Student Debt: Bad Loans Or Bad Education?

by: YCharts

By Jeff Bailey

Contrary to what the gobsmacked television pundits and other knuckleheads would tell you, there was plenty of warning that the U.S. mortgage system was heading for a crisis. As a country – borrowers, lenders, regulators – we simply chose not to act sufficiently on data and commentary predicting enormous losses.

Are we now in a similar spot on student debt? The loans outstanding have tripled over the past decade, and a good half of that time period was an era of debt reduction when consumers were paying off or paying down credit card balances, home equity loans and mortgages. A regular trend bucker we have in student loans:

US Student Loan Debt Chart

US Student Loan Debt data by YCharts

Businessweek now warns about the overall economic consequences of a student debt collapse: those indebted grads (and drop-outs) will be funneling money to student loan payments instead of renting apartments, buying cars and otherwise helping the economy grow.

From here it seems less a problem that people are borrowing to attend college and grad school than the fact that they graduate (if they do) with skills insufficient to make a decent living. Oh, and to service their student debt. The prime example in the smart Businessweek article is a young woman who racked up $170,000 in student loans to become a parole officer. The ROIC seems lacking there, eh? Even if she hadn’t borrowed to attend school, the education she got, relative to the job she attained, seems pretty pricey. Inflated, just like housing prices were during the go-go mortgage era.

It’s politically correct to think every person – pursuing any educational field, regardless of job and income prospects – deserves an equal shot at attending college and at getting Uncle Sam to finance it. But if it’s a loan, rather than a gift, that ends up being naïve and destructive to the student. As the Businessweek piece relays:

“If you’re a pre-med student, you’re an engineering student, and you take out $40,000 or $60,000 of loans, I have no problem with that,” John Silvia, chief economist at Wells Fargo (WFC), told the audience at the January Chamber of Commerce event in Raleigh. “But if you’re going to be a French major, you’re going to study social welfare, and you’re going to take out $60,000 of loans, who is making the economic judgment there?”

The parole officer in the article, and the people who helped her take out the loans, are obviously not good enough at math (actually, the college admissions people who likely helped could probably care less, as their institutions have no skin in the game on student loans). So, she’s living with her parents and making loan payments.

So, already we have rising delinquencies on student borrowings. The debt isn’t easily discharged in bankruptcy, however, so unlike banks that made imprudent loans, Uncle Sam, the guarantor, has a strong position in collecting. That sounds good if you’re Uncle Sam, but forgiveness of debts in bankruptcy is a great deterrent to lending someone more than they can repay. Foreclosing that option drags out insolvencies and keeps people and institutions from getting on with their lives. It’s like debtors’ prison, only you’re on work release.

US Student Loan Seriously Delinquent Balances Chart

US Student Loan Seriously Delinquent Balances data by YCharts

For-profit education stocks – Apollo Education (APOL), Corinthian Colleges (COCO), DeVry (DV), Career Education (CECO), Education Management (EDMC) and Strayer (STRA), among them – could well suffer in any government reaction to the growing loan mess. And well they should, as they live off the government loan programs and have generally done a crummy job of helping students size borrowing to likely educational-and-career outcomes. (The prospects of these companies vary widely, and it’s best to read the 10-K and aggressively apply financial advisor tools before jumping in to such a funky industry.)

But this being the United States, there will be a call for a market solution. Pulses will quicken at the thought of the all-knowing free market imposing discipline on these young, wayward souls.

Spare me. It’s no free market when the buyer (and in this case, borrower) has poor information. As with much of the sub-prime mortgage market, instead that’s called a rigged game. The kids need help in gauging their likely financial return on an investment in school. College admissions people are doing a crappy job because they have no downside risk. The task either needs to be taken out of their hands or, as has recently been proposed, sufficient financial risk tied to the loan outcomes needs to be retained by the school to force them to use better judgment.

US Consumer Price Index: College Tuition and Fees Chart

US Consumer Price Index: College Tuition and Fees data by YCharts

With government guaranteeing the student debt, talk of free market forces is a fantasy. This instead is welfare for the for-profit education companies and for non-profit and public institutions. And it pushes up tuition prices artificially, shown above growing at roughly three times the rate of prices overall in the economy.

Disclosure: None