Student Loans: Bubble, Bubble, Toil & Trouble

I laughed pretty loudly when I opened an email from the university to my faculty account explaining how wonderful the increased retention numbers were looking!  Our new funding formula from extortionist governor Bobby Jindal depends on graduating and retaining students.  I guess they don’t have economists in that section of administration.  Just look at the unemployment rate for the typical student population  (16-24 year olds) and the decreasing labor force participation rate from August, 2011.  You’ll see exactly what’s going on.  Got no job?   Where do you go to find money and hopefully place yourself higher up on the meat market ladder if businesses ever go back to hiring?

The number of unemployed youth in July 2011 was 4.1 million, down from 4.4 million a year ago. The youth unemployment rate declined by 1.0 percentage point over the year to 18.1 percent in July 2011, after hitting a record high for July in 2010. Among major demographic groups, unemployment rates were lower than a year earlier for young men (18.3 percent) and Asians (15.3 percent), while jobless rates were little changed for young women (17.8 percent), whites (15.9 percent), blacks (31.0 percent), and Hispanics (20.1 percent).

So, we’ve got the biggest numbers of young people since the baby boom with parents whose employment situation is not great and whose assets and real incomes have taken a major hit over the last ten years.  We’ve got kids that can’t even find the usual kid jobs.  What are they going to do but go for those student loans and hang at university as long as possible? This brings me to the next big bubble phenomenon–Student Loans–plus the next GSE that’s going to be seeing default rates sky rocket.  That would be Sallie Mae.

Here’s the headline today: Unpaid student loans top $1 trillion.  That’s a lot of tuition, books and dorm rooms.

The $1 trillion of outstanding loans means that Americans now owe more on student loans than on their credit cards. While students have been racking up educational loans, American consumers have been paying down credit cards and home loans.

The average full-time undergraduate student borrowed $4,963 in 2010, up 63 percent from a decade earlier, even after adjusting for inflation, the report says.

Meanwhile, with a greater loan burden, the percentage of borrowers that defaulted on their student debts also rose – from 6.7 percent in 2007 to 8.8 percent in 2009.

That gives a lot of credence to the argument that the next big bubble will be in student loans. Here’s an investor’s view point from seeking alpha from back in July.  Should we all start hedge funds and short student loans?  Well, for one thing.  You can short sell for profit university’s stocks who thrive on churning loans and assume Sallie Mae will be a goner just like its buddies Fannie and Freddie. Dump their bonds and short them!

With the current state of the job market, many if not most of these unfortunate borrowers will not be able to pay off their debt with a lower than expected income. This trend is showing itself through increasing default rates of student loans. Three-year default rates have risen from 11.8% for loans issued in 2007 to 13.8% issued in 2008 (most recent data available). Meanwhile, the fundamental factors driving these defaults have not changed since.

Historically, investors have not worried about the default of these securities because of their explicit government guarantees through FFELP. In addition to this, student loans are the only debt that cannot be forgiven through bankruptcy. Student loan collectors have gone to the extent of garnishing wages and racking up penalties that can double the borrower’s debt in the name of “forgiveness” to maintain a return for bondholders.

This story sounds similar to housing: If the borrowers fail to pay, lenders seize the asset (house for a mortgage, garnished wages for student loans). The story will end the same way, as students lack the income to maintain their living expenses plus the debt or even just the interest payments if they are unemployed. The other option that students will begin to take more is moving abroad to avoid collectors. Financial distress will make it practical to exile oneself to avoid a lifetime of debt slavery. The combination of lower incomes for college grads and expatriation will increase the default rate to even high levels than current record rates.

So how do investors go about shorting the bubble in higher education? Ideally, the best way would be to buy credit default swaps on student loan asset-backed securities, which have a similar construction to the mortgage-backed securities that caused the last financial crisis. However, this strategy is not available to most readers. Average investors are better off short-selling the leading providers of student loans or for-profit universities, which have some of the highest default rates of student loans for any academic institution.

The leading student loan provider in the United States in the Sallie Mae corporation (SLM). It was launched as a government-sponsored enterprise (since privatized) similar to Freddie Mac and Fannie Mae; it currently services and manages $180.4 billion of government-backed student loan debt. It’s also begun to issue private student loans as well. With a debt to equity ratio of 36, Sallie Mae is already on the edge of insolvency. A small drop in collections can amount to significantly levered losses to the company. If the student loan default rate increases to 20%, Sallie Mae will most likely not be able to survive. The continuing upward trend of student loan defaults will lead to either insolvency of Sallie Mae or a government takeover — which will both wipe out shareholders.

Above the Law even asked if there was any one out there left that even believed that this wasn’t a disaster waiting to happen.  How’s this for harsh?

The problem is that our colleges and universities are charging a $100,000 to pump out the next generation of dog walkers. Sure, part of the fault lies with the people themselves; parents who let their 18-year-old children borrow a ton of money to go to an expensive private university to major in art history are no better than strung out crack mothers.

But the dean who sits there and says, “come study comparative literary criticism for the low, low price of $40,000 per year,” is the price-gouging drug dealer. These deans are pushing a product at a price point that they know is dangerous for most of their consumers.

This is what worries me.  This is also from Above the Law and it mentions just how married you and yours going to be to that student loan.  Not only that, but graduate students will have a much bigger balances to pay in the future thanks to an Obama sell-out on the deficit. Talk about setting people up for loan failure.  Why not just pump the least able to pay for more money?

In the total debt ceiling cave-in that will mark Barack Obama as the most successful Republican president since Ronald Reagan, there was one cut that really illustrates how little the president cares for his young, college-educated constituents. To save about $26.3 billion dollars, the debt ceiling deal eliminates the graduate student loan subsidy. That means that law students (and other grad students) will continue accruing interest on their non-dischargeable educational loans throughout their graduate studies.

I can see why they call education the “silver bullet,” because education certainly seems like a surefire way to kill one’s economic future….

The graduate loan cut wasn’t the most ridiculous so-called compromise Obama made while John Boehner was pumping him like Richie Aprile did to Janice Soprano. But it is illustrative of the extent to which Obama has abandoned the young people who helped elect him so that he can court… well, I don’t know exactly what universe he lives in where he thinks a black Republican running as a pro-war Democrat wins a general election

Meanwhile back on the Planet of  anecdotal evidence, we get these examples.    Ask me about Doctor Daughter’s student loan debt or mine, for that matter.  I got two degrees in the late 70’s and early 80s by working and that was it.  I just couldn’t swing it this time.  I now have student loan debt that would’ve bought me a Mercedes and I’m jobless and on the jobfree labor market.  Sallie Mae’s like a loan shark too.  They’re worse to deal with than the bookies in my neighborhood.

“I have ~$75k in student loans. I will default soon. My cosigner, my father, will be forced to take my loans. He will default as well. I’ve ruined my family because I tried to rise above my class,” writes one testimonial on the 99 percent website on Wednesday.

The 99 percent website is one of the places where the Occupy Wall Street movement first got its inspiration from.

“I am a young medical professional who BARELY makes it paycheck-to-paycheck because I have OVER $200,000.00 in student loan debt,” says another testimonial on the website Tuesday. “I pay almost $1,000 a month just in student loan repayment. I will have to do so for the next 30-years. How will I ever afford to buy a house, have children, or save for the future?”