Archive for Monday, November 7, 2011

Analysis: Is student loan, education bubble next?

November 7, 2011


First the dot.coms popped, then mortgages. Are student loans and higher education the next bubble, the latest investment craze inflating on borrowed money and misplaced faith it can never go bad?

Some experts have raised the possibility. Last summer, Moody’s Analytics pronounced fears of an education spending bubble “not without merit.” Last spring, investor and PayPal founder Peter Thiel called attention to his claims of an education bubble by awarding two dozen young entrepreneurs $100,000 each NOT to attend college.

Recent weeks have seen another spate of “bubble” headlines — student loan defaults up, tuition rising another 8.3 percent this year and finally, out Thursday, a new report estimating that average student debt for borrowers from the college class of 2010 has passed $25,000. And all that on top of a multiyear slump in the job market for new college graduates.

So do those who warn of a bubble have a case?

The hard part, of course, is that a bubble is never apparent until it bursts. But the short answer is this: There are worrisome trends. A degree is an asset whose value can change over time. Borrowing to pay for it is risky, and borrowing is way up. The stakes are high. You can usually walk away from a house. Not so a student loan, which can’t even be discharged in bankruptcy.

But there are also important differences between a potential “student loan bubble” and an “education bubble.” Furthermore, many economists think the whole concept of a bubble is a misleading way to think about what’s happening, and may actually distract from the real problems. College affordability is a serious issue, but it’s a different one. Borrowing for college and borrowing for, say, a house, are fundamentally different in important ways.

To be sure, there are some classic bubble warning signs:

l Everybody wants in. The idea that higher education is the only way to get ahead has become widely held. College enrollment has surged one-third in a decade. With rising demand, college tuition and fees have more than doubled over that time, outstripping inflation in every other major sector of the economy — energy, health care and housing, even when housing was bubbling itself.

l Those bills are paid with borrowed money. The volume of outstanding student loans is rising rapidly and now exceeds credit card debt, though recent reports of it crossing $1 trillion may be premature. Moody’s Analytics puts the number at about $750 billion. But while credit card debt is declining, student loan debt keeps going up.

l Just like housing, many student loans were made with little or no research into whether borrowers were fit. Federal Stafford loans are basically automatic for college students, and government backing for other types of loans gave other student lenders little reason to be picky.

l Defaults on federal student loans jumped from 7 percent to 8.8 percent in the most recent fiscal year. That measures just recent borrowers who were already behind within two years of their first payments coming due.

Those numbers are all alarming. But putting them in context requires thinking separately about the ideas of a “student loan bubble” and an “education bubble.”

First, one thing that’s important about the possible student loan bubble is that it poses much less of a threat than housing debt did to drag down the entire economy. Yes, many individual borrowers may find themselves in trouble. But total student loans probably amount to less than 10 percent of outstanding mortgages. More importantly, unlike mortgages, Wall Street isn’t knee-deep in securities comprised of bundled student loans, as it was with mortgages. (It also helps that it’s also harder to speculate in student loans; an investor can flip a house, but not a brain.)

The other big difference with student loans is the dominant role the federal government has assumed in the market in the last few years: It accounts for roughly 85 percent of student debt.


Ron Holzwarth 6 years, 3 months ago

1) "The hard part, of course, is that a bubble is never apparent until it bursts."

That is ridiculous!

Inflating bubbles are recognized by a few, but most will never listen to those few. I suppose it must be because they must be thinking "All those other people can't be wrong."

The fact is that upon just about any subject, most people know lots of things that simply are not true. Instead, they prefer to listen to "experts" of their own choosing.

I am reminded of a couple incidents in particular, among a few others. One of them was when someone I know inherited a rather large sum of money. When I was talking with that person's spouse on the phone, I remarked: "You should pay off your house."

The answer was loudly exclaimed: "That's the stupidest thing you can do!"

Then, in a somewhat calmer and condescending tone of voice: "We're going to invest it."

I believe that was in 1984, the mortgage rate was 6.25%, and at that time a safe return on a diversified investment portfolio was about 8%. The difference involved was only $2,000, which would be quickly devoured by frictional losses, so there could be no possible net gain, especially for an inexperienced investor.

Later, I was told the details of the fantastic investment that had been made instead of paying off the mortgage on the house. "Medium risk" had been selected, which paid a 24% return, and on top of that, the investor received 5% of whatever any other investor invested. All you had to do was locate more investors! It was too good to be true!

I had two questions. The first was: "Is your money safe?"

"Yes! They've always sent out the checks."

My first thought was: Since antiquity? But instead I asked a more probing question: "What is your money invested in to give you a 24% return?"

"Oh, shopping malls and real estate and stuff."

That was apparently the entire prospectus of the company. I quickly exclaimed, "There's something wrong! Get your money out while you can!"

I was quickly informed of my utter ignorance on the matters of High Finance.

About two years later, Ponzi, Inc. collapsed, leaving many investors wondering about the locations of all those shopping malls, all that real estate, and all that stuff.

They were all located in Mr. Charles Ponzi Jr.'s imagination.

I suppose that the investor in Ponzi, Inc. was consoled with the fact that at least he had not done "the stupidest thing you can do," which is to pay off the mortgage on his house with his inheritance.

Ron Holzwarth 6 years, 3 months ago

2) The other incident I am reminded of was a phone call I received from southern California in about 2006. The phone rang, and first off, I was excitedly asked, "Have you been watching the value of our house on Zillow?"

"No," I answered, wondering why I would do such a thing.

At almost a shout, that person exclaimed, "Our house is worth $650,000!"

"You should sell it!" I blurted out, realizing that in no way was that piece of real estate was worth that amount for various reasons, the top one being that the economic base to support real estate values at the level they were trading at in southern California was not anywhere near what would be required in order to keep them at the levels they were trading at. That situation was not sustainable at all, and that was so very obvious, at least to me.

With a tone of utter disdain, this is what I was informed of: "Real estate in southern California is always a good investment."

The tone of voice made it very obvious that person considered me to be incredibly stupid.

A few years later at the foreclosure sale, the house changed hands for less than $200,000.

Most people will never listen to the very few stupid ones.

I wonder if that has anything to do with the fact that 99% of the wealth in the USA is held by only 1% of the population.

Surely not.

Ron Holzwarth 6 years, 3 months ago

This is the very best investment advice you will ever get:

First, procure and work your way through a first year college level accounting textbook. It is not necessary to enroll in a class, it is only necessary to work through the book and understand it.

After you understand those concepts, read further and become more informed upon accounting and economic subjects as you do the following:

Read all of Warren Buffett's letters to the shareholders of Berkshire Hathaway. Read them all, starting with the very first one. They are available free of charge here:

If you do those two things, you will realize that if you are going to invest any substantial sum of money, you need to always follow these two basic rules:

1) Never invest more than 5% of your portfolio in any one investment vehicle.

2) Never invest in any investment vehicle that you do not thoroughly understand.

Oh wait, I forgot that I'm stupid. So, don't pay any attention to anything I say.

Ron Holzwarth 6 years, 3 months ago

Here's proof that I'm really stupid:

1) In my second comment, I inserted an extra "was".

2) I never graduated from college, the closest I ever got was to complete about 165 semester hours.

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