The higher education revolution

I had an excellent discussion recently about the similarities between the mortgage crisis and the increasingly common news reports about a student loan debt crisis. At some point I was asked this question (roughly):

Will a student loan debt bubble eventually push down the price of higher education, as the mortgage crisis forced down the price of houses? 

I hesitated. The two situations have glaring differences. However, after a few days of contemplation, I am now convinced that this is the start of a revolution in higher education. It will probably take most of the next decade but we will finally see the growth in higher education costs slow down, and even reverse. Here's how it will work (roughly >.>)

First, the popping of the debt bubble will shake up the industry. Since a disproportionate amount of the problem debt is concentrated in private loan companies and for-profit institutions, those will suffer most first. Expect the weakest and most aggressive schools to fail.

Second, the government will act to relieve the pressure. Suppressing interest rates is all well and good (as a grad student, I still have to pay 6.8%, what a joke), but I think the government will attempt to implement the following:

1. A debt forgiveness program. This is simply the fastest way. Yes, those of us who paid our education debts will grumble, but the system can't function with so many unemployed educated young people stuck paying insane interest rates. [Maybe we should swap their student loans for mortgages and give them houses in distressed neighborhoods on the condition that they fix them up in 5 years... Homestead Act 2013... I digress, this is too unrealistic - even for me]
2. Regulation against "predatory lending". This will probably involve making interest rates and monthly payments very clear, based on an actual projection of how long it takes to finish a degree and so forth. Somewhat readable billing statements, huzzah!
3. Bailouts of respected institutions. I said this half jokingly, but I think it could happen. I'm fuzzy on how the responsibility for this would be split between state and federal governments. Essentially, I think the biggest, wealthiest public schools will be just fine, but those with unworthy football programs and small endowments will either go private or the government will fund them like they used to - back in the good old days.

Third, the feisty entrepreneurs of the world will really shake things up. The best of the for-profit schools will survive. They will thrive by designing programs that focus on training people to actually do jobs that real companies need people to do. They will leverage the wonders of modern technology to cut costs. Stanford may go on and on about how their online courses that are open to the public do not count towards any kind of accreditation but I see that slipping out of their control. Companies know best what skills they need and it will only take a minor cultural shift to decide to recognize participation in online certifications.

Here is where I really see the change occurring. I thought this society would never get over this idea that everyone had to go to college. In a world where college no longer guarantees a job, some people will do the math and decide to try something else. In a world where jobs go unfilled because no applicants have the necessary skills, companies will learn to encourage (and accept) applicants who demonstrate skills regardless of where they obtained them.

Ideally, we would see the traditional university continue to offer scholarships to bright, ambitious students from poor families along with governments' continued support of public universities. I can imagine a version of this revolution that is not regressive. That said, I think these changes will adversely affect poor (and middle class) students who desire a true college degree because the government will probably be slow to restore funding to the public universities that offer the best chance.

The bright side is that the chasm between a college degree and lack thereof will be bridged as a full array of education products fills the gap and continuing education plans become the norm. As much education as a student can handle, instead of as much as they can(not) afford.

Some helpful links:

Some background info

The criticism of for-profit schools

Is Higher Education A Giant Pyramid Scheme?

Stanford's Free Online Computer Science Courses

How (not) to deal with 401k loan defaults

Read the article "Loan defaults drain $37 billion from 401(k)s each year" on CNN Money. The last paragraph made me so angry I had to go read the study in its entirety. If you care here it is:

401(k) Loan Defaults: How Big Is the Leakage and What Can Policymakers Do to Preserve Americans' Nest Eggs? Robert Litan (Brookings Institution) and Hal Singer (Navigant Economics)

First of all, I have no complaints about the quality of the research done here. The facts themselves seem reasonable. My problem is with the policy suggestions. If these suggestions make it to Congress, I'll go back to writing letters to my representatives. That's a big deal; currently I only write letters when Wikipedia asks me to help save the internet.

Let's start with some assumptions that the study presents that I agree with (assume if it needs to be backed up with data, that the citation is in the study).

1. Many 401(k) borrowers have been denied other forms of credit and are using the 401(k) as a last resort
2. People have 60 days to repay the loan in full if they lose their job, or even just switch to a different job.
3. People are less likely to put money into a retirement account if they believe that the money will for inaccessible in the event of an emergency.

Here's what happens if a person defaults on his 401(k) loan.

1. He loses that portion of his retirement savings
2. He must pay income taxes on the loan amount
3. He must pay "penalties" (in some cases)

The story points out some proposed solutions that I summarize below. These ideas attempt to balance restricting using these funds for purposes other than retirement with preserving liquidity in the event of an emergency.

1. Limit borrowers to one loan at a time or limiting the size and scope of loans
2. Easing the repayment terms to reduce default.
3. Extending the time to pay back the loan in the event of job loss
4. Allowing a grace period if the person is currently collecting unemployment.
5. Making loans portable from one employer to the next.

Some of these seems quite reasonable to me (2-5, say), and the researchers claim to "largely agree". However, they also seem to think these proposals ignore the "welfare of the borrower". What this means is that none of these solutions help a borrower who has been forced to default on their 401(k) loan. They propose signing people up for loan insurance by default. They also point out that the policy administrators won't tinker with the average 401k plan on their own so policymakers need to come to the rescue.

"In particular, the law should be amended so that plans may choose to allow 401(k) borrowers to be automatically enrolled into insurance coverage unless they opt to decline such protection."

This is a horrible solution. The study points out that the average 401(k) loan borrower is 

• liquidity-contrained
• earning a lower income
• generally less wealthy
• less financially literate

So the answer to dealing with a poor, cash-tight, financially illiterate customer is to offer them an additional financial product? Actually, it's to offer them the right to refuse it, should they read all the paperwork and decide to do so. On top of this, lets charge them for this.

I understand why people need to be encouraged to keep their money in their retirement plans. But lets not forgot that this is, essentially, money that people have earned. They are borrowing from themselves. The primary beneficiaries of this policy change would be the insurance companies and that bothers me.

I confess that the actuarial math behind their proposal almost convinced me. I believe that insurance, in general, has a place in the overall solution. What I would like to see is a policy change that makes it easier to carry a loan from one employer to another and to allow for grace periods. Yes, people still forego the return on investment (what are they really making in the market anyway...), but at least this way we have made it as easy as possible for borrowers to repay themselves.

Along with this, I would like to see a stronger market for 401(k) loan insurance. I dread the idea of borrowing against my 401(k) (I'm considering it to buy a house) because it seems complicated and full of paperwork. If I can navigate this process, I can surely be presented with my options - including loan insurance. The problem, as the researchers point out, is that there is no incentive to create these policies such that they are affordable. There is no market. Then propose a solution that encourages a market without taking advantage of ignorance. That is something I would love to read.

Why the 99% should resent Zuckerberg's 1% mortgage

Don't know about Mark Zuckerberg's 1% mortgage on his seven million dollar home? You can read Bloomberg's article about it. Or start where I did with this blog post.

I like the blog post. It's well written, it uses sound financial logic, and it attempts to clarify that this is NOT a fixed rate. Zuckerberg has signed up for one of those fancy floating rate mortgages and it will probably work out for him. The bubble's burst, after all. I also completely respect his defense of the mortgage company. For the firm this was simply good business and I completely agree.

None of that changes that this is a pretty blatant example of the inequality problem our society faces today. I see three problems with Mark Zuckerberg getting a lower mortgage rate than lesser mortals.

1. Our financial system rewards the wealthy for nothing more than liquidity.

Liquidity is a very powerful thing. When I first graduated college and got a real job, I could get all kinds of things cheaper just because I could pay more (or pay in full) up front: cell phones, gym memberships, appliances, and cars - just to name a few off the top of my head. The concern is that this benefit scales - with most of the benefit accumulating at the top. Like all forms of leverage, what saved me hundreds of dollars will save a wealthier individual hundreds of thousands of dollars or more.

Related to this is the idea of risk tolerance. Sure, Mr. Zuckerberg holds the interest rate risk on this mortgage, so what? It's not like he couldn't just buy the house outright. Such liquid capital increases his risk capacity in a way that would be impossible for a poor person. He gets the benefit of an insanely low rate and the benefit of all that free cash and what does the average person get? The same opportunity, scaled down to his or her disposable income level. Good luck closing the gap with that math.

What is he doing with that free cash anyway? Starting a new business? Charity? Mr. Zuckerberg has a real PR problem if the best reason I could find was his resentment of Morgan Stanley.

"My investment bank botched my multibillion dollar IPO so I have to find time to shop for a new manager for my millions." #firstworldproblems #lifeishardfortheonepercent

2. The crisis + bailout that caused these record low rates becomes a problem when the wealthy fashion their own recovery while the lower classes wait for jobs.

I believe the bailout was a good option. I believe we would be in a worse position had our government done nothing. However, I resent being told that these record low interest rates will benefit the middle and lower classes while simultaneously watching the 1% benefit more. So what if I can finance a house at less than 4% - apparently the wealthy can finance for 1%. And with low interest rates practically guaranteed for as long as it takes the economy to recover I have a feeling Mr. Zuckerberg will do pretty well with his floating rate mortgage. And he'll have a pretty good idea when to consider refinancing because the Fed will all but call him up personally.

3. LIBOR? Hey, isn't that the rate the banks have been manipulating for years? How fair is this?

I am not enough of a conspiracy theorist to say that Mark Zuckerberg fixed LIBOR rates to secure a better mortgage rate. However, it is essential to the American Dream that the average person believes the system is fair. We could always conclude that there is no longer a ladder to the top and mercilessly raise taxes. Wall Street should be grateful that the European model looks so dysfunctional these days - it takes the pressure off. Lately, the financial news shows a surprising ignorance of how important it is to maintain the appearance of fair play. For example, I was more or less ok with the idea that Barclays fudged LIBOR rates to reduce the risk of a panic in the system. But then the Fed had to go and point out that they knew about this in 2007. This stinks and everyone should know it stinks.

I'm a horrible champion for the 99% (full disclosure: I think I'm in the 8%). I know enough about finance to leverage the money I have and invest it as well as I can. I take advantage of tax breaks I think are unfair. Hell, I sometimes even vote for them. I will not fault a wealthy man for a wise investment.  However, the average American should think long and hard about what it says about equality of opportunity in the financial system.