The Student Loan Bubble is the Next Subprime

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Don't look now but there's another giant bubble out there. It's so big it rivals subprime.

I'm talking about the student loan bubble.

Recently, the outstanding volume of student loans passed $1 trillion. What's more bothersome is that the average individual amount owed by new college graduates has passed $25,000.

With college costs zooming upwards faster than inflation, this is rapidly becoming another subprime mortgage-like sinkhole.

Just like subprime, the problem is that people of modest means are being suckered by high-pressure salesmen into taking on too much debt.

The difference is that since student loans are government guaranteed and can't be released in bankruptcy, the burdens will be paid by the unfortunate ex-students and the U.S. taxpayer.

The standard justification for soaring higher education costs is a simple one.

The United States needs to maintain an educational lead in order for its wage levels to remain above those of its competitors.

I'm talking largely about emerging markets, which have been helped enormously by modern communications, making global sourcing much easier than it was.

There are two problems with this view.

First, the more esteemed colleges take great pride in not providing vocational training, and graduate large numbers of students with degrees that don't obviously qualify them for anything.

In what way is the U.S. being made more competitive by graduating students in (insert your favorite useless college major here)?

Second, even as the demand for a college education is increasing, the efficiency of providing it is declining. Both the Ivy League and state university systems increase tuition rates far more rapidly than overall inflation.

The Student Loan Bubble Drives Up Costs

In fact, there is considerable evidence that finance availability is itself pushing up college costs.

As college funding has become more readily available to the general population, it has reduced the financial pressure on colleges, since few of their students are today paying their way from part-time jobs and parent cash flow.

Huge endowments in the Ivy League, which allow those elite colleges to provide full scholarships for students, focus the competition between colleges ever more closely on league table "prestige" rather than costs.

The ranks of college administrators have also exploded since they are effectively insulated from market forces – not unlike those in medical professions.

So have their earnings – according to The New York Times, in the decade between the 1999-2000 and 2009-10 college years, the average college president's pay at the 50 wealthiest universities increased by 75%, to $876,792, while their average professorial pay increased by only 14%, to $179,970.

Meanwhile, the cost of tuition has increased by 65% while prices generally rose by 31% during the same decade.

That's precisely the opposite of what you'd want to happen, if you were concerned about college productivity and cost.

Buried in Debt by Student Loans

There are two factors pushing the escalation in student loan volume.

One is the nationalization of most student loan programs in 2009, providing government guarantees on most student loans.

That has altogether removed the risks of student loan provision from banks, as well as encouraging low-quality degree scams by for-profit colleges. For-profit colleges are a good idea, but not when combined with government-guaranteed student loans.

The other factor pushing up student loans is the Bankruptcy Act of 2005, which allowed consumers to relieve themselves of all debts in bankruptcy except student loans.

This special privilege for the student loan market has caused great hardship.

The Washington Post reported this week that Americans 60 and older still owe $36 billion on student loans, and gave one sad example of a 58-year old woman who had borrowed $21,000 to fund a graduate degree in clinical psychology in the late 1980s (which one would think was at least moderately useful), had never been able to earn more than $25,000 per annum and was now left with student loan debt of $54,000.

If government guarantees and bankruptcy exemption remain in place, the volume of student loans will continue soaring, as unscrupulous lenders provide them to naive students.

That will cause the cost of college to continue rising in real terms as college administrators pad their sinecures.

As with the subprime mortgage industry, an eventual crash is inevitable. But unlike subprime mortgage borrowers, student loan borrowers will be unable to start afresh after bankruptcy.

The solution is to eliminate the two unwarranted subsidies to the student loan industry. Student loans must no longer be guaranteed by the government.

And in bankruptcy, they must be treated like any other debt. The banks will scream, and student loans will be much more difficult to get.

For most students, that will return them to choosing a cheaper institution and working their way through college, in the traditional way – some of them might choose more marketable degree courses, too.

For the poor but brilliant, the Ivy League can continue providing full scholarships and the government can continue providing Pell grants – with their cost fully accounted for on-budget.

College costs will drop back to 1970s levels in real terms, as overstuffed bureaucracies are eliminated.

And for college administrators and student lending banks, life will get considerably harder – which is no bad thing.

All bubbles eventually burst. This one will be no different.

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  1. Jonathan | April 5, 2012

    You make a good case that there are big problems with the student loan program. However, your article implies that this is an investment bubble that will crash in some similar way to stock market and real estate bubbles. However, there are important differences here. For example, the prices of houses in a given area are highly correlated…same with stocks. But the ability of two randomly chosen people to pay off their student loan is probably far less correlated. Furthermore, having student loans being government-insured protects against some sort of bank catastrophe taking place because of too much student dept. So really, what we're talking about is merely an indirect government subsidy to colleges and banks, with all the consequences that entails. Whether it's good or bad doesn't prove that it's the same as an investment bubble or is bound to "crash" in the same way.

  2. Deon Moore | April 5, 2012

    It's about time Money Morning has approached this issue. I am currently borrowing for an MBA, but working my way through the program. I am one of the few at my institution who is attending at night. The school pushes students to attend full-time and it actually frowns upon us who are part-timers. My cohorts are borrowing not only for their degrees but living expenses, achieving upwards of $100K in debt. This is such an elephant in the room….

  3. Carolyn Wu | April 5, 2012

    "With college costs zooming upwards faster than inflation, this is rapidly becoming another subprime mortgage-like sinkhole. . . . The standard justification for soaring higher education costs is a simple one. . . . The United States needs to maintain an educational lead in order for its wage levels to remain above those of its competitors. . . . Both the Ivy League and state university systems increase tuition rates far more rapidly than overall inflation. . . . In fact, there is considerable evidence that finance availability is itself pushing up college costs. . . . College costs will drop back to 1970s levels in real terms, as overstuffed bureaucracies are eliminated."

    While you may be correct for the Ivy League, your argument isn't accurate for the state university systems. The primary reason for the increase in costs at the state university system is something called "cost-shifting" as taxpayers pay less of the bill and more is being required of students.

    Thus, it is the unavailability of finance from the taxpayer and the requirement that the student pay that drives costs at state universities. There is a minimum cost to provide an education and all that will happen if we eliminate state financing (which is down to 4% of the overall budget at Penn State, for example) is that tuition must rise, even if universities engineer the efficiencies that they admittedly must undertake.

    There is only one problem with the analysis: it isn't true.

  4. Md.Azadur Rahim | April 5, 2012

    i need $12,50,000.00

  5. john | April 5, 2012

    how would you short this sector

  6. JK11 | April 5, 2012

    Excellent summation by Hutchinson — dead on.

  7. Steve G | April 5, 2012

    Student loans have always been a scam…Your article points this out profoundly… College administrators get rich off the easy money while posing as educators. I remember working 30-35 hours per week back in the 80s to afford school and joining the reserves to get my B.S.– which is exactly what most degree programs are B-ll Sh-t…

    • Steve | April 10, 2012

      Lets see… College administrators, health insurance executives, congressmen, senators, lobbyists, Fed chairmen….. I wonder if there is a connection here.

  8. Dutra | April 5, 2012

    Martin, it is another good article written by you, a master in the field. However I dare to support Jonathan in his simple and clear reasoning. USA has other more important problems on economics and financials, some connected to the very American Way of Life. There are some that goes far ahead of the Student Loan Program. May be time to review behaviors, procedures and adapt the culture of the world leading democracy in order to better survive the future times. The rest will follow.

  9. Fred Stork | April 5, 2012

    I have objections to Matins argument "And in bankruptcy, they must be treated same as all other loans". Exempting them from bankruptcy was a SMART move, prompted by necessity.
    The same was implemented in Canada, as it became rampant, and widespread scam, to graduate on borrowed money, and then go bankrupt.

  10. Steve | April 5, 2012

    Thanks, Martin for your common sense. Student loans are to education as insurance is to medicine.

  11. Malcolm Rawlingsonj | April 6, 2012

    I agree with Jonathan that a large debt does not necessarily form a bubble. The inability to pay the debt is highly variable and that of course is linked to whether or not ex-students have sufficient income to repay it . Securing work following the the course of study becomes the key to paying it off. There is most certainly a con game being played out that kids (and parents) are being conned into the belief that a degree in anything is automatically a ticket to a good job. That is a complete fallacy as many are finding out. Many young workers in the Alberta Oil Sands for example are earning much more than their degreed peers. A degree is not proportional to earning money and actually never has been.
    I am in full agreement that just getting any kind of degree makes the US economy more competitive. To me there is something very wrong when the US graduates 50,000 lawyers a year and only 1500 petrochemical engineers. As far as I know lawyers don't know how to get oil out of the Oil shales the US is sitting on but petrochemical engineers do. Does the economy REALLY need 50,000 lawyers a year. I hope not. I have nothing against lawyers – they have their place in society – but if the expectation is that the legal profession will propel the economy to growth and riches you do need to give your head a shake.
    The growth of the US economy is linked to the growth of its manufacturing, resource and farming industries and the provision of services is secondary to that. The US has it entirely backwards by placing economic development of the service sector first.
    The Chinese this year will graduate 250,000 engineers.
    Which country do you think will be the first to set up bases on the Moon and Mars. I'll give you a clue – it is not the US and it saddens me to say that.

  12. Doris Kelsey | April 6, 2012

    Some colleges are refusing to give students with debts copies of their transcripts. The best employers demand transcripts. So, the debt prevents them from getting the best jobs. Catch-22. Only the rich can afford to go to college. The poor, smart ones occupy wall street.

  13. Aprov | April 8, 2012

    Great analysis! Thank you!

  14. Rapscallion | April 9, 2012

    "And I say welcome, welcome to the boomtown. All that money makes such a succulent sound!"

    What's going to go 'BOOM' first? Our ecomomy or the student loan bubble? Does it really matter…?

  15. Antonios | April 10, 2012

    College degrees: A.S (American Sh_t), B.S. (Bull Sh_t), M.S. (More Sh_t), PhD (Pile hill deep).

    I am a great victim of the easiness of getting in terrible debt with Master's Degree student loan.

    I got the degree with an subsidized and a unsubsidized loans.

    To be able to pay the monthly payments I consolidated them. Great error.
    Both turned into unsubsidized loans!

    I got into great financial problems, low paying jobs, not necessary to have a masters degree.

    In 2001 had a chapter 7 discharge, but not the SL. Although I wqs in a very difficult financial situation three "bankruptcy" lawyers said that SL couldn't be discharged.

    I was left in a Chapter 7 condition even after the discharge.

    Five years later I learned that in a "financial hardship" they could be discharged. I could have quailified if "my" bankruptcy lawyer had wanted to help me. But it was too late at this time.

    In 2009, I had to get into bankruptcy again, now a Chapter 13 filing. Since the new 2005 rules, bankruptcy is more difficult. In reality, bankruptcy has done more damage than good for me.

    I have a SL until I die. Divorces are not allowed. They will even get paid through your pensions (Ex: Social Security), not even disabilities can prevent them.

    The sad thing is that I have friends with high school diplomas with technical/vocational training earning in one month what I earn in a year.

    One year technical schools are more profitable for their students even with loans than B.S. four year colleges.

    And with the present financial crisis, paying those SL will be probably impossible.

  16. Ted | May 7, 2012

    Unlike home mortgage loans, however, there is no security underlying the student loan. Therefore, the write off is not limited to the collateral recovery sale value. With 30% default in student loans vs a 3% home mortgage default rate the down side for all of us as tax payers is in effect greater. Those willing to do a bit of home work on this issue can identify tens of thousands of students who are getting student loans and not even going to school (an interesting trick the proponents of student loans won't disclose to you.) One more well meaning welfare program, ignorantly conceived, incompetently administered, and covertly abused by millions who see it as another entitlement program where those so inclined can get something for nothing.

  17. L. Cav | June 13, 2012

    Bankruptcy protection should be returned to the consumers (for private student loans). These predatory loans never should have been given out in the first place- at least not at intrest rates of 14% plus libor.
    These private student loans (especially Sallie Mae's loans) are in a very high rate of default. Once a private loan is in default the consumer has no option or protection from being sued by a lender. ALL consumers should have some protection within the law. In the case of a defaulted private student loan, a borrower can't officially 'rehabilitate' it. Then, the borrower can't even get a job to pay off the loan.
    This is a dangerous situation, and very unfair to the borrower. I urge Congress to act quickly and reinstate bankruptcy protections for private student loans.

  18. Just another jobless graduate | November 30, 2012

    I just graduated with a 4 year degree in finance and economics. Could not intern anywhere because my parents couldnt afford to pay rent and living expences. I had to instead work full time as a real estate agent just so i could surive. along side attending school full time. Now post graduation I can't find a job anywhere within the field I went to school for, and have almost 80k in loans. The good ol "we require experience" bullshit. How will I ever gain experience if you won't hire me?!?!

  19. FratBoy | January 5, 2013

    I believe young people get a well-rounded education in K-12 but they are never taught about how important it is to take major financial decisions seriously. Its a shame that 18 year olds are blindly getting into debt over their eye-balls without even thinking, they will learn how important these financial decisions are, after they've screwed up. Honestly most college students should be able to tell that the education they are getting is watered down, non-practical, and way too easy. I thought college was all fun and games until I switched my major to electrical engineering and starting doing an internship in between classes. It doesn't surprise me that companies in my city prefer to take engineering majors; I never saw the same kind of work ethic in my old major.

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