May 11, 2008
The recent meltdown of the mortgage bubble illustrates a basic insight of Austrian Economics: cheap money leads to distortion and malinvestment, which can only be resolved through mass liquidation. Liquidation is an anodyne term, but in real life it means lost jobs, declining wages, “upside down” bank notes, bankrupt businesses, and stagnant housing values. The Federal Reserve’s decision after the September 11 attacks to drop interest rates precipitously”at one point lowering the federal funds rate to 1%”contributed significantly to the situation the country finds itself in. The sheer cheapness of this money created various pressures on lenders to loosen lending criteria, which in turn led to massive real estate speculation, artificially inflated housing values, and, now that the gap with actual economic demand has appeared, a necessary and precipitous drop in prices.
The real estate boom is not the only bubble in our economic life, and when these other credit-driven bubbles burst, similar episodes of liquidation will be necessary. Federal subsidization, coupled with immaturity and ignorance by borrowers, has created another bubble that threatens to burst: the great education bubble.
The latter half of the Twentieth Century has led to an explosion of spending on higher education in the United States. In 1900, 2 percent of young people went to college; today the percentage is above 30%. The GI Bill was a major factor in expanding college attendance after WWII. Avoiding the Vietnam draft was another. In the years since, the number of educational institutions and offerings expanded. Many small teachers colleges became universities. Notoriously unrigorous “for profit” universities appeared on the scene, while large and growing McUniversities are found in every state. The cost of education has risen, as well; in fact, it is an order of magnitude larger than the rate of inflation in the economy in general. All of this growth”in institutions, students, degrees, and educational investment”is driven by government-subsidized credit. As in housing, excessively cheap credit has created the conditions for a correction, which will lead to fewer universities, fewer degrees, recalibrated obligations to lenders, and, one should hope, a change in the culture of higher education in the United States.
While it is laudable that the United States has become more of a meritocracy with few barriers to higher education for qualified students, human nature has not changed. Only a small percentage of students can really benefit from a traditional university education. Yet many people desire a degree for themselves and their children, even if they don”t really care for what it entails. Underlying much of what we do is the great American goal of upward mobility and social respectability. As Paul Fussell observed, “In the absence of a system of heriditary ranks and titles, without a tradition of honors conferred by a monarch, and with no well-known status ladder even of high”class regiments to confer various degrees of cachet, Americans have had to depend for their mechanism of snobbery far more than other peoples on their college and university hierarchy. In this country, just about all that’s finally available as a fount of honor is the institution of higher learning.”
Nonetheless, money is the other great American passion. People do not attend modern-day universities to study Plato and Aristotle and Shakespeare, so much as to get a credential to obtain a job that gives them access to an upper-middle class standard of living: plasma TVs, SUVs, a nice house in a neighborhood with “good schools,” and the like. To accommodate the ranks of modestly intellectual students, educational offerings have become more vocational in nature, including such dubious degrees as “packaging” and “communications.” For a lot of reasons, university graduates typically earn more than those without a degree. Aspirants and their parents have reasoned that the degree itself”rather than what it once signified in terms of IQ and work ethic”is the key. This is a confusion of correlation and causation of the worst kind. Parents and students of modest IQ are starting to realize that a $100,000 student loan obligation for a Nova University degree hinders, more than it advances, the goal of an upper-middle class lifestyle. As this happens, this racket will collapse. Indeed, the decline of male university attendance suggests that this process is already underway.
There are several reasons degrees, universities, and the associated educational debt load has risen so dramatically. For starters, the folk wisdom persists that universities are a good investment. More important, the young decision-makers delay payments on their student loans for four years or more. Like adjustable rate mortgages, the tangible pain and constraints of these obligations are hard to fathom. Unrealistic hope about future earnings encourage additional indebtedness, and everyone from parents to guidance counselors encourage educational investments without rigorously considering the student, institution, and degree involved. Students and their parents may even reason that the market itself is revealing the relevant information and that the return on investment must be some multiple of the present-day cost of education.
Universities certainly have little incentive not to maximize tuition and encourage the acquisition of student loans, because they get paid up front by students. Subsequent defaults do not affect the university and only create burdens for the lender, the borrower, and the federal student loan insurance programs. Finally, the near impossibility of escaping student loans”even through bankruptcy”is not fully appreciated by borrowers. Everything from deficiency judgments on mortgages to credit cart profligacy can be set aside through bankruptcy, but not student loans.
Lenders are already starting to get the message. As the federal government has withdrawn its once generous support for student loans”through the (now private) Sallie Mae Corporation and its insurance programs”banks have tightened up lending criteria as well. While the Harvard and Princeton students will still do fine, folks at the Novas, Fiskes, and Culinary Institutes of America will face more rigorous scrutiny. Many lenders will likely leave the field altogether, a process already begun because of the meltdown of secondary markets in securitized loans of all kinds, including educational loans.
But the biggest revolution will have to come from students and their parents. As young college students working as secretaries, paralegals, and restaurant managers see the kids from shop class, military technical skills programs, and other “blue collar” fields buying nicer homes, nicer cars, taking more vacations and generally doing well, word will trickle down to the buyers and their parents. This is the essential thesis of the best-selling book: The Millionaire Next Door. Instead of repeating hoary and well-meaning advice about education, it’s becoming clear that the most secure jobs will remain those that must be done locally. Everything that involves a mobile product”from programming to engineering and other fields that require college education”have been pummeled by outsourcing and will remain less appealing. If it happened to telephone engineers in the late 1990s, why not accountants and marketers tomorrow?
The declining economic fortunes of college graduates, coupled with tales of white collar drudgery, suggests that necessary and high skill blue collar jobs”plumbing, car repair, cable installation”will become more appealing and more renumeritive. Graduates of high school and community college vocational programs, far from dooming these students to second class status, are starting to have the last laugh as marginal college graduates (and drop outs) enter default status on their student loans. As the information of inflated degrees expands, businesses will likely drop college degree requirements to obtain quality employees, instead giving high marks in “two year” training programs more respect than four years of partying at State U. Not available when Fussell wrote his work Class, the U.S. News college rankings have done much to demonstrate to the general public how little a degree from a third or fourth tier institution is worth.
A certain percentage of students belong in college, benefit from it, and have higher wages afterwards. Their ultimate life successes stem from the qualities that got them into a top school: brains, a work ethic, comfort with complexity, and creativity. An education for these kinds of skills and abilities is not for everybody. And this is not a tragedy. In America, folks of average intelligent are neither handicapped nor destined to a life of unproductivity. An advanced economy like the United States” provides many opportunities for nearly everyone to do well, engaged in everything from service occupations, repairing complicated devices, people-centered occupations, and the like. But most of these occupations do not justify or require a four year degree. The reasonable (though modest) incomes of these positions make a $75-150K student loan burden a very real one.
Government insurance, government subsidies, borrower ignorance, and a culture of excessive optimism have done their part to create a distorted market filled with mediocre colleges and mediocre college graduates. Just as the McMansion bubble couldn”t last forever, neither will the education bubble as defaults from low-earning borrowers put extreme stress on lenders to marginal applicants. The borrowers themselves may soon create a political constituency demanding relief in a way that shifts costs from the government to private lenders in the form of more generous bankruptcy protections. This will be easier for liberal politicians to promote than a government bailout, but it won”t be good news for the University of Phoenixes out there, nor all the other mediocre institutions propped up by disappearing cheap credit.