We live in an era of fraud in America. Not just in banking, but in government, education, religion, food, even baseball... What bothers me isn't that fraud is not nice. Or that fraud is mean. For fifteen thousand years, fraud and short sighted thinking have never, ever worked. Not once. Eventually you get caught, things go south. When the hell did we forget all that? I thought we were better than this, I really did
Mark Baum (played by Steve Carell)
The Big Short
The Big Short, the Academy-Award winning movie on the home-mortgage crisis of 2008, shows movie goers how greedy banking institutions created a housing bubble that burst in a shower of home foreclosures and trillions of dollars in financial losses.
A similar bubble has emerged in the federal student-loan program. And although the housing bubble is more complicated than the student-loan bubble, there are some eerie similarities between the collapse of the housing market a few years ago and the student-loan crisis. For example:
Hiding risk. The Big Short includes a scene in which Mark Baum, a skeptical investment banker played by Steve Carell, quizzes a representative of one the bond rating agencies--Moody's or Standard & Poor. The rating-agency representative admits that the agency gives mortgage-backed securities the highest rating--AAA--even though the agency knows that many of the instruments are packed with risky home mortgages that are headed for foreclosure.
Something similar is happening in the federal student-loan program. Although the Department of Education recently announced that student-loan default rates went down last year--especially in the for-profit sector, that's not really true. The for-profits have been aggressively signing up their former students in economic-hardship deferment programs that excuse borrowers from making loan payments without being counted as defaulters.
When we look at the five-year default rates in the for-profit sector, the numbers are scary. Almost half the people who took out student loans to attend a for-profit institution default within 5 years of beginning the repayment phase on their loans. And two years after beginning the repayment phase, 3 out of 4 of these students are seeing their loan balances go up--not down--due to accruing interest that is not being paid down.
In short, about half the people who take out student loans to attend for-profit colleges don't pay back their loans. Clearly, this sector of the student-loan program is a train wreck.
Unsustainable rising costs. As many people still remember, the cost of housing went up rapidly during the early 2000s, with people buying homes and flipping them for huge profits over a matter of months or even weeks. Everybody was making money in real estate--until the housing market collapsed.
Similarly, America has seen college tuition costs rise faster than the inflation rate for many years. The cost of attending law school, obtaining an MBA, or studying at an elite private college has gone through the roof. I graduated from University of Texas Law School in 1980 and only paid $1,000 a year in tuition. If I enrolled at UT Law School today, it would cost me 36 times as much--$36,000 a year for Texas residents!
Of course, these tuition hikes can't be justified any more than the dizzying cost of a split-level home in Coral Gables, Florida in 2005. And of course, those costs must eventually come down. Already, law school enrollments have plummeted and the schools have lowered admissions standards to attract students. And the elite private colleges are now giving huge discounts on their posted tuition rates; the average freshman now pays about half the college's sticker price.
Hidden costs and fees. Finally, the home mortgage bubble was fueled by greed and fraud. The bankers who packaged mortgage-backed securities were not taking any risks--they took their fees from the transaction costs. The banking industry was selling toxic financial instruments to gullible investors, including pension funds and people invested in mutual funds.
Similarly, the college industry is charging a gullible public more than a liberal arts degree is worth, and the suckers enroll because, hey, going to Barnard or Brown or Amherst must be a good investment. And the colleges aren't assuming any risks. Their pliant students are borrowing from the federal student loan program, and the government guarantees the loan. Ivy League U doesn't care if its graduates default on their loans any more than Goldman Sachs cared what happened to the investors who bought their mortgage-backed securities.
And the fees! People who default on their loans get assessed huge collection fees and penalties. People are routinely going into the bankruptcy courts trying to discharge student-loan debt that is two or even three times the amount they borrowed due to accrued interest, penalties, and fees.
So if you haven't seen the Big Short, go see it. And as you watch this riveting drama, think about the student-loan program. A bubble is about to burst at a college near you.
"I thought we were better than this."