- Charles Mackay "Memoirs of Extraordinary Popular Delusions and the Madness of Crowds"
As a young finance student many, many years ago a professor recommended that I read Charles Mackay's "Memoirs of Extraordinary Popular Delusions and the Madness of Crowds" written in 1841. Skeptical as ever, but intrigued by the title, I remember searching for it in the library (that's where you used to go to get books). How could a book written in 1841 teach me anything about investing in the 1980's? Surprisingly I found it to be both highly entertaining and informative, and I later learned that it is consistently one of the most recommended investment books. Today you can download it for free on your iPad or Kindle, or here Memoirs of Extraordinary Popular Delusions and the Madness of ...
One of the most important aspects of investing is understanding crowd psychology, and more importantly being on the right side of that psychology. Recognizing bubbles, participating in them, and getting out while the getting's good. In my short career I've participated in the leveraged buyout bubble of the 1980's, the tech bubble of the 1990's, and the housing bubble of the 2000's. Bubbles can be extremely rewarding as well as extremely dangerous.
Today I'd like to talk about a different kind of bubble, the student debt bubble. As a father of two, with just a few more years left until college, I'm very cognizant of the ever escalating cost of a college education. Can the cost of a college education be a bubble? When something appreciates for nearly two decades at more than twice the rate of inflation or income growth, then it starts to look a bit bubblicious.
Now nearly everyone agrees that higher education is good for the individual and society, and therefore most governments subsidize it in one form or another. Government subsidies really got rolling with the GI Bill after WWII. The government decided that higher education would lead our country to prosperity, and therefore all taxpayers should subsidize it. It's a noble intention, but doesn't it sound just a bit like, "home ownership is a right". Washington began deciding who qualified for a loan, who could loan them money, and what interest rate they would pay. Since they told the lenders who to loan to and what interest they could charge, the lenders were indemnified against default. The result was a hugely profitable, nearly risk-free business for the banks and Sallie Mae. This system worked too well for the banks, and in 2007 Washington cut the interest they could charge in half. As the banks began to withdrawal from the business, Washington cut them out entirely in 2010 and began lending directly to the students.
The colleges, realizing that their customers have an unlimited availability of government money, have been able to raise prices at a rate that far exceeds inflation. In 1990 the average college tuition was $10,500 and was 25% of median household income of $40,800. Today the average tuition is $17,500, which is 35% of median household income of $49,500. Not surprisingly US Federal Education lending has more than doubled in just the last ten years. For students the average debt upon graduation is now $27,000, and $34,000 if you count parent-plus loans. These are just averages, the numbers for the middle class are much worse. The poor get nearly a free ride, while the rich pay cash, the middle class are by far the largest borrowers, that's why it's not unusual to find graduates with more than $50,000 in debt.
Paying for a college education is an elaborate daisy chain of moral hazard in which tuitions can soar, as lending soars, without regard for the quality of the product or the borrowers ability to pay it back. Doesn't this sound an awful lot like the housing crisis? A universally desired good is dangled as a "right" in front of an ever-growing population of borrowers at ever-higher prices, and paid for with government subsidized easy money, resulting in rising unsustainable debt and an eventual taxpayer bailout.
Today only 56% of the graduates of the Spring class of 2010 have jobs, that's down from 90% in 2007. Not surprisingly defaults are soaring. But even in bankruptcy graduates can't discharge their student loan debt, the IRS has the power to garnish wages and withhold tax refunds to get their money back. Is it any wonder that many students are angry. They've been told to go to college, graduate, and you'll get a good job, but it appears that many of them didn't read the fine print or do the math. The fine print states that you might want to think twice about paying $72,000 for a four year degree in a field where you'll make $45,000 per year (assuming you get a job). The math simply does not work.
Now these students want the taxpayers to bail them out (forgive their loans) because they overpaid for a degree that has limited real world demand. Of course our President, campaigning for that young persons vote, is more than willing to use taxpayer funds to forgive these loans. He's proposed that borrowers not pay more than 10% of their "discretionary income" each year, regardless of how much they owe. Discretionary income is defined as the difference between the borrower's adjusted gross income and 150% of the federal poverty line. For a single person the poverty line is $10,890, 150% of that would be $16,335. So if a graduate had a job paying $30,000, they would only be required to pay $1,366 per year ($113/mo) in loan payments (30,000-16,335 = 13,665 * 10% = 1,366). Don't worry if this is still a tad restrictive, if you can't pay it back in 20 years the balance due is forgiven. And, if you are lucky enough to land a "public service" job after graduation (including teaching), then your debt is forgiven in ten years.
Fortunately my oldest daughter is thinking of pursuing a career in teaching. Do you think for a moment that I might calculate the benefits of holding back her college fund, letting her max out the loans, pay the minimum for ten years, and say thanks to Mr.Taxpayer? She can apply the money I've been saving to making her loan payments, or making a downpayment on a house, pay the minimum on her loans, and have it all forgiven after 10 years. (When I was a student in the early '80's I maxed out my borrowing at 6% interest rates, invested the proceeds in an 11% money market, and used the float for essentials like beer.)
Lets do the math together for fun. Say she borrows $70,000 over four years to go to an OK school. According to the college loan calculator she'll pay interest of 6.8%, have a monthly loan payment of $805.56, and make total payments of $96,667.60 (principal & interest). Assuming she gets hired, she'll make about $40,000 as a starting teacher. Under the Presidents plan she would only have to make loan payments of $197 per month (40,000-16,355 = 23,645 * 10% = 2,365/yr.), not $805. Over the course of ten years she'll make total payments of $23,640, she'll still owe $73,027, which our generous taxpayers will graciously forgive. Shit, I think I might even vote for Obama!
Seriously, as a life-long investor I've learned that spotting financial bubbles can be the difference between success and failure. Clearly our colleges (especially for-profit colleges), and the lenders, have profited handsomely from our government sponsored student loan programs. The students who've struggled with math and borrowed more than they can ever hope to repay are the immediate victims. But, as the President and the Occupy Wall Streeters have shown, the ultimate victims will be the taxpayers.
Normally the price of a service is determined by supply and demand. A rising price depresses demand and stimulates supply, leading to a stable or lower price, and vice versa. But in a bubble the higher the price the more the demand, until it finally falls apart. We've seen it dozens of times over the decades and it never ends well. Since our government has constantly stepped in to supplement the purchase of an education, the supply/demand price equilibrium has been broken. We taxpayers will be paying for the housing bubble for years, and our payments for the education bubble are just beginning.
Eventually the taxpayers will revolt, and they will demand a restructuring of higher education. More focus on careers that provide skills that are in demand, and more alternatives to the classic four year university. Technology will clearly play a bigger role in lowering the time and cost of an education. All bubbles pop, make sure you're aware of the game you are playing.
