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A Developing Financial Bubble And What We Can Learn from Real Estate

In the advent of the worst financial crisis seen in decades, there is much to be learned. Many economists agree that creating false demand will eventually create a bubble and crush a market much faster than the natural economic cycle. Take for instance the student loan market. Student loans, subsidized and unsubsidized, allow an 18 year old to finance some or all of the next four years of his or her life including living expenses. Morally, is it right to allow our children to start their lives immersed in debt?

In 1992, Congress increased the amount of money a student can borrow from the federal loan program with the Reauthorization of Higher Education Act. The act also enabled students defined as "in need" easier access to funding. Now we see student loans dominating the higher education industry accounting for 50% of all financial aid packages. According to, the average range of tuition inflation is normally 8% annually and prices have not fallen or stabilized once since 1977 regardless of economic climate. In 2004, the Census Bureau released a report saying private university and college tuition are "up 93 percent from 1990." This symptom may be attributed to cheap and accessible money and yet is becoming an issue now because tuition is still rising but wages have been flat for a decade.

The Department of Education reports having a $63.7 billion budget in appropriations for 2010 and it has also received $96.8 billion from the American Recovery and Reinvestment Act of 2009. From the department's website, "Department programs also provide grant, loan, and work-study assistance to more than 14 million post-secondary students." That is roughly 4 million short of every college student in the country. Does this mean that only 22% of students in the U.S. have adequate means of paying for college? Based on America's economic model this statistic should theoretically be impossible. This means that over three-quarters of Americans attending higher-education institutions are "in need."

There are benefits to the industry being able to increase prices. Colleges and universities need to be competitive. New revenue means that a college or university can afford better professors and improve infrastructure. It can create new dorms for incoming students and build new facilities to allow better access to labs and campus centers. The overall quality of a school and educational services it offers will increase. Loans and grants are not necessarily a bad thing but when the amount of money flooding the industry drives up the demand to the point of the former becoming a market essential, there is an influx of risk. Similarly, health care has also enjoyed the fruits of easy money because of the insurance industry. The added funding for research and development has aided advances in medication and technology. But third party funding usually drives prices up because consumer decision is weakened in the economic equation. Now health care is becoming somewhat unaffordable to the independent purchaser.

In most cases student aid is an immeasurable liability. The individual's risk at 18 years old cannot be accurately quantified even with a cosigner. Realistically, no private institution would lend this kind of capital to such a young demographic without credit history. It also should be noted that reports have shown average college students to carry 4 credit cards and carry an average balance of $3,000 that they cannot pay off in full. This is a small sum compared to the amount they will inherit after a four-year tenure but it shows that credit is being handed out indiscriminately. A massive amount of speculation is being placed on the payee with no indication of them being able to afford repayment.

A boost in educational funding for financing, aside from the intention, may come at a price. If the current trend continues students will increase the amount financed where they will be paying for the majority of their education in loans. In the January 14 edition of The Economist, "Only about 400,000 more Americans were employed in December 2009 than in December 1999, while the population grew by nearly 30m." With an unemployment rate of 10% (real figures are closer to 17%) matters look only more ominous. Millions of students will be graduating with the same popular majors and competing for fewer jobs because a significant amount manufacturing and industry has left the United States. The supply of students entering the job market will be endless and businesses will lower the base pay of new employees because of their abundance. The other scenario is that businesses do not hire them at all because they are fully staffed, creating a bottleneck in the job market. Unemployment, Social Security and Medicare will all suffer from the supply and demand effects of this type of crisis.

State and City universities will not be able to handle every student but they may remain the most inexpensive way of obtaining a diploma. City University of New York has reported a 77.5% increase in transfer students in the last year and is a sign of education becoming unaffordable. Without major state funding or tuition increases CUNY's infrastructure will not be able to handle the capacity of incoming students.

It is difficult to come to a reasonable assessment on how to address an impending student loan crisis. Candidates running on a platform of limiting financial aid or reducing the Department of Education will be writing a political death sentence for themselves. The recent Affordable Health Care for America Act will end subsidies for student aid to private lenders. This will make it easier for students to shop for a loan by going directly to the source but will only address who controls the market and has no effect on the economics of tuition cost. Payments will have a threshold of 10% of a graduate’s disposable income and will be forgiven after 20 years while a public servant will be forgiven after ten. The risk associated with loan obligations are shifted to the taxpayer. Consequently, the Health Care Bill removes obligation and creates a moral hazard with the creation of a virtual backstop. With the combination of this backstop and decreasing wages because of an over-supply of workers, the result can only perpetuate default. This bursting bubble will be massive and will affect other major industries such as housing, auto and credit.

Because of the ease of obtaining these types of loans and leniency in repayment terms the post-secondary education industry may possibly raise tuition at a faster rate. There lies no risk for a college or university. As long as prices are met schools can charge whatever the market is willing to pay. Keeping up with the rising costs will be difficult to do because public funding will have to increase exponentially relative to tuition.

Posted Apr 13 2010, 07:50 PM by bdonleavy