A few months ago, Steve Rhode posted a thought-provoking blog titled "The Student Loan Bubble That Many Don't Want to See." He argued that student-loan indebtedness is in a bubble that will soon burst, creating two huge problems:
First, when the student-loan market collapses, postsecondary education will be out of reach for most people, which will "put a drag on the overall economy as fewer and fewer people will be able to pay for tuition that outpaces inflation."
Second, a sharp contraction in federal student-loan revenue along with a shrinking student base will force many colleges to cut tuition, putting them under enormous financial stress. Rhode predicts that "[m]any schools, public and private, will fail."
Mr. Rhode sees a parallel between the the student loan program and the overheated housing market that led to a global financial crisis in 2008. Just as financiers packaged home mortgages into mortgage-backed securities called ABS, the banks have bundled student loans into so-called SLABS, or student-loan asset backed securities.
The home-mortgage market went into free fall when investors woke up to the fact that the ratings services (Moody's, Fitch, etc.) had rated ABS as investment grade when in fact a lot of them were junk because they were packed with mortgages that were headed for default.
Now we see Moody's and Fitch downgrading SLABS based on the fact that student borrowers are not paying off their loans as investors expected. More than 5 million borrowers have signed up for income-driven repayment plans that lower monthly loan payments and stretch out the repayment period from 10 years to 20 or even 25 years. SLABS investors now don't know when or how much they are going to be paid on their investments.
Some policy commentators reject the notion that the student-loan market is in a bubble. In a book published last year, Beth Akers and Matthew M. Chingos wrote: "Student loans have a zero chance of becoming the next housing crisis because the market is too small and essentially functions as a government program rather than a market." Akers and Chingos point out that student debt represents only 10 percent of overall consumer debt while home mortgages accounts for 70 percent of household indebtedness.
Personally, I think Steve Rhode is right: Higher education is sustained by a student loan bubble that the nation's colleges and universities refuse to see. In fact, there are eerie similarities between the housing market before it crashed in 2008 and the current level of student-loan indebtedness.
First, higher education at many colleges and universities is wildly overpriced, just as the housing market was overpriced in the early 2000s. This is particularly true in the for-profit sector and at private liberal arts colleges.
As as been widely reported, liberal arts colleges are now discounting tuition for freshman students by almost 50 percent--a clear sign that their posted tuition prices are too high. And for-profit colleges are seeing enrollment declines. University of Phoenix, for example, has seen its enrollments drop by about half over the past 5 years.
Second, the monitoring agencies for both markets failed to do their jobs. As illustrated in the movie The Big Short, the financial ratings agencies rated mortgage backed securities as investment grade when in fact those bundled mortgages included a lot of subprime mortgages.
Likewise, the Department of Education reports three-year default rates for student loans that vastly understates how many student borrowers are failing to pay back their loans. DOE recently reported that about 10 percent of the most recent cohort of student borrowers defaulted within three years. But the five-year default rate is 28 percent; and the five-year default rate for a recent cohort of students who attended for-profit schools is a shocking 47 percent.
And of course the government's vigorous effort to get distressed student borrowers into income-driven repayment plans also helps hide the true default rate. A high percentage of people who enter IDRs are making loan payments so low that they will never pay off their loans.
In short, Steve Rhode's analysis is correct. A rising level of student-loan debt has created a bubble; and the bubble is going to burst. Colleges raised tuition prices far above the nation's inflation rate, knowing that students would simply take out larger student loans to pay their tuition bills. Millions of Americans paid too much for their postsecondary education and can't pay back their loans.
So far, the Department of Education has hidden the magnitude of this crisis, but the game will soon be up. Colleges are closing at an accelerating rate, stock prices for publicly traded for-profit colleges are down, and long-term default rates are shockingly high.
It is true, as Akers and Chingos pointed out, that the student-loan market is not nearly as large as the home-mortgage market when it crashed in 2008. But Akers and Chingos fail to acknowledge the enormous human cost that has been imposed on millions of Americans who took out student loans in the hope of getting an education that would lead to a better life.
Instead, all many Americans got by taking out student loans is an enormous debt load that they can't pay off or discharge in bankruptcy. Eight million Americans have defaulted on their student loans; 5.6 million are in income-driven repayment plans that stretch their payment obligations out for as long as 25 years, and millions more are playing for time by putting their loans in forbearance or deferment.
Beth Akers and Matthew Chingos. Game of Loans: The Rhetoric and Reality of Student Debt. (Princeton, NJ: Princeton University Press, 2016).
Anamaria Andriotis. Debt Relief for Students Snarls Market for Their Loans. Wall Street Journal, September 23, 2015.
Patrick Gillespie. University of Phoenix has lost half its students. CNN Money, March 25, 2015.
Adam Looney & Constantine Yannelis, A crisis in student loans? How changes in the characteristics of borrowers and in the institutions they attended contributed to rising default rates. Washington, DC: Brookings Institution (2015).
Steve Rhode. The Student loan Bubble That Many Don't Want to See. Get Out of Debt Guy, July 15, 2016.
Amy Thielen. Declines at For-Profit Colleges Take a Big Toll on Their Stocks. The Street, May 8, 2015.
Kellie Woodhouse. Discounting Grows Again. Inside Higher Ed, August 25, 2015.
Sunday, January 8, 2017
Sunday, March 6, 2016
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."