When I studied for the CPA exam (20+ years ago) we had an instructor who prepared us for the legal portion of the exam. He asked the question – why can you not discharge debt used for higher education in bankruptcy? He joked it was because the medical students used to graduate with cap in one hand and a bankruptcy petition in the other, so after a while the financing providers got together and changed the rules to what they are today, which basically say that you can never discharge your student loan debts through bankruptcy.
I remember when the housing bubble began and started reading about complex mortgages with payments that rise or even interest only mortgages, and was thinking, who are the people taking out these loans and how can they possibly understand the down side of what they are doing? There COULD be a reason to do these types of loans by a rich and financially sophisticated investor (more so than me) if they had offset positions or had a cash poor business with long term potential but these circumstances did not apply to the average guy who just used these tools to leverage up even more, betting on continuing gains.
While some people may have seen the real estate boom collapsing, or Fannie and Freddie going under, NO ONE saw that the GOVERNMENT would basically take over the entire housing market. Today government FHA loans comprise the vast majority of new originations, and government moves like the $8000 housing credit for first time buyers prop up the market. The government also keeps interest rates down as well as down payments, meaning that people can qualify for 30 year mortgages at insanely low rates with virtually nothing down (3%, but many builders or other parties can even front you this pittance). They continue to operate Fannie and Freddie which hemorrhage cash and run up big losses and there aren’t even plans to get out of the market for fear that housing will plummet since there is hardly a financing private sector anymore.
How are these two concepts connected? Easy. As people start to digest that people with $100,000+ of debt that is accruing interest faster than they can hope to earn on their investments (to the extent that they have any) are basically indentured servants to this debt, there will be calls for the government to take over this burden. You will see it happen in bits, here and there, but over time the government will take on more of the role of providing debt and of offsetting debt for various hardship reasons. And as the government starts to weaken this rule that you can’t discharge bankruptcy debt, private investors will exit immediately and then soon only the government will be issuing education debt, making it that much easier for them to let people “off the hook” for paying it (after all, it just is piled into the $3 trillion debt, along with the hundreds of billions Fannie and Freddie consume).
Another way to come up with a lot of quick votes would be just to rescind the exception that you can’t discharge student loan debts. Maybe they’d start with veterans or some other sympathetic group but once they open that door a crack it will swing wide open.
When you see a situation that is unsustainable, many people can see the first step, but you need to follow through to the end. Piling up this much debt on young people that they can’t escape seems morally reprehensible, especially when there aren’t a lot of jobs out there today even if they had a useful degree, which many of them don’t. In the end, somehow or another, they are going to walk from these debts, and when it happens at a huge magnitude (like people walking away from their mortgages today) then it will hit a tipping point when it is not morally questioned and then the system will capsize. The judges aren’t going to garnish all their wages forever, and they won’t be sent to jail. It will just be a massive walk-away.
I am not smart enough to see where it ends up. Likely if the debts weren’t guaranteed, the universities would have to pare back to something that was reasonably payable, and most of the marginal universities would fold. Loans for professions that were unlikely to be paid back (sociology, history, English, philosophy, plus many trade-school type degrees like cooks) would also be impossible to get.
Assuming this is right, what investment can you make to profit from this development?
Probably short the US dollar. Get out of US based investments.
But don’t take my financial advice. I am my own contrarian indicator :)
I really don’t know. Who is profiting from the US housing market now that the government has taken on the entire burden of propping up the venture and agreed to swallow billions of dollars in financing even more debt every day?
If they ever were to reduce the “discharge bankruptcy” laws I would expect that the for-profit schools you see advertising on late night TV would be dead almost instantly. Maybe long dated put options on those stocks?
Some investors have already identified the for-profit education industry as a good short opportunity, for example hedge-fund manager Steve Eisman, who said “Until recently I thought that there would never again be an opportunity to be involved with an industry as socially destructive and morally bankrupt as the subprime mortgage industry. I was wrong. The for-profit education industry has proven equal to the task.”
The attention being paid, appropriately, to the sins of the for-profit education industry should not be allowed to distract from the sins of the (much larger) non-profit education industry.
Agreed that there is nothing per-se wrong with having a for-profit education industry.
If this industry was tailored to help students increase their earnings power quickly at a reasonable cost, it would be better than the public system. Since many of the for-profit enterprises aren’t burdened with expensive campuses, tenured professors, sports stadiums, etc… they could offer a cost effective solution.
However, often the for-profit colleges are SEEKING the most marginal students so that they can lock in the loans (which aren’t their problem if they go bad, later) and giving them any course load at all. Some of them even offer STIPENDS (basically cash payments for going to class) to lure in some of the worse students. At least most of the public colleges have some sort of standards and don’t go after those completely marginal students.
I don’t know enough about for-profit schools to separate the wheat from the chaff, or to know if the wheat means a damn at all.
The for-profit universities are there SOLELY because of this guaranteed loan; the public schools, while inefficient and full of unions and burdens, at least understand that they also have some sort of mission for the public good. They may be failing at their mission, but they have a mission.
Private schools don’t have to behave this way, and maybe some don’t, but the vast majority do.
“I am not smart enough to see where it ends up.”
Carl, (although it erodes my confidence when you don’t think you’re smart enough to see it) it seems obvious to me that, if government increases benefits (or forgives debt which amounts to the same thing) and doesn’t increase it’s revenues in some way it will “print” the money. The fed and the government are essentially doing that now, aren’t they? We’re just talking about the line for benefits growing bigger and bigger.
Debts that can’t be paid, won’t be paid. And Lenders have to write them off promptly.
We need to force lenders to clean up their balance sheets and we need to allow debtors to get out from under their rocks.
A serious mistake was made withe the Bankruptcy amendments of 2005. They should be repealed. The exception of student loans to discharge should also be repealed.
If lenders stop lending to students and impecunious consumers, we will not have to see a repeat of this catastrophe.
Carl,it seems to me as more and more parents weigh the cost/benefits of higher education, more and more students will opt out of college. At this point there will be a large shrinkage in universities and then our government will take the European model and use very arduous testing to determine the few who will go to colleges. These people will be the ones hired to run the huge bureaucracies and state run industries that will run the country.
A lot of people recoil at the word socialism, myself included, but if the current policies of throwing good money after bad arn’t stopped, I see no other outcome that doesn’t involve violence.
My optimistic side says we will take the route Mr. Schwartz suggest and stop the lending.
It seems to me that the entity that should guarantee student loans – the one that should be left holding the bag if they are not paid off – should not be any level of government or some bank that finds it difficult to judge a student’s willingness or ability to repay. It should be the college or university the student is using the money to attend. That would force colleges to provide value proportional to cost, as judged by their students. I suppose it would take a re-reform of the bankruptcy laws, as well as a reversal of the federal takeover of student loans, to achieve this. But it seems, to me at least, the only fair system.
The bubble in education costs exists only because of federally guaranteed loans. These guarantees create a vast amount of money chasing too few classroom spots. Therefore the spot price of classroom spots keeps increasing.
No school can keep its prices at 1960s level. If it does, it is swamped with applications, skyrocketing admin costs to sort thru the applications, and enormous lawsuits to justify its decisions. Its better for the school under every criterion to match prevailing prices and offer “grants” to deserving students.
Remove the federal guarantees and the spot price collapses. Students will be better off without loans. School admins will just have to take a haircut.
“When you see a situation that is unsustainable, many people can see the first step, but you need to follow through to the end.”
Sounds like the pressure to make decisions and changes in ed-debt dischargeability will be peaking right around the time significant numbers of governmental entities become fully bled out by their own unsustainable long-term obligations.
The fact that student-loan-debtors (NOT a small group) will be looking for some relief from their government loan repayment obligations even as the creditor governments find themselves paying out 80% or more of collections to pensions and health plans and thus unable to perform their usual base functions makes for a tough battle, but one which governments can have a final word by refusing to release the debt, while the debtors can also have the final word by simply not paying.
(I’m looking for one of those blood/stone or something/turnip aphorisms here and not coming up with one, but the point is, those without money cannot pay.
I just rather doubt that the creditor governments – or, more exactly, the retired government workers looking to quietly pocket 80%+ of gov collections – will be willing to simply go quietly into the pensionless night just so a bunch of recent grads can do an ed-loan walkaway and buy that new house instead.