March 6, 2013
DANIEL LUZER SAYS THAT HIGHER EDUCATION IS NOT A BUBBLE. But what he really seems to be saying is that it’s not as bad as the housing bubble.
That may be true, but that doesn’t mean that it isn’t bad. Note this from the Financial Times:
In basic economics, a bubble occurs when the value of an asset exceeds the level determined by economic fundamentals. The fundamental value is typically measured by the discounted stream of expected future cash flows. For equities, this is a function of the fundamental value of the stock market, which analysts use different measures to gauge. And for housing, the fundamental value is a function of the potential return of renting the property. We therefore look at the ratio of home prices to rent as a gauge of fair valuation. In the case of tuition, fundamental value can be defined by future earnings, and hence income. . . .
A basic rule of thumb, as advised by FinAid, is that total education debt should be less than half of expected starting salary upon graduation. The median salary for 25-34 year olds with a bachelor’s degree is $45,000, and $54,700 for a master’s degree and the average debt upon graduation upon is about $25,000 for undergraduate and $35,000 for a Master’s degree (the latter is based on estimates from FinAid). This suggests the debt burden is too high – in both cases, it is more than half of the starting salary.
And for many, it’s much, much worse than that. Also, focusing on the amount of student loan debt being traded, which is what Luzer does in concluding that it’s not a big problem misses the point. As the Financial Times piece notes:
It’s unlikely that, say, German Landesbanks or Norwegian pension funds will surface as major holders of student loans — we don’t expect flashbacks to funky structure subprime revelations. And why is that? Because the US government is holding a hell of a lot of it — something in the region of 85 per cent of student loans outstanding were either issued by the government or have a government guarantee.
That’s not to say that the potential for inaccurate pricing of the risk, especially given the cultural aspects of education, isn’t there. It very much is.
Who’s making simplistic comparisons to the housing bubble, again? Also, the consequences of higher education debt being too high play out in a lot of different, but destructive, ways. First, they make the housing bubble worse, as people leave college or graduate school with the kind of debt they used to not take on until they bought their first (or second) home. The student loan debt makes it harder for them to buy a house at all, thus limiting a major source of new demand.
Another impact is that student loan debt causes people to delay marriage and have fewer children, which not only (again) reduces housing demand, but has a long-term negative effect on economic growth. Not only does it exacerbate the “baby bust” in general, but it makes the baby bust worse among the most educated, which can’t be good for society, unless your goal is something like Idiocracy. This seems like a bad idea.
Meanwhile, if you’re thinking about borrowing money to attend college, check out these charts.
UPDATE: Reader Aaron Chmielewski writes: “Looking at gross income isn’t quite good enough either, what we should be looking at is also cost of living. Many of those jobs are in expensive areas. What really matters is the person’s ability to save. What is their debt relative to discretionary, disposable income (income after taxes and basic living expenses and financial obligations)? What is their financing expense relative to discretionary, disposable income?” Good point.