes rise scarcely at all (except for the top few percent), numerous students from less privileged backgrounds will be financially squeezed out of traditional college experiences.  How quickly and how far online education grows depends on how purveyors of online education and traditional colleges confront certain basic challenges.

Online education has to prove that it can provide a quality education, one that makes its graduates competitive in the marketplace for good, well-paying jobs.  Online students obviously won't enjoy football Saturdays, beer in the student union, or impromptu chats with professors; nor will they be able to disgrace themselves with embarrassing behavior on fraternity row on weekend nights.  And it's difficult to replicate certain educational experiences online--laboratory work for physics and chemistry classes isn't quite the same if all you're doing is watching someone else do it through a computer monitor.  But the educational content of many, and perhaps most, college courses can be presented online with little or no loss of substance.

The online educational process may be more adaptable to meeting the needs of employers.  Physical institutions tend to subscribe to a traditional belief in the value of a broadly based liberal education.  While this concept remains valid, it isn't essential for everyone.  The billionaire founders of Microsoft, Oracle and Facebook are all college dropouts.  The denizens of academe may sneer at trade schools, but Europe's most powerful economy--Germany's--includes trade schooling as a crucial part of its educational system.   There is more to life than work, but life really stinks if you need a job and don't have one.  If online schooling can produce competitively employable graduates, it will transform education the same way that Amazon and Alibaba have transformed retailing.

Physical colleges have overpriced their product, and now confront an overcapacity problem.  The elite schools (the top 100 or so) will continue to do well because there will always be a certain segment of the population willing to pay (or having parents willing to pay) the costs of a name brand sheepskin.  Students aiming to be professionals--doctors, lawyers, and so on--will benefit from the friendships and contacts they make by being on campus. Students who don't really know what they want to do may be able to find a focus for their energies from exposure to the breadth of topics covered by a liberal education.

But the days when getting a college degree in anything and still being readily employable for a good salary are long gone.  There is increased pressure on kids at the high school level to choose a field and get a focused education so they can get a job.  Mid-tier colleges that provide good students with a good general education will find that's often not enough.  And even as they struggle to adapt, they'll be competing against numerous other mid-tier colleges that are struggling to adapt.  Reality is that a lot of mid-tier colleges have limited half-lives.

Much of the problem lies in the easy availability of educational loans.  There is no meaningful underwriting process for these loans.  Anyone admitted to an accredited institution can get a loan.  And, in order to preserve the principle that there's no free lunch, these non-underwritten loans are virtually impossible to discharge in bankruptcy.  For many kids, educational loans are like a pact with the devil--easy to enter into, but binding for eternity.  Many colleges are culpable participants in this pact.  They used the availability of easy education credit to raise tuition and fees much faster than incomes were rising, and to pad the compensation of administrators and top level college officials.  They aren't stuck with having to repay defaulted loans of their students.  So they have every incentive to encourage students to take out loans that benefit the college and its officials, but impose no costs when the educations they provide aren't sufficient to land the students good jobs.

Political considerations preclude any meaningful reform of college loan programs that would balance the costs and benefits, particularly by penalizing colleges for churning out graduates who can't repay loans that the colleges helped them obtain.  But economic forces will compel change.  Many high school graduates, looking at the bear trap college loans can become, will choose low cost routes through community college, trade schools, and, increasingly, online education.  Many physical colleges that have floated on the cushion of educational loans will have to downsize or close, as their cost structures cannot be sustained by their likely future revenue stream.  They will no doubt lobby the political process, whose knee jerk reaction will be to make college loans even easier to obtain.  But that will, if anything, make the problem worse, not better.  Students, having been served too many coffee drinks by well-educated baristas, won't take the bait. 

The economy as a whole is better off if students can obtain high quality, low cost educations.  Indeed, as the American middle class continues to decline, inexpensive higher education may offer one of the few avenues for recovery.  The end result will be workers who can succeed, prosper, and consume, rather than have pauper's lives in quasi-debtor prison. 

The Point Missed in the Budget Debate

It's become all the rage in Washington to froth over the federal deficit and produce sound bite-driven proposals on how to reduce it. In the relentless quest for media coverage, everyone involved in the budget debate has something accusatory to say about someone else. As in sports, trash talking and cheap shots get more attention than real accomplishments.

The lack of attention to real accomplishments allows an important point about the budget deficit to go unnoticed. When we talk about splitting up a pie, the size of the pie is crucial. A large, fast growing pie is much easier to divide than a smaller, slowly growing pie. A stagnant or shrinking pie can be poisonous to the debate. Right now, we have a slowly growing pie that may go stagnant or shrink soon given the rising costs of energy and food. And the debate is indeed poisonous.

We need to focus more on expanding the pie, not in the Federal Reserve short term-next quarter, money printing, inflation-risky way, but for the long term. We also can't look to the federal government to solve all our problems. At the risk of asking Americans to behave like adults, it would be better if we looked for some non-federal ways to boost long term economic growth. There is a limit to the effectiveness of federal policies, which are mostly subsidies and handouts, and we pretty much surpassed that limit a while ago. What should be done?

Embrace Innovation. Innovation was the key to America's spectacular growth in the past two centuries. Railroads, the telegraph, the telephone, the airplane, automation of farming, new energy technologies, electronics and computers were essential factors in making America an economic powerhouse. We celebrate the concept of innovation today, but don't encourage it enough. Immigration rules for the highly educated should be relaxed--we'll never recapture manufacturing from Asia, but we can try to bring more of their brainpower to America. Many of Asia's smartest people want to live here, at least for a while and maybe for the rest of their lives. Brains produce innovation; tariffs don't. America's economic future will be in the production of high value added goods and services. (And not, contrary to what the Fed thinks, a revival of housing, which can't be revived by the government because it remains buried under a crushing load of bad debt, and only politically unacceptable levels of taxpayer subsidies will revive housing.) Innovation was the key to America's past prosperity and will be the key to its future.

Hug nerds. America's educational system is roundly criticized for failing to teach many students the basics. That's a valid point, but we're too focused on making America's schools training facilities for corporate employers. Schools should also be a place for exploration and creative thinking. They're not. Today's elite universities' admissions standards place enormous emphasis on being well-rounded, having not only fantastic grades, but athletic achievement, public service, experience in the arts, internships left and right, and international travel. The people admitted will make good corporate executives, management consultants, corporate lawyers, accountants, and doctors. Those with good math skills may become Wall Streeters. Most likely, none will create innovative technologies or establish major businesses. It's not an accident that Bill Gates, Steve Jobs, and Larry Ellison were all college dropouts. (So was Mark Zuckerberg, although it's not yet clear if Facebook is a transformational company or a fad-and-fade like Yahoo.) America's leading universities don't embrace original thinkers; they favor compliant kids who know how to manipulate and please their elders. Today's elite schools don't encourage or even tolerate the wacked out thinking that transformational economic change requires. Gates, Jobs and Ellison had to swim upstream to accomplish what they did. One can only wonder how many dozens, hundreds and maybe thousands of other free thinking, but slightly less determined kids have been discouraged from fostering innovative change. We need to think outside the box to make America grow again, and one way would be to encourage, and indeed embrace, kids who think outside the box.

Improve transportation and communications. America is a big country. Look on a globe, and you'll find very few other countries as large. We need really good transportation systems, because ultimately goods and many services need to be physically delivered. One can't live off Internet access alone. State and federal governments in the 19th Century did a much better job in this respect than their counterparts today. The Erie Canal was sponsored by New York state. The railroads were subsidized by the federal government. In the 20th Century, air transportation and the interstate highway system were creations of federal policy, and local governments took on much of the burden of building suburban infrastructure. America became wealthy from the massive markets permitted by these government supported transportation systems. Today, highways need to be maintained, bridges repaired, and subway systems renovated and expanded. Suburban roads need maintenance and improvement--remember that most economic growth is in suburban areas, in spite of renewal in a few urban areas. Roads and other transportation systems don't have powerful lobbyists, so they are easily ignored. That is a serious mistake.

Fostering high-speed Internet access for all should be a priority. This would include hard wired access and wireless access. The easier it is to communicate, the more innovation we'll have. And, let's face it, the more consumption we'll have since we're approaching the point where you can buy almost anything over the Internet. Way too many people share way too much about themselves in the Internet. But speed of communication speeds up economic activity. Even if some people are tacky and tasteless, others will increase their productivity--and, along with it, our prosperity.

Export Educational Opportunity

The recession is doing a lot of damage to the economy, much of it outside the financial sector that is now being so heavily subsidized by the government. Some parts of the economy won't fully recover. Automobile manufacturing is the most obvious example. Real estate construction is another. Investing in long term economic growth is essential as a way to replace these losses. Many of America's problems would become more manageable if long term economic growth is enhanced. Covering the cost of the ballooning federal debt, coping with the growing burdens of Social Security and Medicare, supporting the long term values of real estate and stocks--still the most crucial assets in retirement planning--and paying for the protection of the environment are some of the more obvious examples of problems that become less challenging if GDP growth rates rise.

Almost all of the federal government's bailout and stimulus measures are understandably focused on short term difficulties. If we don't fix short term problems like the banking crisis and the ongoing recession, prospects for the long term become dimmer. But the long term also becomes dimmer if we omit to make long term investments.

One of the best long term investments America could now make would be to export educational opportunity. We're not talking about American universities opening campuses overseas. We mean providing more opportunities for foreign students to study here. The United States has the best university system in the world. Not only is it superb--Nobel Prizes in the sciences go predominantly to faculty of American universities--but also very large, enrolling some 14 million students. There is plenty of space of for additional students, as enrollments are under pressure because of the weak economy and reduced availability of financial aid. Most importantly, foreign students can be among the best long term investments for the U.S. economy.

Something like half the startups in the Silicon Valley were founded by people who were born in another country. Sergey Brin and Jerry Yang, co-founders of Google and Yahoo, respectively, were both born in other nations. Many of the Silicon Valley's entrepreneurs first came to America to study, and then stayed because the opportunities were better than at home. Going farther back in time, foreign born engineers played important roles in the electronics revolution of the 1950s, which saw the development of the transistor (a key component in virtually every electronic device now made) and the computer. One, An Wang (no relation to this writer), helped design the structure of computer memories, and then went on to found Wang Laboratories.

America's role in the world economy will be mostly ideas-based in the future. Manufacturing, although still a critical sector, will decline relative to overall GDP. America's best economic opportunities will come from the production of high value goods and services, and we need brain power to create those products. By having foreign students study and stay here, we obtain some of the best and brightest from around the globe. Even though we're mired in recession right now, many foreign students will stay because America offers individual liberty and freedom in ways many and probably most other countries do not. They can cast off limitations in their home countries imposed by ethnicity, gender, religion, social stratum, and political beliefs, and like native born Americans recreate themselves. America is a nation of immigrants, and a flexible immigration policy is a gift that keeps on giving.

Of course, we can't simply open the borders, for both economic and security reasons. But ambition is the life force behind long term economic growth. Generosity in allowing foreigners to study and stay here channels into the United States ambition that would otherwise build the wealth of other countries.

Foreign students generally come up with the money for their educations on their own, with little aid from American sources. In that respect, they help to reduce the balance of payments deficit that the U.S. has with the rest of the world. We're not suggesting that the U.S. government provide support to foreign students, since they generally have powerful enough reasons and sufficient funding to come here anyway. However, the government should shape its immigration policies to give smart, well-educated foreigners greater opportunity to study here and then stay to work. Granted, foreigners applying for jobs here compete against native born Americans. But, from a longer term perspective, they enrich the nation as a whole. These people have, time and time again, proven immensely valuable to America. Over the long term, the most valuable capital is human capital, and America shouldn't shortchange itself.

How to Maximize Your Investment Gains

Profiting from investment consists of two things: (a) making money; and (b) keeping it. There is risk in almost every investment--even federally insured bank deposits are subject to loss of value from inflation--and risks can cause losses.

Risk and reward walk hand-in-hand down Wall Street. The higher the potential rewards of an investment, the greater the risks it involves. If you invest in something that offers large potential gains, understand that it's likely to have high risks of loss as well.

From time to time, you may hear of investments that are sure bets. When someone offers you a chance at one of these sure bets, put your hand on your wallet and go for a walk around the block from which you don't return. There are no sure bets in the financial markets.

Maximizing your investment gains involves a balancing of risks and rewards. Look for investments with reasonable returns and moderate risks, and you have a good chance of making money and keeping it in the long run.

So, if you are an ordinary investor, what are good investments? We mean the ones where you have a reasonable chance of receiving gains and then keeping them. Here are some ideas:

1. Stocks and stock mutual funds: stocks give you ownership of a small piece of a company. Stock mutual funds own a large number of different stocks, and give you a tiny bit of ownership in all the stocks that the mutual fund owns. Stocks are generally a good long term investment. Of course, we all know that the stock market fluctuates. But if you ride through the ups and downs, you'll likely do well over the years. Stock mutual funds smooth out some of the ups and downs by giving you a diversified pool of investments. As a mutual fund investor, you put your eggs in many different baskets, and therefore have a smaller chance of taking major losses from any particular stock.

2. Bonds and bond mutual funds: bonds are an investment where you invest an amount of money (the "principal") in the bond. The company or government that issued the bond pays you interest from time to time, and eventually repays the principal. In this sense, bonds are like bank certificates of deposit (except they aren't federally insured, although U.S. Treasury bills, notes and bonds are safe). A bond doesn't offer great potential for gains. However, it tends to have low risks, especially U.S. government bills, notes and bonds. A bond mutual fund holds a number of different bonds and helps to diversify your bond investments. You would invest in bonds and bond mutual funds to provide stability to the value of your financial portfolio. Every portfolio should have some stable assets, especially as you get older.

3. Lifecycle or target date mutual funds: these mutual funds hold both stocks and bonds. They are a blended mix of financial assets and are designed to give you the potential of stocks for good long term growth while somewhat stabilizing the value of your portfolio by investing some assets in bonds. The company managing these funds does the investment selections for you, so all you have to do is pay in your money and let them do the rest of the work.

4. Real estate: we now understand that real estate is not a wonder asset that will make everyone rich through no effort whatsoever on their part. Real estate historically has increased in value more slowly than stocks (about 1% after inflation versus approximately 3% after inflation for stocks). Nevertheless, everyone needs a roof over their heads and buying real estate is a good way to pay for that roof while adding to your investment portfolio. Owning a home provides some diversification away from the financial markets, and the home could serve as an asset of last resort in retirement, especially if you own it free and clear of debts.

5. Education: last, but certainly not least, is education. The gap in earnings between those who have a four-year college degree and those who don't has been growing over the years. The U.S. economy has shifted away from traditional manufacturing to knowledge and informational based activities, and it rewards those who know how to utilize knowledge and information. A college education doesn't provide everything you need for a job or a career. But it teaches you how to learn. You have to absorb information faster and on a more sophisticated level in college, and therefore you learn how to learn. That skill is highly rewarded in an economy based on knowledge and information. Education is one of the best investments you can make. Don't worry a great deal about which college you attend. Statistically speaking, there is little evidence that going to an expensive Ivy League school will make you significantly wealthier than attending a good state university. Just make sure you graduate.

Strange News: Apes with expensive tastes--http://abcnews.go.com/Technology/CSM/story?id=3158484&page=1.