The next crash

It is inevitable that the college loan bubble will burst as a result of government intervention in the education market.  How has this happened and why do these bubbles continue to recur time after time after time?   The how of this question is quite simple.  Any time the government intervenes in any market, distortions and abnormalities leading to booms and busts occur because normal free market pricing/cost incentives do not apply.  During the 1920's as the FRS engaged in major credit creation to stimulate foreign trade and help the Brits solve their currency valuation problem in the aftermath of WWI,   excessive investments were made by businesses simply because they could, not because they made economic sense.  Pricing signals were ignored, malinvestments occurred, a major boom led to the disastrous bust of the stock market followed by the severe economic depression of the 1930's.  All this happened because the FRS artificially allowed for the expansion of credit unrelated to the real demand in the economy.

"At this juncture . . . the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained" - Ben Bernanke, March 28, 2007

"I don’t think student loans are a financial stability issue to the same extent that, say, mortgage debt was in the last crisis because most of it is held not by financial institutions but by the federal government" - Ben Bernanke,August 7, 2012

Please mark your calendars accordingly as yesterday the Chairman just guaranteed that student loans will be cause for the next "financial stability issue."

Here are the facts, courtesy of a just released expose on the WSJ:

• Rising college costs and a sagging economy are taking the biggest toll on a surprising group: upper-middle-income families.
• According to a Wall Street Journal analysis of recently released Federal Reserve data, households with annual incomes of $94,535 to $205,335 saw the biggest jump in the percentage with student-loan debt from 2007 to 2010, the latest figures available. That group also saw a sharp climb in the amount of debt owed on average.
• Ms. Hofmeister, an insurance broker and financial planner, says she and her husband, an operations manager, combined earn a six-figure income that puts them in the upper-middle class and were surprised by the amount they will have to borrow. She says she feels trapped in financial purgatory, between "people with lower incomes who have a lot of subsidy, and the truly affluent, for whom this isn't a problem."
• The Journal's analysis defined upper-middle-income households as those with annual incomes between the 80th and 95th percentiles of all households nationwide. Among this group, 25.6% had student-loan debt in 2010, up from 19.5% in 2007. For all households, the portion with student loan debt rose to 19.1% in 2010 from 15.2% in 2007.
• The amount borrowed by upper-middle-income families, meanwhile, has soared. They owed an average of $32,869 in college loans in 2010, up from $26,639 in 2007, after adjusting for inflation, according to the Journal's analysis.
• The typical low-income family receives grants and scholarships totaling 36% of the cost, the lender says, while for higher-income families such packages total 21%.
• More than three million households now owe at least $50,000 in student loans, up from about 794,000 in 2001 and fewer than 300,000 in 1989, after adjusting for inflation.
• Some families are turning to loans because they spent heavily or used extra cash to save for retirement. More than one-third of parents with incomes of $95,000 to $125,000 with a child who entered college in 2011 didn't save or invest for that child's education, according to a survey by education consultants Human Capital Research.
• With their finances strained, some higher-earning parents are making their children pick up more of the tab. Among families earning $100,000 or more, students paid 23% of their college costs in 2012 through loans, income and savings, according to Sallie Mae, up from 14% in 2009; the share covered by parents fell to 52% from 61%.

And last but not least, those ever-altruistic baby boomers:

"The boomers are the first generation shifting the cost of college to their kids," both through increased student borrowing and reduced taxpayer support for higher education, says Susan Dynarski, a professor of education and public policy at the University of Michigan.

Because leaving them with $16 trillion in public debt is not enough.

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Here is the issue in a nutshell: college tuition, just like government spending, is off the charts. Both are so high, that on an unlevered basis, the payback rate is N/M. Note the use of the world "unlevered" as it is one which will never occur, before the next systemic reset, when talking about anything involving the government. And what leverage does is mask true supply and demand. If college tuition was representative of real supply and demand, prices would be tumbling on average. Instead the easy access to student debt makes college seem quite affordable at any price point and thus there is no pressure to lower the equilibrium price. Which explains this chart, where the government-funded student debt surge is merely there to fill the needs of all those kids going to college, all of whom will never be able to pay it off especially as America increasingly transitions to a part-time worker society.

But at least they too, like their parents and grandparents, are indentured debt servants, just like the government wants.

And to the perpetually wrong Bernanke, the thinking is that if more people are on the same wavelength as the US Treasury, i.e., so deeply in debt that everyone will be begging for a dollar devaluation and/or debt hyperinflation, then the Fed will be not only able, but encouraged to debase the US currency at will.

Sadly, Bernanke is and always has been wrong, and when the student loan bubble does pop, and it will, the cost will once again fall squarely on the shoulders of that one nearly extinct species: America's middle class, which not only generates positive cash flow, but, gasp, saves a little money here and there.

Make no mistake: they are squarely in Bernanke's bulls eye, and are slated for extermination at all costs. In a world in which everyone is broke and defecting from every game theory equilibrium possible, those who still play by the rules are the system's mortal enemies.

In the meantime, we can't wait for Obama's next brilliant contraption: cash for flunkers.