#71 The Student Debt Bubble

There is a growing chorus in America, especially among the youth, for an outright cancellation of outstanding student loan debts and a total subsidization of all secondary education at the federal level.

After all, costs of a 4 year college degree have sky rocketed in the last several decades putting young people emerging from from the school system with a college degree (in some mundane topic of study) at a significant disadvantage when starting life. Huge outstanding debts with no claim to appreciable assets is a bad mix in an inflationary environment if one wishes to start a family or just be generally successful in life.

And with the costs of college education rising by the semester to unprecedented levels, people are rightfully asking “how will I pay for this?”, however, the questions that should be on everyone’s minds are “Why is this so expensive?” and “Is this actually worth the cost?”.

As a milennial, I can remember my parents talking about working part time as a dishwasher through college and collecting a handful of small scholarships, scraping by on a shoestring budget in a crappy little apartment and hopefully finishing out their degree with little to no debt. Today’s environment is a much different story, where even well to do adults with professional full time careers can hardly pay outright for their offspring to attend a university.

The story here is a familiar one, as is always the case with government intervention in markets. Subsidization of debt, and in this particular case, subsidization of mal-investment which cannot liquidate, have created a bubble of rising costs in secondary education at little, if any, marginal improvement on the services rendered.

The 1993 student loan reform act instituted direct government lending to students, and in many cases this debt is directly subsidized as well. In addition to this, student loan debt is quite different from other types of debt in that it is nearly impossible to discharge said debt through a chapter 7 or chapter 13 bankruptcy.

The double whammy of subsidized investment into education and inability for a student who makes a poor investment to liquidate their debt plays into a monstrous feedback loop of lopsided risk borne by the student with almost no risk on the shoulders of institutions.

Allocation of capital in a free market system distributes risk amongst all participants. Not necessarily all risk is distributed equally in circumstances of financing investment, however all parties bear some amount of risk in this transaction. A college education is an investment, supposing that by spending X amount of capital today with an institution of higher learning, one will be more productive to society and thus emerge with a higher earning potential in the future, making this a profitable investment.

In a situation where this investment is not subsidized by the federal government and at risk of being liquidated through bankruptcy, all involved parties must carefully weigh the risks of losing capital in the case of mal-investment. A lender must have a certain degree of due diligence on the student which they finance, and where they intend to study and in what topic. The student must choose an institution and course of study which will provide them an ROI in the future, and institutions must provide students with rigorous courses and networking opportunities which ultimately improve the individuals opportunity for a higher wage.

Notice that in the current paradigm of higher education, the vast majority if not all of the risk of higher learning is carried entirely by the student. They cannot declare bankruptcy after their bad investment and in many cases are on the hook to repay their principle debts in entirety no matter the circumstances.

How many baristas with a useless art history degree have you met?

Institutions of learning receive their money up front, and are in no danger of loosing access to cheap capital provided by the government. Thus they are offered little to no incentive to increase the ROI of an undergraduate or even post graduate degree. They are, however, incentivized to increase spending of the institution for the sake of its own bureaucratic ends. After all, with unlimited financing available to their customers (students), why wouldn’t it be in their best interests to increase spending, thereby increasing costs and revenues, in as many areas as possible.

An interesting contrast here can be observed in the free market educational system. Newer trade schools, in high demand fields such as computer programming, have created payment models that create aligned incentives for both the student and the institution. Lambda school is one example which charges students nothing upfront for their streamlined, highly focused educational curriculum. The students enter a repayment agreement which stipulates that they will pay a certain percentage of their income for the first few years of employment following their graduation.

This model incentivizes the school to not only provide an education which dramatically equips the students productive capacities, but also to market them and network for them in an effort to find them as high paying of a job as possible. After all, the schools ROI is dependent upon the earning capacities of their students once they enter the workforce.

Interestingly, billions of dollars of government subsidy thrown at secondary education stagnate profitable investment rather than helping to align the incentives which make for better opportunities for everyone except rent seeking bureaucrats.

How does the government manage to finance and ensure limitless amounts of debt and mal-investment again? My general advice these days is to forgo any form of secondary education unless it is a component of a specific qualification wicket necessary to pursue a career plan which you have meticulously evalutated…and again, those jobs usually carry certification processes overseen by some government entity…What a surprise.


Book of the Month:

The Road to Serfdom by F A Hayek

-“We are ready to accept almost any explanation of the present crisis of our civilization except one: that the present state of the world may be the result of genuine error on our own part and that the pursuit of some of our most cherished ideals has apparently produced results utterly different from those which we expected.”

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