Ravengate
Partners - Stock market, economic and political commentary by Patricia Chadwick

Confiscatory Student Loans Are a Huge Drag on Our Economy

The housing market, while still under water and providing little contribution to economic growth, is at least seeing light at the end of the tunnel. That is because mortgage rates are now at a fifty year low, providing significant economic incentive for buyers to enter the marketplace. The excess supply of homes is slowly dwindling.

However, just as the housing market appears to be coming out of its depression, the country faces another threat. It is an insidious economic cancer that threatens to sap potential growth for decades to come. This cancer is none other than STUDENT LOANS!

An entire generation of twenty somethings who were not privileged enough to be provided higher education by their parents is entering the work force with a giant noose around its collective neck. And that noose is in the form of huge student loans they were required to take out in order to get an education that would give them a competitive entrée in the work place. It is the magnitude of the debt that is frightening. In many cases, their middle class parents are broke and now they are starting their careers broke as well. By some measures, the total student debt outstanding is over $1 trillion, according to an article in the Wall Street Journal on March 23, 2012.

The economic impact of this scenario is scary. Today’s young college graduates should be the trailblazers for the continuation of the American dream. Their energy, stamina, creativity and appetite for risk are the ingredients for entrepreneurship. It has been that way in this country for decades and even centuries. But now suddenly that ability to dream big and take risk is being choked off by the crushingly high level of debt they must repay. They cannot afford to take risk or to invest. They can barely afford to spend on discretionary items because they have so little money left each month after paying their student loans.

Student loans have long been a part of the American way of life. I had such a loan myself for seven or eight years. But there is a huge difference today. When I paid my student loan, it was in the late 1970s, a period of extraordinarily high inflation and consequently high interest rates. However, the interest on my student loan was a manageable 5.5% and the loan carried simple interest.

Today, with interest rates under 2% on the 10 year Government note, student loans carry rates of 6% at a minimum and as high as 11%, most of them under a Federal Government program. And to add insult to injury, the interest on many of these loans is amortized. The newly minted graduate, assuming he/she gets that far, is racing just to service the debt without paying down the principal.

I recently spoke to a young woman who put herself through college and graduate school with no financial support from her family. Upon graduation, her eleven separate Federal loans totaled $135,000. She currently earns nearly $65,000 annually by working a full week and one day on the weekend. Since she started working, she has paid more than the monthly minimum required on her loans and after nearly two years of payments that have totaled $26,000 her balance today has grown to $141,560! She is deeper in debt than at graduation because some of the loans are paying down no principal at all. She is caught in a vise that will make home ownership an impossible dream for decades. She called Sallie Mae, the company that services the vast majority of Federal student loans, to inquire about consolidating her many loans the possibility of getting a lower rate. The Sallie Mae employee said that the company was willing to consolidate but would give her no break on the interest rate. And when she inquired as to why no one at Sallie Mae reached out to her, she was told that policy prohibits such action. If that is true, that policy is criminally negligent.

Another young woman, the daughter of a friend of mine, has a $42,000 private student loan with Discover carrying an 11% interest rate. When her father contacted Discover in an attempt to negotiate a lower interest rate, the (evidently naïve) employee said there was nothing that could be done. In further conversation, she admitted that the student loan business was Discover’s most profitable and that employees were provided incentive compensation based on how successful they were in ‘selling’ loans to students. Again, if true, such a corporate ethic is moral turpitude. And Discover’s website advertises student loans for “as low as 6.79% APR”.

These stories are far from unique. They are repeated hundreds of thousands of times in this country. The lenders decry the fact that student default rates are high. Well of course they are high when the interest rates are so onerous. The system is downright Dickensian.

The recently passed bill signed by President Obama unfortunately will not relieve the interest rate burden on the generation of young graduates who are drowning in debt, although it does alleviate conditions from getting even worse for some students. In response to the new law, Sallie Mae and other student debt servicing companies have bemoaned the fact that they will be forced to lay off employees. But I argue that those layoffs are nothing compared to the negative impact on the economy from a generation of workers who have diminished resources to buy basic goods and services, much less to take on economic risk.
So what is to be done? How can this cancer be cured?

A complete overhaul of the student loan industry is essential. For one, the business should be tightly regulated, in much the same way that utilities are. I am sure this concept is anathema to many, and I myself abhor overregulation, but the abuse that is being heaped on the vulnerable (i.e. young, desperate students) warrants such a response.

And something must be done about the cost of higher education, which has spiraled out of control. There are many studies that show that the cost of college tuition has increased at multiples of the rate of inflation. When an asset (college education) is priced to become a liability (it bankrupts the buyer) the price must fall. That is simply an economic fact of life.

Ruminate on these statistics for a moment or two.
CONFISCATORY STUDENT LOANS
Tuition Per Annum 1960 1960 (in 2008 $) 2008 Actual
Harvard $1,520 $10,147 $33,709
University of Texas $100 $695 $7,530
Michigan State $279 $1,939 $8,843
Source: ClearPictureOnline.com

Is it no wonder that parents can no longer afford to provide a college education for their children? But without such higher education, the outlook for gainful and fulfilling employment is miserable.

The debt being incurred by the young in this country has reached the level of a national crisis. We had better address it now before this it takes on the proportion of our Federal Government’s debt.

Patricia W Chadwick
President
Ravengate Partners LLC

2 Responses to “Confiscatory Student Loans Are a Huge Drag on Our Economy”

  1. John Alexander Says:

    “The housing market, while still under water and providing little contribution to economic growth, is at least seeing light at the end of the tunnel. That is because mortgage rates are now at a fifty year low, providing significant economic incentive for buyers to enter the marketplace. The excess supply of homes is slowly dwindling.”

    Regrettably, I’m afraid that light at the end of the housing market tunnel is likely the proverbial train.

    Though interest rates are compelling, if that were sufficient stimulus for either the real estate market or the economy as a whole I believe we would have seen more encouraging signs of life.

    Further, it appears a mere oddity of bank accounting is holding the floodgates of more houses entering the closed for now. Specifically, banks are allowed to value the foreclosed homes on their balance sheet at the price the borrower *originally paid* for the property and avoid taking a loss from a foreclosure sale by simply not selling the property.

    Witness numerous stories about the ‘shadow REO’ market with estimates placing the number of foreclosed homes on the market at well under 15% of the total inventory *yet* to be placed for sale ( see http://realestate.aol.com/blog/2012/07/13/shadow-reo-as-much-as-90-percent-of-foreclosed-properties-are-h/ for as one example).

    Should property values begin to show sustainable signs of strength, thereby allowing banks to sell properties at a level that may mitigate entirely or at least sufficiently their present losses, the inventory of houses climbs – with a corresponding decline in housing prices.

    Regrettably, the significant incentive to borrow will only bring about a meaningful impact when banks decide to lend at that rate – something countless people can attest they are unwilling to do.

    So., in the final analysis, we have both the housing market AND the tragic impact of student loans holding the economy

  2. John Alexander Says:

    I came across this recent article in the Washington Post and thought of another recent post regarding the Fed’s pushing down of interest rates and how it’s a boom for consumers.

    In an article published Sept. 18, the author writes,

    “The Federal Reserve took aim at the nation’s wobbly housing market last week with its biggest stimulus action in two years, but that firepower is doing little to lower mortgage rates or make home loans more available for Americans.

    Instead, banks are set to see a windfall since the Fed’s actions will immediately lower the cost of issuing loans. It may take months or longer for benefits to trickle down to consumers, analysts say.”

    The article further notes:
    “Critics argue that banks are simply maximizing profits at the expense of consumers. Mortgage bankers are recording higher gains from home loans as the gap widens between the interest rate they charge consumers and the rate they must pay investors who finance the loans by buying mortgage securities.

    Another challenge for the Fed is that many people eager to buy a home or refinance an existing mortgage simply can’t qualify because of poor credit histories. That may not change even if rates fall.”

    Though housing data released today was encouraging, we still have a long way to go and those who can refinance, in all likelihood, already have done so.