Government Created Potentially Catastrophic Education Bubble

By | June 12, 2012

With the discussion of student loan debt expected to dominate the airwaves in the coming months, Antony Davis senior scholar at the Mercatus Center at George Mason University and James R. Harrigan fellow of the Institute of Political Economy at Utah State University stated that government is responsible the current crisis surrounding higher education debt.  It’s nothing new. In fact, it follows a similar narrative that led to the housing fiasco.  Harrigan and Davis state:

The government, in a fit of social engineering spanning decades, established Fannie Mae and Freddie Mac to make real the dream of home ownership for working class Americans. Beginning in 1996, the Department of Housing and Urban Development told Fannie and Freddie that more than 40 percent of their loans had to go to low-income borrowers. Tax breaks followed. Finally, starting in the early 1990s, the Federal Reserve pushed interest rates to historically low levels, making mortgages cheaper.

The net result of this was very predictable: People took out more mortgages, increasing numbers of mortgages went to low-income people, and the government became a major lender in mortgage markets. In 1990, Fannie and Freddie held one of every four outstanding mortgages. By 2003, they held almost half of all mortgages. Between 2001 and 2006, the fraction of new mortgages that were subprime tripled.

This is coupled with the fact that Americans, by the late 1980s, decided to become less frugal, which resulted in the savings rate dropping from 9% to 5% by the mid 1990s.  By 2005, the U.S. savings rate went negative and so American borrowed against the equity in their homes in the surest confidence that the real estate market would remain stable and the price of their home would remain profitable.  This disease of spending and NOT saving is the reason why we have 1.4 billion credit cards in U.S. circulation, that’s nine per cardholder.  Well, bad habits catch up and by 2008 the consequences of reckless spending  caught up with us in a series of events that are finely ingrained in our memories.  However, with credit card debt now overtaken by student loan debt, this next chapter in failed government will be have a more serious fallout ,especially when it targets America’s future working class.

With student loan debt, it’s even harder for young Americans to manage that debt since you cannot declare bankruptcy to re-organzie your finances.  You could have it forgiven, but that’s only if you were to die before you pay back the loan in full.  Like housing, government tried to orient higher education through a social engineering lens and “established Sallie Mae in 1972 to encourage banks to loan more money for college. The Affordable Care Act of 2010 allowed the government to loan money directly to students. The following year the Taxpayer Relief Act extended tax breaks to student loan borrowers. Predictably, the Federal Reserve kept interest rates at historically low levels, making college loans cheaper.”

In the meantime, “the price of a college education soared…[and] by law, lenders cannot even deny Stafford and Perkins loans (types of federal student loans) based on the borrower’s credit or employment status. What other reason is there to deny a loan? And just as home buyers took out loans to speculate on houses they could never hope to afford, students are taking out loans to cover educations they often cannot complete and which often do not hold value in the market even when completed.”  Between 1976-2010, higher education costs have soared 1000 percent.  With no solution in sight to solve this problem and holders of debt unable to declare bankruptcy or return their four year degrees, the consequences of the eventual education bubble bursting will certainly feed on the flesh of a generation who will have to solve our entitlement problem and find ways to pay down the massive debt we have accumulated over the past two decades.  However, that’s just the beginning.  In a more technologically  advanced and connected world, we have to continue to innovate to keep up and stay competitive.  Sadly, if the  student loan debt bursts, which I’m hedging it will if history repeats itself, then innovation is at risk.  As a result, we could see America’s place as the dominant socio-economic force in the international community disappear.

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