The Independent Market Observer

10/23/12 – The Next Crisis: Student Debt and the Future of Higher Education

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Oct 23, 2012 4:10:02 AM

and tagged Debt Crisis, Yesterday's News

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The market is a beautiful thing. Money flows to what people want, and the end result is that the optimal balance of desires and available resources is obtained with minimal guidance and intervention.


The problem comes when the “available” resources are expanded beyond what is really available. Imagine a scenario where something everyone wants, something fundamental to an American’s perception of a good life, is available at a subsidized price. Debt is available freely, over long terms, in a way that does not have to be paid back immediately. Moreover, the value of the asset that is being bought is beyond question—in fact, is a prerequisite to a good life!

You might think that I am talking about housing (and you would be right), but that was the last crisis. I am talking about a college education and the next crisis: student debt. I have mentioned this growing concern before, but a couple of headlines made me think it warranted another look.

First, take a look at this graph of different forms of consumer credit.

For the past five years, every form of consumer debt has decreased as borrowers have paid off loans and saved more. Except student loans, which are up by almost 80 percent.

What is driving this? Is the number of students up by 80 percent? No, the number of students has only increased by about 12 percent. The driver is the amount of debt per student, as shown in the following chart.

Average debt per enrolled student has gone from about $29,000 in 2007 to almost $44,000 in 2011, an increase of 50 percent. Why so much?

Although student numbers are up, college tuitions are up much more—well above the level of general price inflation. This increase has been driven by competition. Declining student numbers during the baby bust and college-rating surveys that scored partially on amenities led to a building and amenity boom, with schools trying to attract more students from a smaller pool. In a real market, rising costs from these improvements would have rapidly led to a decline in potential students, as fewer could afford the higher tuition.

Education is a not a real market, though. Loans are provided on a deferred basis to borrowers—college students—who think they have nothing but blue skies ahead. Students are therefore price-insensitive to tuition increases and pay what the colleges demand. To me, it sounds a lot like the subprime mortgage boom.

There is a good article on page A3 of the weekend Wall Street Journal (WSJ), “Teaching the ABCs of College Costs,” that deals with this. College costs have gone up by almost 140 percent in the past 20 years, and the typical graduate has $22,000 of student debt. Default rates are at 14-year highs. Many schools are trying to educate students on how to manage their costs. For many, it may be too late.

Just as the housing boom was based on the assumption that values would keep increasing, the student loan boom is predicated on the ability of graduating students to find jobs that allow them to pay back their debt. In a struggling economy, that assumption may not be well founded. Until the economy improves, the debt that was so blithely assumed by students may become a much bigger headache for everyone.

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