Apr 30, 2019
The Truth About Education Debt
The problem is bad when both sides don’t want to talk about it.
It seems it’s never apparent that people slept-walk into disaster until about a decade after the fact. Oh sure, some people talk about it as it’s happening, but most or all of the mainstream media and the politicians — you know, the people who are supposed to lead the national conversation — seem oblivious until it’s too late. The debt/housing crisis of 2008 was a cheerleading session until it was too late. World War One was minor until it was major. And while many are talking about “student debt” issues, few are addressing the systemic problems. And yet, we have a massive institution gorging itself on funding at the expense of the nation. Just like U.S. banks did in 2007 or the German military did in 1913.
Moral Hazard
How to systemically incentivize bad behavior, drive a critical mass of people to desperation, and elect literal Hitler.
Economists have a term for misaligned risk/reward: moral hazard. It sounds like self-important academic jargon, but it’s actually real. The free market generally aligns risk and reward/benefit. The bond market is a great example. Dicey bonds from banana republics pay well because on any given day the president-for-life may decide to kill the governor of the Central Bank and hide all the country’s money in his jungle shed, while U.S. government debt doesn’t pay well but it’s safe.[1]
Consider the following: there are about 7,000 higher education organizations in the U.S., about 1,700 of which are traditional 4-year colleges. The vast majority of those colleges are subsidized by the federal government (by ‘vast majority’ I mean that I think I can count the number that aren’t subsidized on my kidneys … by ‘subsidized’ I mean most would go out of business if not for federal subsidizes.)
Most of these subsidies are in the form of student loans. Now consider the risk/benefit of the process:
1. Who gets the money? The university.
2. Who gets the risk? The student (mostly). (Some risk is on the tax-payer.)
So we’ve entirely untethered the benefit (money) from the risk (debt). This is how to generate systemic moral hazard.
One could argue that the student (and tax-paper) gets some of the reward because the student (maybe) gets a degree. But there’s no arguing that none of the debt-risk is on the university while all of the near-term money-benefit goes to the university. While the student may get a reward (if they graduate, if they major in something useful, if they learned anything … more on that later), it’s not arguable that the university carries all near-term monetary reward and no risk.
Propaganda
Mass moral hazard gets juiced and whitewashed by media & politicians
So now that we’ve got a grip on moral hazard, on to the propaganda. A recent opinion piece in Bloomberg by an opinionator and AEI scholar is fantastic … at illustrating why Trump and Bernie are popular.[2] For these scholars, behind every populist idea is Marx or Hitler waiting to spring into action, riling up supposed idiots with phantom problems to thrust upon the unsuspecting nation an orgasm of lunatic policies. Had this guy been writing in 1931 Germany, he would have taken the Alfred E Neuman approach — What Problems? Everything is awesome. Of course, The National Socialists (ah, yes, the Nazis called themselves socialists) weren’t wrong that there were problems. Germany had many problems. They were just wrong in thinking that the solution was: invade everyone and kill millions. Nazis don’t get elected (yes, they were elected) if everything is honkey-dory. Populist solutions may sometimes be thin on reality and decency, but populism is often a leading indicator of real problems.
So Senator Warren has a final solution regarding the student debt question; namely, to eliminate most of it.
The Bloomberg Opinionista objects to this final solution on the basis that massive government subsidies (Warren’s final solution will cost somewhere around a trillion give or take hundreds of billions but who’s counting?) should be spent on the poor, not a “those who are relatively well-off.”
Yeah, calling a 24-year-old making $15/hour with $20,000 debt “relatively well-off” sounds like the something you’d say between caviar canapés while your maid irons your underwear. And relative to whom? The Borats of Glorious Nation of Kazakhstan?
According to the Opinionista, relative to “lifetime income.” The argument is that $20,000 of debt today is an acceptable risk compared to the lifetime of increased earnings from which you will (maybe) benefit. This reminds me of Baghdad Bob, who stood before reporters in 2003 and assured them that the American invaders are being repelled and will commit suicide … as American tanks rolled down the street behind him.[3] He then invited reporters to come to his house and read a book on American history that (he claimed) proved all his points. Bob never revealed the title of this book, but the Opinionista links to a study that, he claims, proves his point.
But first, a diversion into the stupidity of economists. “Lifetime income” is an economic fiction; no one earns it. Instead, workers earn paychecks every week or two. If you’re a 24-year-old college grad barely getting by, there’s no solace in your “lifetime income.” It won’t pay for the car repairs you need or your next dentist visit or a plane ticket to see your parents. This conversation has never happened:
24-year-old: hey I need a car but I don’t make much and have lots of debt.
Car dealer: no problem we’ll just give you a car loan based on the average projected lifetime earnings of your cohort.
It’s also a fiction because it ignores the enormous student debt that comes later. The Brookings Report to which the Opinionista links reports on “student debt,” which seems reasonable, but the mother lode of debt often rests with the parents in the form of public and private loans. Scratch the surface under the $20,000 student debt and you’ll discover an additional $60,000 in student debt held by the parents that’s often not included in these reports. So imagine: 15 years after you finish paying off your own student debt, you get to assume more student debt for your children.
Further, the entire argument ignores the problems by employing the black magic of averages wherein les Misérables are disguised by the top third.[4] Look at the bottom third and you find people who graduate with >$30,000 in debt (student debt only) and aren’t making more than that ten years later. Sure, those debt payments are only a few hundred dollars per month, but that’s also a car payment, food, money that could be saved to buy a house, etc. And economists wonder why people in the 20s aren’t buying cars or houses or starting families. It’s because some significant part of their disposable income has vanished. Instead of saving in their 20s, they have to wait to save until their 30s.
I’m from a think-tank, and I’m here to help you.
Now to Baghdad Bob’s history book — or, rather, the study on which the Bloomberg argument relies. Here’s their leading graph:
I’ve added the red to illustrate the ridiculousness: so, from 1992 to 2013, the amount borrowed has gone from about $10k to about $30k while wages are stuck in the mid 40s? First, understand that a few thousand in additional debt has a significant impact on disposable income for people in the 20s because you’re usually talking about small numbers — a few hundred dollars per month is meaningful. (A bi-weekly paycheck for someone working full-time making $15/hr is around $950, depending on municipality.) Second, they apparently only use data from those that “were making positive monthly payments.” So yeah, let’s drop the almost 12% of those who are >90 days late or in default on their loans.
If you look at the bottom third (e.g. many millions) of all of those with student debt — including those in default (why would you ignore them?) — you see the real disaster of the economic magic of “lifetime earnings” in people who are struggling, with credit ruined, no savings, and life-on-hold for a decade after college while trapped in a vicious cycle of debt, because when you’re in debt and can’t afford things, you borrow more. You want to know why growth of the black middle class has stalled? It seems like economists are goal-seeking apathy.
Here’s the truth of the matter:
Since the 1970s (pick a year and chart it), wages have stagnated.
Since the 1970s (again, pick any year), private debt — car, credit card, education — has sky-rocketed. And debt begets debt, so it keeps getting worse.
More debt at the same wage = less disposable income, less house-buying, smaller and later families, etc. You want to know what caused the 2008 housing crisis? People had debt they couldn’t afford because wages had stagnated and they we already holding other debt. Shall I run in more circles before the problem becomes clear?
So what happened in the 1970s?
1. We went off the gold standard. Inflation started to get rigged. I’ve previously discussed the Boskin commission wherein >1% of inflation was magiced away. Readjust for the politicization of inflation and you get a dreary picture that explains why debt is more toxic than your graphs demonstrate. (You know, like in 2008.) (Side note: does anyone trust the CPI numbers? Healthcare and education expenses have almost doubled over the past two decades yet we live in perpetual 2% inflation?)
2. Education debt was removed from possible bankruptcy. (Generally, the only personal debts not dischargeable in bankruptcy are education and tax/government debts.) Of course, this was deemed necessary because why else would a bank lend an unemployed and unskilled 18-year-old thousands of dollars?
Since the 1970s…
1. Various boondoggles to make the economic numbers look better — inflation low, GDP growing, etc.[5] Lower inflation means cheaper money means more debt. And economies are built on debt to compensate for a lack of innovation.[6]
2. Increasing efforts to keep the debt machine humming along, such as the 2010 Obama administration coup that seized the entire education debt machine.
The result?
The Big Q
Left unanalyzed by most is whether the costs of the risk/benefit are aligned. Is a degree in puppetry worth $20,000 in debt?[7] There’s a mountain of evidence that many students learn nothing in college — not specific skills (puppetry) or general skills (reading/writing).[8] Maybe we should improve K12 a bit and encourage companies to hire more straight out of high school and skip the debt treadmill entirely. Maybe we should stop calling it “education” and start calling it “credentialing” and recognize that a lot of young people are hocking themselves into a decade a debt for something less valuable than a medieval indulgence (what’s a vicious cycle of debt compared to “lifetime salvation”?).
Also left unanalyzed is the cost of higher education. There’s no evidence that a university education should cost as much as it does. There’s a lot of evidence that universities can lower costs by as much as 70% while not negatively effecting teaching and learning. Some private colleges (e.g. Oglethorpe) have lowered costs — but most colleges have little incentive. Subsidize colleges further and costs will increase. That’s how economics works.
And I’d be remiss not to mention the elephant in the room: all this technology — education innovation to scale and increase access — and yet higher education costs have almost doubled in two decades? How has the enormous investment in ed-tech not lowered costs? We haven’t increased efficiency; we’ve only increased complexity. Further, the correlation between tech and cost in education is Exhibit A in the general correlation since the 1970s. We do have more tech, but we also have most costs, not less.
The solution, though, is to align not just risk/benefit costs but risk/benefit entirely. Universities currently share none of the risk, so in the debt risk/benefit analysis they have no incentive to improve (or, really, even measure) whether their students learn or what they learn or whether they get good jobs. This isn’t to argue that they are all callous but rather that market forces should be adequately applied.
So why not
1. Make universities co-sign education loans. Sure, some kids will always screw up but a large operation can handle some variance; by co-signing, the university will have a vested interest in developing employable skills.[9] The university is getting the money, so maybe they should have some responsibility.
2. Make education debt dischargeable in bankruptcy.[10] This doesn’t create a counter moral hazard because it’s unreasonable to assume that a swarm of 20-somethings will flock to bankruptcy — it’s an ugly process that destroys credit. But it does ensure that everyone (e.g. universities) keeps their eye on the ball.
The result of those changes would be that universities would become invested — literally — in lowering costs and producing value. Though some students and universities will engage in risky behavior (lots of debt for worthless degrees), such changes will significantly align risk with benefit and decrease moral hazard.
Of course, I don’t expect most politicians to engage these conversations because universities are signifying co-conspirators.[11] The great moral hazard isn’t economic; it’s political. So, Bloomberg Opinionista, keep telling the millions trapped in debt-hell that they are “relatively well-off” …
[1] Equatorial Guinea’s Macías Nguema actually did that. https://web.archive.org/web/20141104035212/http://www.afroarticles.com/article-dashboard/Article/Macias-Nguema--Ruthless-and-bloody-dictator/117291
[2] “Warren’s College-Loan Plan Is a Subsidy for the Comfortable Class: Forgiving loans today is a transfer payment to people who will earn several million dollars over their working lives.” https://www.bloomberg.com/opinion/articles/2019-04-23/warren-s-student-debt-giveaway-to-millennials
[3] Baghdad Bob blazed the trail for fake news. https://en.wikipedia.org/wiki/Muhammad_Saeed_al-Sahhaf
[4] “The average person in Chicago doesn’t get murdered” isn’t helpful to the guy who has a knife in his face. Just stop using aggregated averages.
[5] Good place to start: https://en.wikipedia.org/wiki/Boskin_Commission
[6] See https://medium.com/@nathan.a.allen/shiny-dark-ages-part-1-58d7c4823ed3 and https://medium.com/@nathan.a.allen/shiny-dark-ages-part-2-or-ray-dalio-hates-money-517c10259780
[7] Real major: https://drama.uconn.edu/programs/puppet-arts/bfa-puppet-arts/
[8] https://press.uchicago.edu/ucp/books/book/chicago/A/bo10327226.html; https://thechoice.blogs.nytimes.com/2011/01/17/academically-adrift/
[9] Taleb (of Black Swan fame) would call this skin-in-the-game. On the debt side, universities don’t have skin in the game; as such, they shouldn’t even be included in the conversation.
[10] Really, everything should be dischargeable via bankruptcy, including government and state debt. It’s the only backstop to the moral hazard of steroided debt treadmills.
[11] https://medium.com/@nathan.a.allen/institution-as-signifier-1db9da011107
About Nathan Allen
Formerly of Xio Research, an A.I. appliance company. Previously a strategy and development leader at IBM Watson Education. His views do not necessarily reflect anyone’s, including his own. (What.) Nathan’s academic training is in intellectual history; his next book, Weapon of Choice, examines the creation of American identity and modern Western power. Don’t get too excited, Weapon of Choice isn’t about wars but rather more about the seeming ex nihilo development of individual agency … which doesn’t really seem sexy until you consider that individual agency covers everything from voting rights to the cash in your wallet to the reason mass communication even makes sense….
