For the better part of this year, I've been telling friends and family of the disaster about to happen: the mountain of student debt taken on for college education. Let's start with some aggregate data. In the first quarter of 2012, the NY Fed estimated there was $902 Billion of student debt spread over 37 million borrowers. Studies by other consumer bureaus place the number well over the $1 trillion (or $1000 billion) threshold. In contrast, the 2010 census estimated the outstanding credit card debt in 2012 is $870 billion spread over 160 million cardholders. Moreover, credit card debt has been relatively flat over the last 5 years, while student loan debt has increased by 10-15% per year for the last 5 years!
So what? Why is this such a big deal? People want to and should be edumacated, you might say. Let me tell you a story: The story is about item XYZ, a crucial must-have for many as part of the American Dream. For a long time, only people who were well off or saved assiduously could afford to purchase XYZ. Then, public institutions and private lenders began offering loans for people that needed a little help to buy XYZ and sent them on their way to attaining their American Dream. XYZ sellers started noticing that demand for XYZ was rising rapidly, as well as the number of people who had the borrowed money to pay for it, so naturally the price had to go up. Now the cycle starts feeding itself: buyers were happy to borrow and buy since they saw their investments increase in value rapidly, sellers were happy to raise prices, expand their capabilities and inventory, and keep selling, and lenders were happy to keep lending as the value of XYZ kept rising. What happened? Shady buyers/sellers/lenders who had no business whatsoever buying/selling/lending entered the cycle, buyers stopped buying, and the whole system came crashing down. Replace 'XYZ' with 'houses' and you get the housing crash; replace 'XYZ' with 'college' and you have the current student debt situation just before the "buyers stopped buying and system crashing" part. What's even worse is that you can sell a house for 10 cents on the dollar if you were desperate, but recycling centers won't even give you a penny to scrap your diploma. Plus, student debt doesn't disappear in bankruptcy whereas you can surrender your house in exchange for the mortgage forgiveness.
Yesterday I stumbled upon a blog by Mark Cuban, the owner of my beloved Dallas Mavericks, while doing research for this post. Seems like he beat me to the punch on putting ideas on paper, so you should definitely read his thoughts. On a lot of things, he sounds pompous and over-confident (though it makes him a colorful sports owner), but on this he is brutally honest and spot-on.
Here's what I have to add: The bill this summer to keep interest rates on subsidized federal loans at 3.4% does not help the problem. At all. It only keeps the engine locked into 5th gear: more cheap loans available to throw out like candy. What really saddens me is the number of people in my age cohort whose votes may have been bought with their own impending misery (because what sounds good for the individual worsens the entire system). Instead of continuing to moan about our politicians' complete ineptitude of basic economics concepts, I offer some ideas/solutions.
Idea 1: As soon as possible, preferably before this upcoming admissions season revs up, announce the following limits on student loans: In the 2013-2014 academic year, all private and government student loans for undergraduates are capped at $4000 per year, decreasing to $3000 the next, and to $2000 after that (some semi-arbitrary amounts based on the current mean and median student debts of $23000 and $18,000. The time frame of the decrements could be extended as well). Mr. Cuban suggested an immediate limit of $2000/year, but here's why I favor the decremental approach. We don't want a big shock that might throw the jenga tower into collapse, and schools deserve time to adjust their income expectations. I repeat that the main driver of spiraling tuition costs is the easy availability of loans. Here's why: suppose you're a school official, and suppose you only have the noblest of goals of providing a quality education (so we're not even considering those who'd take a kid's money and say "See you in 4 years"). Say two otherwise similar applicants come to you for one spot, both have families that can pay $10,000 (an arbitrary amount), but one has taken out a loan of another $10,000. How much do you charge? You charge $20,000 because that extra $10,000 will help you towards paying for a Nobel Laureate professor, a new dorm, shiny lab buildings, a state of the art stadium, better student services, etc. The next year, with even higher demand, schools realize that they can charge a little more because students will still be willing and able to take out more loans. With tempered expectations on how much loan money is flowing in schools will have to put a brake on spending and going into debt on new buildings and whatnot. The other key is for the rule to apply to all loans used towards undergraduate education (I am not as familiar with costs of graduate and professional school so will not discuss those.) That way schools can plan knowing everybody else is going to cut back on the new building/services/staff spending spree, since a big part of increased university spending is because "every other school is doling out cash on buildings/services/staff so we have to as well in order to keep our prestige."
Idea 2: Promote and offer incentives for programs like the Ed/X initiative that MIT, Harvard, and Berkeley have agreed to start. I'm not sure what exactly the government could do since these are very recent developments. They could offer publicity, but that might smack of the government picking a champion, and the government has a long history of supporting way more unsuccessful ventures than successful ones.
Sorry for the long hiatus. I've been on vacation for parts of August. Still to come: pension arithmetic and why they are a much bigger problem than you think ... and another topic: the dirty secret of economics.
