The US’s tepid economic recovery could become derailed by yet another bubble. This time it’s student loans, warned the Federal Advisory Council, a group of a dozen bankers who meet quarterly to advise the central bank. Guess what? It smells suspiciously like the housing crash that precipitated the Great Recession only half a decade ago.
The Federal Advisory Council noted that recent growth pushed student-loan debt levels to almost $1 trillion, which “now exceeds credit-card outstandings and has parallels to the housing crisis” Bloomberg News obtained documents last week of the February meetings through Freedom of Information Act requests. The trend has only continued. The Consumer Financial Protection Bureau reported in March that student debt had now topped a record $1 trillion.
If it all sounds eerily familiar, it should, with the council griping over “significant growth of subsidized lending in pursuit of a social good.” In an effort to prop up yet another American myth -- this time, the idealization of higher education instead of homeownership -- the government is fueling a bubble that could undermine the already battered American Dream.
And it is a myth, just like the idea that everyone should own a home is an economically favorable proposition. In fact, high levels of homeownership can actually kill jobs, according to a recent study. The same could be said about going to college. Now, to be perfectly clear, this is by no means an indictment of the college experience, which, debt or no debt, remains the straightforward path for any enterprising person looking to move up in the world, no matter what Peter Thiel tells you. College graduates have better navigated the recession versus their less educated peers. But problems arise when the net is cast too wide and too frivolously, where students are shepherded towards unbearable burdens without enough consideration as to how that investment might pay off, simply because the current climate makes it so easy. Lenders don't care because it's the government that's on the hook. And kids may be less discerning because, well hey, they're kids.
An investment of over $40,000 a year so you can do keg stands, chase tail, and make questionable life decisions while pursuing a degree in Business Administration provides a wildly uncertain return at best. We know the job market is tough, especially for fresh grads (unless you’re some kind of programming prodigy). And while the cost of tuition continues its unstoppable rise, we’ve officially entered the era of the unpaid internship. While a college education is no longer a guarantee of a good life, it can guarantee unwieldy debt.
Both homeownership and a college degree are symbols of the middle class and the hope of upward mobility. But that’s all they’ve become, a nice thought that doesn't always deliver, especially at the fringes of the spectrum. In reality, this is America desperately hanging on to a fiscally unsustainable lifestyle fueled by cheap money and debt, the overarching theme of our lost generation.
And when everyone’s doing it, bankers get lazy and as the FAC noted, banks are exhibiting a "lack of underwriting discipline." As in the subprime debacle, the worst-affected are the less well-off. Second tier schools and an ecosystem of aggressive lenders hand out government-backed cash like candy so that starry eyed students can fund a life they can’t afford and hope for a future that doesn’t exist. Those with any kind of ambition have little choice in the matter. While the cost of higher education has increased (in part due to the availability of such loans), so has the college premium.
It’s the kind of environment where bubbles thrive, and it’s not just student loans. There’s also the inflation of farmland. "Agricultural land prices are veering further from what makes sense," noted the minutes of the FAC's Feb. 8 gathering. "Members believe the run-up in agriculture land prices is a bubble resulting from persistently low interest rates."
All of which is fueled by the central bank’s mandate of “print motherfucker print,” when it comes to monetary policy. With the interest rate at essentially zero since December 2008, the Fed has had little option but to keep the printing press running on turbo through three rounds of bond purchases known as quantitative easing, targeting an inflation level of 2 percent.
The point of creating all this money out of thin air is to spur on an anemic economy, but remember, it’s low interest rates that got us into this mess in the first place. When traditionally safe investments become a losing proposition, the only alternative is more risk. When low rates are not only the solution but also the fundamental problem, we get this inescapable cycle of bubble after bubble after bubble.
"Investors who are seeking a positive return on their funds have shied away from bond markets," the council said, describing the “collateral consequences” of the current policy. So they’ve turned to farming real estate "as both a hedge against inflation and a means of achieving better than the negative real return associated with fixed-income securities." The situation is forcing "many to seek higher returns by accepting greater interest rate or credit risk," the FAC's minutes said. "As the period of low rates is extended, these pressures have increased."
Fed Chairman Ben Bernanke has generally tried to downplay the similarities between the current situation and the subprime mortgage fiasco. "I don't think it's a financial stability issue to the same extent that, say, mortgage debt was in the last crisis because most of it is held not by financial institutions but by the federal government," Bernanke told a Bloomberg last August. Bernanke's messages to the public must be taken with unhealthy portions of salt. Though his overall management of the crisis should be commended, he did little to stem the subprime explosion during its buildup.
But Bernanke has a point, to a degree. The housing crisis was marked by a wave of financial alchemy, the reckless re-packaging of mortgages into bundled securities with fancy monikers like synthetic collateralized debt obligations, triple-A rated instruments pension funds binged on, a fixed game of musical chairs where savvy investment bankers passed on all the risk to naive institutional investors (i.e. people’s retirement funds) and industry chumps like AIG, milking massive fees along the way. In the end, it was the taxpayers on the hook.
This sort of intertwined counter-party risk, which made the entire system vulnerable to a domino-like implosion, thankfully, doesn't exist with this latest bubble, or at least not to the same extent. Fooled once, investment funds have wised up, but the issue of securitization remains. From 1998 to 2007, $350 billion in student loan asset backed securities or SLABS were issued. Given the environmentally-induced appetite for risk, the demand for these instruments will only increase. Indeed, rising demand for student loan assets has spawned the development of new platforms that allow lenders to issue securities backed by student loans directly to investors.
"The catalyst for this new suite of services is investor demand," Barry Silbert told the Wall Street Journal. Silbert is the founder and chief executive of SecondMarket, one such platform that launched in March. "At the end of the day, investors are yield searching."
There are indications this party could soon end. The New York Fed reported in November that the percentage of student loans over 90 days delinquent had risen to 11 percent during the quarter, a new all-time record. According to a 131-page report released by the Education Department and the Consumer Financial Protection Bureau last July, cumulative defaults on private student loans exceeded $8 billion.
The rise of SecondMarket and similar platforms may also portend the beginning of the end. Not only do investors have easier access to dubious financial innovations, doom-and-gloom punters can now short the student loan bubble, effectively cashing in on a crash, as Goldman Sachs famously and controversially did in 2007. With the potential for profit even if this thing pops, we’re perfectly primed for an inevitable correction.
Of course, as argued by Bernanke, predictions of the next financial apocalypse are premature. At $1 trillion, the student loans market is a mere fraction of the $14 trillion mortgage behemoth. The ongoing trend, however, is clear and there are few signs of slowing down. Student loan debt has tripled in just eight years, according to fourth quarter 2012 statistics from the New York Fed, weighing on an already struggling economy.
But most worrying is how little things have changed. Yet again, people are taking out cheap loans they will struggle to repay to chase an unsustainable mirage. Meanwhile, investors hunt for more and more risk as the Fed literally creates money out of thin air. Invariably, new bubbles replace the freshly popped. With history ignored, a resurgent Wall Street is more or less back to business as usual. Even if revenues and bonuses have come down, mainly due to higher capital requirements and layoffs, the banks are still too big to fail. Stripped down and compromised by lobbyists, regulations such as the Dodd Frank Act marginally addresses certain issues but is absurdly convoluted and gaping with loopholes. Will we ever learn?
There is one key difference this time around. Unlike mortgages, bankruptcy won’t free student debt holders of their obligations, which is nice for banks and investors. For students, it’s modern day indentured servitude without any chance of a get-out-of-jail-free card. So even if this latest ordeal doesn’t dissolve the system all over again, there is only one bitter truth to the modern American Dream. The kids are still fucked.