Wednesday, April 24, 2019

Nothing Is Free

Mark Dice has a nice takedown of generic old white lady/fierce Indian warrior Elizabeth Warren and her desperate gambit to get some momentum by promising to wipe out college debt.




Warren's obvious target audience here are the hordes of (mostly white) millennial college grads who took on six figure student loan debt to get degrees in the "History of Renaissance LBGTQ Architecture By Womyn Of Color" and now for some odd reason can't get a real job and therefore have no way to pay back an unsecured loan the size of a home mortgage that is enforced by the near unlimited debt collection ability of the Federal government. It is obvious pandering and that is really what the Democratic primary contest, early as it is, has turned into. Naked, raw pandering. Which candidate can promise the most "free" stuff. Andrew Yang proposes a $1000/month handout. Cory Booker proposes a lump sum for "disadvantaged", in other words non-white, young folks. Bernie promises free everything. So in order to cling to relevance, Warren is proposing not only "free" college but also magically wiping out the hundreds of billions in existing student loan debt. Of course that doesn't happen by actual Hogwarts magic (Debtus Obliterato!). The money was borrowed and the money was spent. Colleges aren't going to give it back. That means either the big lenders like Sallie Mae have to write off an incredible sum from their books, which I would assume would force them into insolvency and out of business, or the government will have to bail out these borrowers, tacking another trillion dollars onto the existing debt.

That sounds like a great idea!

In all seriousness, Warren and others promising "free college" and loan forgiveness are not dealing with the actual underlying problem. The problem is two-fold. First, kids with no business borrowing unlimited sums of money are given loans, no questions asked. Second, this spigot of easy loan money makes it possible for colleges to inflate their prices year after year, because no matter how high it goes, a kid can get loans to pay for it. The demand for college degrees is huge and the supply of loan money, backed by the Federal government's guarantee of repayment, is unlimited so there is no pressure on price.

The only way a student should be able to finance college via loans is to apply for a loan like anyone else. When I worked in banking, there were some things we looked for in a loan application. First, if you borrowed the money, are you likely to pay it back? That comes from your credit history because if you are responsible with credit in the past, you probably will also be in the future and the opposite is usually true, if you habitually are terrible about paying back loans in the past, chances are you will be the same in the future. Second, can you pay it back? It wasn't smart to loan someone money if the required payments were more than they made in a month or if they were already juggling a huge pile of debt (your debt to income ratio and your payment to income ratio). If you make $2000 a month and already have $1500 of that spoken for, I am not going to give you a loan with a $700 monthly payment. Finally, what happens if you don't pay back the debt? That is why we have loan appraisals and car valuations. If you want to buy a house worth $150,000, I am not going to give you a loan for $250,000 (or even $150,000) because if you don't pay and I get your house, I am not going to be able to sell it for enough to recoup my losses. So those are the big three factors.

The problem with student loans is that 1 and 3 are out the window. Most college students are young and don't have a long credit history to work from. Plus student loans usually have no collateral so if you don't pay my only recourse is to hound you for money, an expensive and usually less than fruitful practice. That only leaves the second factor, ability to repay.

When it comes to ability to repay, the lender should look at your course of study and how likely that is to lead to a career where you can service the debt. If you are majoring in electrical engineering or better yet actuarial science, you can almost certainly swing repaying a loan of almost any reasonable amount.

For example (and an opportunity to dad-brag). One of our daughters has always wanted to be a doctor. She is an undergrad now about to finish up her degree in biology and will graduate with distinction for her GPA. She recently took the Medical College Admissions Test and scored in the top 1% of all pre-med students taking the test, with a score well above the average score for Harvard's 2019 incoming medical school class. So she is essentially assured admission to almost any medical school in America. As a graduate of medical school and a practicing physician, depending on specialty, she will be pulling down a six figure salary and perhaps a very high six or even a seven figure salary. As a lender, giving her loans for $200,000 to pay for medical school is a pretty sound decision as she has a better than reasonable ability to pay it back.

Now, what if instead of medical school, she wanted to get a graduate degree in Classical Congolese Literature and it would also require a loan of $200,000. Why would a lender give her that loan? She already has limited credit history and no collateral and now you are adding in the likelihood that she won't get a job that would allow her to service that debt and likely never will be able to keep up with the minimum payments, much less ever pay it back in full. It makes absolutely no sense and no lender would ever give her a loan. Except that they do because the risk equation is all out of whack thanks to the government guaranteeing the loan.

When the government is guaranteeing a loan, it suddenly becomes smart to make bad loans. Why not make a bad loan if you don't have to deal with the consequences of it defaulting? That is the whole sub-prime mess in a nutshell. Banks made crappy loans to sketchy borrowers that they never would have normally because there was so little risk to the bank in doing so. Back in my banking days people were taking mortgages for huge amounts of money, some with payments that didn't even cover the monthly interest so just making your regular payment meant the loan balance was going up every month. This easy money meant that housing prices skyrocketed. Lots of available loan money meant that buyers could borrow more easily and that allowed them to stretch their offering price and pay more than they should. Housing prices went up, loan balances went up and the banks got rich making essentially risk-free loans. Then it all went to crap and people who never should have borrowed the money in the first place defaulted and lost their homes. Mortgage backed securities got hammered. The government had to come to the rescue with more make-believe money. Rinse. Repeat. You are going to see this happen again because the elected officials care more about pandering to unqualified buyers than they do about the impact on the economy. Why would they care when they can get the votes, blame the banks and not really feel the impact?

The same thing is happening in student loans. Artificial supply of loan funding has been causing artificial inflation of college expenses so even mediocre colleges offering useless degrees could raise their prices double digit percentages every year and still fill up the classrooms. The big difference is that when you default on a mortgage, at least the bank gets the house and can sell it, although usually at a steep loss. When you default on a student loan, there isn't an asset to seize so you just have to keep squeezing it from the borrower.

While I appreciate those that say that people took these loans of their own free will as adults, and they did, they never should have been approved for those loans in the first place, just like you wouldn't give an 18 year old with no credit history and no job a $25,000 unsecured loan. The government and financial institutions were making bad loans knowing they would fail. So the long-term solution is to stop subsidizing student loans. Again, if you want a loan you go to a lender and make your case. If you can't show how the education degree you are getting will lead to an income that enables you to pay off the loan, no loan for you. That would mean a lot less people getting useless four-year degrees and probably a lot of campuses shutting down and/or laying off staff and faculty. That is a good thing. There are already too many over-educated, overpaid college employees in America. Most people of average intelligence and ability should be learning a marketable skill and a degree in Communications is not a real skill. Nor are most liberal arts degrees. I would argue this is true even of most business degrees. Not that many people I worked with in financial services had business degrees and the ones that did were in no way better at their jobs than people like me with degrees in Political Science. If you want to study Renaissance literature, go to the dang library or use Google. There is no reason anyone needs to spend $125,000 and four years getting a degree in some esoteric field of study unless they can self-finance it.

That will never see the light of day because suggesting that means you are "anti-education" and everyone must slobber on themselves about how much they value "education" to get elected. The average voter has no idea what the word education really means but they do know that more education=good, less education=bad.

Some version of Elizabeth Warren's proposal will probably become law, if not after the 2020 elections then certainly after 2024. It is just one more nail in the coffin of America. We are going to find out pretty soon that when everything is free, it will suddenly become very expensive indeed.


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