The Three Bubbles

If I asked you what three major American consumer products saw the largest steady price rises in the last decade (as opposed to price volatility, as we see in commodities like gasoline) one might well answer "housing, medical care, and college tuition."

Two or more of each of these share a number of features in common

  • Long, sustained government programs to increase access / ownership / usage
  • Substantial portion of pricing paid by third parties.
  • Easy to obtain, government subsidized debt financing.

The housing bubble has of course burst.  Obamacare, by further disconnecting individual use from the true costs of the services, will likely push health care costs ever higher.  And then there is the college bubble.  I am a bit late on this, but this is truly a remarkable chart:

I have already heard the leftish talking point on this, which is that this increase in debt is the fault of (surprise!) private lenders and loan originators.   This is a similar argument to the one made in the mortgage bubble, arguing that all the bad loans are the results of unscrupulous private originators and securities packagers.

And certainly there were many private companies originating awful mortgages and selling them to Fannie and Freddie.   But what we forget in hindsight is that the government was begging for them to do so.  Fannie and Freddie had active programs where they were encouraging mortgages with Loan-to-value of 97% or more.  This kind of leverage is absurd, particularly for American-style no-recourse home mortgages.  Sure, it was crazy to write them, but they were getting written only because the government was asking for them to be written and buying them all up.

In fact, in student loans, almost all of this loan growth is eagerly being underwritten by the Feds, not by private lenders.  Note the only consumer credit line really growing below is the "federal government" line (in red), which is primarily being driven by federally backed student loans.

One might argue that this is once again due to private originators going crazy.  But the Feds took over origination of all federal student loans in 2010.  You can see that much of the growth has occurred after the Feds took over origination.  In fact, I think most of us can understand that when the origination decision is shifted from being a business decision to a political decision, student lending standards are certainly not going to get tougher.  We can see that in home lending, where Fannie and Freddie have already returned to most of their worst pre-crash origination standards (here is an example of government promotion of these low down payment programs).

The other day my mother-in-law argued that the student lending business (particularly private lenders) needed reform because some students were being charged exorbitant rates.  Having not been in the market for student loans lately, I wondered if this were the case.  But the first thing that caught my eye was this stat:  The 2-year default rate (not lifetime, but just in the first 2 years) of student loans was 8.8% last year, and 12% if one looks at the first 3 years.  Compare that to credit card default rates which are around 6%.  And recognized that these are apples and oranges, the student loan numbers actually understate lifetime default rates.

Based on that, the interest rate on student loans should be in the twenties.  Against this backdrop, the rates I see online seem like a screaming deal.  Probably too good of a deal.  Which is why so many people are piling into these loans on the explicit promise society has made to them that their college degree will pay off, no matter what the cost.
Beyond the absurd price increases in both public and private education, here is the 900 pound gorilla in the room -- some majors are simply more valuable than others.  A computer programming grad is going to have a lot more earning potential than the average poetry or gender studies major.

What we really need is tiered lending standards based on a student's major.  Banks don't treat the earning potential of a dog-grooming business and a steel mill the same, why treat a mechanical engineering degree the same as a sociology degree?  But, of course, this is never, ever going to happen.

Years ago I had these thoughts along this line, in response to a Michelle Obama rant about the cost of education

This analogy comes to mind:  Let’s say Fred needs to buy a piece of earth-moving equipment.  He has the choice of the $20,000 front-end loader that is more than sufficient to most every day tasks, or the $200,000 behemoth, which might be useful if one were opening a strip mine or building a new Panama Canal but is an overkill for many applications.  Fred may lust after the huge monster earth mover, but if he is going to buy it, he better damn well have a big, profitable application for it or he is going to go bankrupt trying to buy it.

So Michelle Obama has a choice of the $20,000 state school undergrad and law degree, which is perfectly serviceable for most applications, or the Princeton/Harvard $200,000 combo, which I can attest will, in the right applications, move a hell of a lot of dirt.  She chooses the $200,000 tool, and then later asks for sympathy because all she ever did with it was some backyard gardening and she wonders why she has trouble paying all her debt.  Duh.  I think the problem here is perfectly obvious to most of us, but instead Obama seeks to blame her problem on some structural flaw in the economy, rather than a poor choice on her part in matching the tool to the job.  In fact, today, she spends a lot of her time going to others who have bought similar $200,000 educations and urging them not to use those tools productively, just like she did not.

Postscript:  Kids who find they cannot pay their student debts and think bank home foreclosures are the worst thing in the world are in for a rude surprise -- home mortgage default consequences are positively light in this country.  The worst that happens is that you lose the home and take a ding on your credit record.  Student debt follows you for life, with wage garnishments and asset losses.  People walk away from home debt all the time, the same is not true of student debt.


  1. ElamBend:

    A lot of For-profit schools get hammered in the conversation (especially by the left) and there ARE a lot of crap for-profit schools convincing people to get loans for worthless degrees. [Last winter for an entry-level commission only sales job, I received many resumes from people with MBAs from DeVry University - this is how they'd get around your proposal Coyote, sham versions of real majors].

    However, non-profit schools have been just as guilty. Look at the rise in University President salaries. Instead of sending that extra money out to shareholders, they've simply just allocated among the stakeholders in the university, indeed 85% of the increase of expenses in the last 20 years at universities and colleges has been in Administration.

    It's been one big fat gravy train that the schools have been taking part of, dumping the real cost on the students.

  2. Lyn:

    "Student debt follows you for life, with wage garnishments and asset losses. People walk away from home debt all the time, the same is not true of student debt."

    Absolutely right. It's hard to tell that to teens and young adults though. It is almost impossible to have student loans discharged through bankruptcy. Being declared permanently and totally disabled will get the loans forgiven, but you do have to be re-certified or at least fill out some paperwork every 2 years or so.

    There was an interesting story in Wall Street Journal or USA Today - I forget which - about Americans with enormous student loan debt that left the US forever to avoid repaying it. Sad that some people feel they have to do that.

  3. Ted Rado:

    To control cost, the user must have a stake in the game. As long as third party pays much of the cost, the product will be wastefully overused.

    Half the population pays no federal income tax. Thus, it costs them nothing to vote for candidates who promise to pass out more goodies. If you know it will cost you personally, you will be much more careful with your demands.

    When I was young (in the 40's), I went to a state university to study engineering. Tuition was (Unbelievably!!) $90 per year, plus books and lab fees. Then the USG got into the act and subsidized the system, so that the universities were able to increase their salaries etc. The original idea was to help the GI's, but it got out of hand.

    I knew a young woman from a poor family who worked and saved for two years, then worked her way through a state U for a chemistry degree. This demonstrates that one who has the desire can do it without freebies. Where is that motivation today?

    Since the USG gives student loans, many think they can study snap courses and party. This results in piles of people with an economically worthless degree. This seems to be a growing trend. We'll worry about paying back the loan later (like Obama with the deficit spending).

    By the way, there are really no "freebies". It all comes out of our own pockets. We pay for everything either as consumers or taxpayers. The idea that the government "does something for you" is a total fraud.

  4. Another guy named Dan:

    A big part of the problem with the school loan problem is that they don't look at the student when setting the interest rate. The 4.0 student with AP physics, calculus, and chemistry under his belt heading off to engineering school is a far better risk than the C+ student heading off to a state college to major in undeclared. Yet in today's system, there is absolutely no "risk premium" written into the system to reflect either the individual student's lilelihood to complete a degree, or the anticipated income he will recieve after graduation.

  5. NL_:

    The other thing those 3 things have in common is that people value them for emotional and cultural reasons that are unhinged from their measurable economic value.

    I'll use law school as an example since I'm a law student. There are some people who would be willing to take out loans of $500k to get a JD, especially from a school with a good reputation. (Note that right now no school is close to this amount, but some JD-MBA programs and part-time programs do exceed $300k for students with no aid.) The "market" salary for the best graduates in the top markets is $160k. Assuming 6.8% on the whole loan (which is optimistic) a half-mil loan paid back over 10 years would be $5,700-plus per month.

    Assuming the new lawyer works in NYC (which has by far the most law jobs that pay $160k) they would make $13,333 monthly, with roughly $8,500 after tax. Take out $5,700 and you have a monthly gross of $2,800 with which to try to live in NYC. It's not impossible, but it hardly makes economic sense. Your loan payments would exceed your tax burden. It's like paying taxes twice. With a more realistic interest rate (closer to 8%) you're looking at more like $2,500 after tax each month.

    But we can explain it non-economically if you assume that people become lawyers for reasons unconnected to economic well-being. They get to tell friends and family that they're lawyers. They get to feel good about themselves, maybe. Maybe they just have no clue what to do for a job and they figure they're smart so they should go to law school instead of entering the job market after college. The result is a huge contingent of people bidding up law school tuition. The main brake on tuition is not students' willingness to pay, it's the bad PR schools get if they exceed the average of other schools too aggressively. And that isn't a very strong brake, it just encourages more tacit collective action in tuition hikes.

    Home ownership, college education, postgrad education, and health care all have emotional payoffs unconnected to their economic value. That's why people pay for them well in excess of their value. Third party payment and government subsidies enable the payments, and social value provides the motivation for the payments.

  6. marco73:

    I hope that we are becoming smarter consumers. My son is in high school now, and many of the other parents are looking at alternative ways to afford a college education. When I tell them about how my daughter lived at home, used scholarships wisely, went to summer school, and graduated with a 4 year degree in 3 years from a state school, they are amazed. Sure, Dad had to chip in a couple dollars here and there, but nothing like $20K per year.

    Financing 4 years of college by putting yourself into a financial strait-jacket for life is a complete loser strategy.

  7. NL_:

    Also meant to point out that $20k for college and law school is pretty unrealistic today, even at a state school. Unless you get living expenses underwritten by parents (or a perverted older gentleman with money to burn) the typical cost of living allotment is between $15k and $20k per year. Very few schools grant this amount, even to those who receive full ride scholarships. So even with free tuition and free books, the typical full ride student will still take out loans of $45k to $60k to cover COL.

    Scholarships are also pretty spotty. Most of the decent schools have a restricted number of full-ride and 3/4-ride scholarships. The worst law schools are known for passing out scholarships like crazy, but then imposing stiff GPA requirements such that many or most of the scholarships are reduced or revoked for years 2 and 3.

    So it's a little unrealistic to assume that a state school law degree is all that much cheaper for most people. Even in-state tuition is not what it was ten years ago. Law schools are cash cows for universities. And states are tired of underwriting the education of future rich lawyers.

  8. Sean:

    I think the discussion should be less on student loans and more on why the cost of higher education inflates at an even faster rate than health care. The inflation rate for a college education has averaged 2.6% more than the general consumer price index. This has made higher education less accessible to low and moderate income students. The irony is that the money the government throws as the things it feels we ought to have more of simply raises the price of those things making them less accessible to the very people the government purports to want to help the most. And its response to this vicious cycle is to find even more money to send its way.

  9. a_random_guy:

    "why the cost of higher education inflates at an even faster rate than health care"

    I have no evidence, but a few suspicions. First of all, it is not the teacher salaries - your average college instructor is paid peanuts. Here are (IMHO) the three biggest reasons:

    - Ratio of faculty to staff. Teaching is the core mission of colleges and universities. So you might be pleased to learn that the ratio is 5:1. However, you may be shocked to learn that that ratio is the wrong way around: typically 5 non-teaching staff for every member of faculty.

    - Federal regulations. Part of the reason for staff growth are all of the federal regulations that colleges and universities are expected to follow. This ranges from standard nanny-regulations like the ADA to regulations written especially for universities (like the new regulations for sexual harassment).

    - The number of instructors, courses, and also non-academic programs in purely PC fields. That includes diversity courses, "xxx studies", and all the rest. Entire departments could be closed, and no one would miss them.

  10. Jim Collins:

    Has anybody looked at the classes that students are required to take? I fail to see the need for a Mechanical Engineering student to have to take a Medieval Literature. Don't give me the "well rounded person" BS because it doesn't fly. All this does is to inflate the cost of education and provide "welfare" to people who were stupid enough to get degrees in subjects that have no meaningful jobs. You could reduce what is pretty much a five year degree down to three and a half. Then you have "student activity fees" attached to the cost of each class. Funny part is that other than "Code Pink" and "The Muslim Student Association" riots, I mean gatherings, there are no activities.

  11. sch:

    As to academic salaries, I was perusing the U of Va site a few yrs ago checking on an old acquaintance who happened to
    have named chair in the Dept of Mathematics, now emeritus. Mousing around the site I found a listing of salaries and
    discovered his final years salary was just under $125k/yr. Rummaging further indicated that administrative staff at
    the asst vice dean level was $150k and the admin salaries went up from there. Makes one see why leader types in many
    departments get out of teaching and go into academic deanship, provost office etc: they double their income or more.

  12. Don Lloyd:

    The real problem is that in attending college, the majority of even graduates learn next to nothing of economic value to their potential future employers that couldn't have been inexpensively provided in the first six months of employment.

    In the cases where that is not true, it would be far more efficient for the employers to outsource the education of their employees to specialist firms who are held responsible for results by the employers in a competitive atmosphere.

    If I were an employer, I could make better hiring decisions by interviewing the prospective employee's 11th grade teachers than by paying attention to college degrees, and make hires earlier and cheaper for everybody.

    With internet and other electronic instruction soon able to be copied at virtually zero true cost, and priced purely from perceived value and supply competition, existing colleges are all but dead, and just don't know it yet. Only the football and some other athletic programs supplying paid entertainment will have value.

    I can't help but believe that the destruction of the present college system will make the US far more competitive in the global economy.

    Regards, Don

  13. Dan:


    Couldn't have said it better myself.

  14. Dan:

    I think a random guy is right on target in his assessment of why costs have gone up. Too much damn bureacracy and a lot of courses like gender studies and LGBT studies that are a waste of everyone's time and money.

    What's really outrageous is how little the real professors actually teach. I recently read that in some major universities, non-professors teach as much as 70% of undergrad courses.

    I have a close acquaintance who's non-tenured and not a professor but has a Ph.D. in her field and teaches at a major university here in the Midwest (one that would probably be considered a top-30 in the country). Students pay around $50,000 a year to attend. This year, she's teaching courses that full professors would normally teach. Where are they? Who knows.

    She's being paid less than half the salaries the full professors are getting, but of course, the university is paying her to teach and at the same time paying the full professors to do whatever it is they do (not teaching, that's obvious). And this is in liberal arts, so it's not like the profs are off finding new cures for cancer.

    What the colleges need to do is either force the tenured staff to teach and get rid of people like my acquaintance, or find a way to "un-tenure" the professors so that there's a free market for their services. If this were the case, people like my acquaintance, capable and uncapable alike, would compete with the professors (both the capable and uncapable ones) to teach. In the end, a lot of dead weight could be gotten rid of. It would be kind of like busting a union.

    This would definitely make sense for liberal arts. Less so maybe for science and technology, because universities indeed need to support research in those areas. In liberal arts, the research has become ridiculous. No one reads the 1,643rd book interpreting Don Quixote.

  15. Matt:

    Defaulting on student loans _might_ be less problematic than defaulting on loans owed to the Mafia.

    Or it might not.

    You wouldn't believe the harassment and fraud that student loan collectors are capable of doing and getting away with...unless you've ever been in default on a student loan.

    The worst thing that can happen if you default on your credit cards is that they don't give you any more credit cards. The worst that can happen if you default on your mortgage is that you have to move.

    If you default on student loans...well, let's just say that I can really sympathize with the folks who flee the country to get out of it. If you've got someplace else that'll take you, renouncing your US citizenship might be a good move.

  16. a_random_guy:

    Re tenured faculty and teaching staff. The way it works is this: tenured professors are out hunting grants and supervising graduate students to do the work required by the grants. Whether these grants and the associated research are really of any use (especially outside of STEM fields) is another question altogether.

    Actually instructing students - what one might suppose to be the primary mission of the university - is a second-class profession. The lecturers hired to do the teaching are often paid pathetically, and often given huge teaching loads. The priorities are entirely backwards.

    The most highly paid people in a university ought to be the best teachers - that is, after all, the core mission. Research is fine, and should be accorded an equal (but not superior) place, as long as it is self-financing. Administrators are the clerks, necessary but replaceable, and should be paid accordingly.

  17. frankania:

    In these days when you can google any question you have 24/7, you don't NEED a university all that much except for certain professions like maybe surgery, academics, law, etc.

    If a young person really wants to LEARN something, it can be learned for virtually no cost using the internet and maybe taking a few courses at the local university (which will also give them the "college social scene experience too).

    When I was hiring for my businesses, I did not care about diplomas and papers; they had to prove that they could DO the job, that's all.

  18. Mark:

    Most loans today are still government Backed FHA loans which require 3% down. Only a 580 credit score, bankruptcy has to be only 3 years old, no credit card delinquent by more than 4 months and you get better rates than conforming loans.

    Would you loan to someone like that?

    And with a few shenanigans, you can actually still put negative money down with one of these loans. (You can get a loan to cover 2% of the closing costs, and ask for 3% back)

    I suspect in a few years we will see the housing crisis all over again, as this new group of unworthy owners default all over again.


  19. Ted Rado:

    Jim Collins:

    You are so right. When I was an engineering student in the 40's, I got permission from the engineering school dean to substitute math and advanced eng courses for the required humanities. When I graduated, I was much better trained for an engineering career. You can always read lit and hustory on your own later.

  20. Mark:

    Student loans actually do have a tiered system. If you graduate, and you are doomed to a low paying job. Say you sell tickets at a museum with your sociology degree, they actually have programs to extend the loans beyond 30 years, and forgive what you don't pay after that.

    So the incentive is in reverse, get a crap degree and a crap job and you get a discount. Get a good job and you end up paying full fare.

  21. Smock Puppet, Student Loan Microlender:

    Ah, one thing affecting this is the ridiculously increasing cost of college itself. In the late 70s, college tuition was, for an in-state student in Florida, was like $12 an hour. Granted, that was "low" -- it generally was under what the state actually paid.

    Now? At University of Florida the per credit hour cost for in-state residents is $125.91, 10x as much. Suppose we double the original to closer represent the actual cost of school -- that's $24. Then let's 3x it for inflation... that's $72. Why is tuition 50% more than that?

    The real fact is, the states have been BS-ratcheting their fees using, as an excuse, the cost paid in other states.

    So the school that's ranked 40th in education cost? it bumps up its tuition by 15%, putting it at, say, #26.
    The school that's ranked 38th in education cost bumps THEIRS up by 18%, putting them at #23.
    Three other schools in the bottom half bump up their costs by 12, 15.5, and 17%, respectively, two of them move into the upper half, and the other moves into the middle third, close to the median.

    ... which means that five other schools that were near or above the median are now well below it, and the ones that were on the lower edge of the middle third are now in the middle of the bottom third...

    So THEY rachet THEIRS up.

    And we wind up with each state playing tuition leapfrog on the student's backs, because, hey, this is the government!! There's no tie of any kind to the actual EXPENSE of teaching a student!!! Don't be DAFT, man!

  22. marco73:

    The real scam on tuition is that at UF, as at many schools, it costs the same for an on-line class versus a classroom with a professor.
    I had another one of my kids at UF a couple years back. Her last semester, due to a scheduling conflict, she had to take an on-line class to finish her BA. Just some reading, two on-line tests, and a paper at the end of the semester. She never met the professor face to face, did everything on-line. There were over 200 kids in that class, paying full boat to trade emails with a professor. Easy money.