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Easy Money Bubble

Written by Geoffrey Pike
Posted June 5, 2015

Student loans are truly a double-edged sword. They are somewhat analogous to mortgages in that they can be really beneficial for some and quite devastating for those who aren’t careful.

There is one big difference between a student loan in the United States and a mortgage. With a student loan, if you get in over your head, you can’t easily walk away from it. If you don’t die or move to another country forever, then you are basically stuck paying it in most cases, even if it means having a job and staying broke.

Student loans can be a great investment for some. Think of a heart surgeon who took out a $100,000 loan to get through medical school. If the heart surgeon is now making $400,000 per year, then the student loan does not seem too bad and can easily be paid off.

Then there are the horror stories of people who take out student loans for $100,000 and then end up waiting tables for a living and making $15 per hour. These people would have been better off skipping college. Instead, they end up in student loan prison, never able to get ahead.

Even some college graduates with jobs related to their degrees find it difficult to make ends meet because of the burden of their student loan payments.

Just as it is with taking out a mortgage you can’t afford, each individual does have a responsibility for the financial decision of taking out a big student loan. But it is hard not to have some sympathy for 17- or 18-year-old kids making this decision, even if it wasn’t well thought out at the time.

Just like taking out a mortgage, it is not hard to look at government and central bank policy as a major part of the problem in encouraging reckless behavior.

Student Loan Deception

Recently, the Department of Justice reached a $60 million settlement with Navient Corporation, a student loan servicer. Approximately 78,000 military members will get a share of this settlement money from being overcharged on their student loans.

Some military members will receive refund checks for as little as $10, but a few checks could go as high as $100,000. It is reported that the average check will be $771, to be mailed out on June 12.

Navient is paying out this settlement after being accused of overcharging military members on their student loan payments. Under the Servicemember Civil Relief Act (SCRA), military members are subject to a 6% cap on their loans.

Navient representatives are claiming it was a documentation issue because military members must provide a written request and a copy of orders calling them to active duty in order to qualify for the cap under the SCRA statute.

Of course, it does not appear Navient was going out of its way to remind these people or to help them in any way in collecting the appropriate documentation.

Meanwhile, because of this case, the Department of Education is supposedly streamlining its process for getting active-duty military members easier access to the lower interest rates. The Department of Education is working with the Department of Defense to identify those who would qualify for the program.

In other words, bureaucrats are working to reduce the bureaucracy.

While Navient is a publicly traded company, it should be noted that it was formerly a part of Sallie Mae, one of the government-sponsored enterprises.

And this leads us to the next point, which is that it isn’t just military members who are being deceived when it comes to student loan debt. And it isn’t just companies doing the deceiving.

Government Incentives

According to the latest CPI numbers, consumer price inflation is less than 2%. This may be true for some consumer products, but it does not seem to hold anywhere close to true for those areas with heavy government intervention.

The obvious example these days is health insurance. Premiums are going up 20% annually or more in many cases for plans that cover less. But along with health insurance, we have to consider the case of a college education, which also is obviously going up at a pace well above 2%.

In the early 2000s, the government and the Fed blew up a gigantic housing bubble. With government incentives including low lending standards, along with a policy of easy money and low interest rates from the Fed, people were encouraged to take on mortgages even if they couldn’t afford them.

But things are not much different in the realm of college education. The government has massively subsidized the student loan business. The Fed has also helped accommodate with the easy money and low interest rates. This has led to far more people taking on student loan debt who otherwise wouldn’t have.

This not only burdens people with future debt, but it exacerbates the problem by continually driving up college tuitions. When there is easy money, it is easier for colleges to raise prices well above the price inflation rate, and even higher as compared to average wages.

So the government and the central bank do not just give us housing bubbles and stock market bubbles. They also give us college bubbles. It is estimated that student loan debt in the United States is now $1.2 trillion.

This might be acceptable in a strong economy with strong wage growth, but wages across the board have been mostly flat when taking inflation into account.

Don’t Get Sucked in by Government "Incentives"

It is difficult not to get lured in by government incentives. When there is cheap money available, it is hard to turn it down in many cases. This is especially true when the media, and society in general, tells you that you need to go to college to be successful in life.

But this really isn’t true in today’s world. There are a lot of success stories of people without college degrees who find a great niche or start a successful business. And for those going to college, there are ways to reduce costs by taking CLEP exams, getting college credits in high school, going to a community college to start out, getting in-state tuition, getting scholarships, and finding less expensive schools.

For anyone who is planning on going to college, you don’t have to take on a massive amount of debt that will burden you for a long time.

The worst argument I have heard for taking on big student loans is that we will have high inflation in the future so you can just take on debt now and pay it back later in depreciated money. This is a sure way to get into trouble.

While high price inflation in the future is certainly a possibility, we typically go through periods of booms and busts. There will be times of high price inflation and times where prices are relatively flat. If all we had were inflationary times without any accompanying recessions, then perhaps that would be a good rationale, but that isn’t the world we live in.

In order to get wealthy, you have to collect interest, not pay it out. There is a time and place for debt, but it must be used carefully. If you are going to take on debt, then it should be done knowing that you will have the ability to pay it back without it being overly burdensome on your financial life.

We are still in a low interest rate environment, even with big monetary inflation over the last seven years and a national debt that continues to grow. At some point, interest rates will go significantly higher. It may be in five months or five years, but we know they cannot stay this low forever.

Just as the mortgage bubble started to pop around 2007, the student loan bubble is going to pop at some point. It is going to be painful for a lot of young people and even some not-so-young people, if it isn’t already.

As technology improves and more schools start to compete online, it will start putting some pressure on the traditional college model. When interest rates finally rise and student loans are more evidently unaffordable, we may finally see college prices drop to more reasonable levels. That is why they call it a correction.

Until next time,

Geoffrey Pike for Wealth Daily

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