One topic of discussion in this presidential election season is what to do about the tremendous burden student loans are putting on our millennial generation and their parents as they grapple with the soaring costs of college education. This debt is a growing problem and is beginning to put a serious drag on our economy. The current narrative being used to explain the problem is frighteningly similar to the subprime home lending market from the 2000s.
Both private and public student lenders made as many loans as they could with zero regard to their borrowers’ ability to service the debt. Meanwhile, colleges and universities raised tuition rates based on levels its customers could “afford.” However, just like with the housing crisis, the word “afford” really meant the amount of borrowed money students and their families could furnish, which was close to infinity as long as the student lending market could keep lending. As a result, a lending bubble was created which has now popped as millennials enter the workforce with crushing debts that their new incomes cannot service. In order for the economy to grow, it needs these millennials to begin spending their disposable income on goods and services, especially as older generations cut back. Unfortunately, the millennials have a lot less disposable income due in large part to student loan debt. This is very important because this reduces the number of much needed first-time homebuyers, the driver of our housing market. The housing market makes up about 10%-12% of gross domestic product (I am backing out gross rental spending) according to the National Association of Home Builders.
However, there is another factor that has led to this explosion of student loan debt, and continues to exacerbate the gap between what students and their families can afford and what universities charge. I was talking about this very topic to a good friend the other day since my children are about to go to college. I was joking that I will have to rent out a room in the house, drive a cab at night, etc. to pay for everything. My friend responded, “Man, when my kids were born back in ’98 and ’01, I bought them the guaranteed state college tuition for $6,500 each. The state university system is just taking a bath on that now. It was probably supposed to grow to at least $25,000, and it’s probably more like $12,000.” When you start thinking about that, you start to realize that this is at least one reason schools are charging insane amounts of money for tuition—they are just getting killed by a 2% 10-year Treasury note. They need a certain amount of low-risk assets to grow into a future payment, and they definitely didn’t predict a 10-year yielding less than 3% for a decade! The same thing is going on with university endowments. They have tried to remedy the problem of low risk-free rates by buying risky assets. How many stories have you read in the last few years about endowments getting killed because of “alternative investments?” Quite a few. Sure, there are success stories, but it seems for every success story there are at least three disaster stories.
Now, think of 529 education plans that have autopilot strategies that start heavily weighted toward risk assets and begin to “de-risk” as the child gets closer to college. If you started a 529 for your child in 1998 (I am assuming a fixed monthly contribution), you essentially hit a perfect storm of badness. Just as the plan hit the mid-point and began to “de-risk,” it was 2007-2008. That means the plan was selling stocks as the markets crashed and buying safer-yielding assets just as their yields were cratering. As time went on, the plan continued to skew toward risk-free assets with yields close to zero. Therefore, by the time your child is ready to join the freshman class of 2016, his or her 529 plan has less money than anticipated while tuition has skyrocketed. This is due in large part to the fact that the amount of money the university thought would be in the endowment, or in the prepaid tuition account in 2016, ends up being a lot less. The Federal Reserve’s years of extraordinary monetary policy where relatively risk-free rates have been suppressed have, over time, greatly contributed to things like our student loan problem. They didn’t mean to necessarily, but I think they have.
I compare the years of extraordinary monetary policy to the emission of greenhouse gas—the trigger for climate change. The student loan crisis is akin to the stronger storms and droughts we are now facing, which many believe are a result of climate change. Whether the storms are fiscal or meteorological, once we survive the initial blow, we quickly shrug off the effects, and generally do not change our behavior as a result. We keep polluting, and the Fed, along with the world’s other major central banks, keeps risk-free rates too low. We know there’s a big problem waiting for us down the road, but we dictate policy in the present. A major problem 10 years from now upsets me far less than a problem happening tomorrow. However, tomorrow’s problems will become today’s catastrophes sooner than we realize.
The moral of the story is, the Fed and other major central banks have been meddling with the forces of the marketplace for far too long. Granted, they have had to do this in large part because fiscal stimulus has not done its part. Whatever the case, just like climate change, if we don’t change course and normalize soon, we could have a far worse future than we can possibly imagine.
Like the famous 1970s commercial for Chiffon Margarine said, "It's not nice to fool Mother Nature!"
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