Government Bailout 2.0

piggy-bank w grad capAt HMC Partners, we are always forward looking in regards to portfolio management and the economy’s behavior. We focus equally on growth opportunities but also potential roadblocks to economic growth, and the effects that both may have on your financial future. While we are still positive in our 2014 outlook, one potential roadblock we see in the next 5-10 years is the current student loan debt in America. Over the past decade, universities have steadily increased their tuition costs. While previous generations spent their 20’s and 30’s in the accumulation phase of life buying homes, new cars, and starting families and thus contributing to economic growth, today’s graduates face a different post-grad life. These new graduates are entering a job market with little promise of immediate employment and they soon find themselves unable to pay off their outstanding loans. Instead of putting money into the economy through buying “things,” their first years in the workforce are spent paying off debt.

As a potential fix to eliminate or reduce the debt burden on graduates, the Obama Administration is proposing a program called “Pay As You Earn.” Pay As You Earn will forgive any outstanding loans if graduates work for the government or a non-profit company for 10 years.1 The loan will then be forgiven and universities would be reimbursed by the government.

In many ways, this seems very similar to the subprime mortgage lending practice of big banks leading up to the 2008 Recession. Banks lent money to homeowners with bad credit who bought houses they couldn't truly afford. When interest rates went up, homeowners defaulted on their mortgages and couldn't pay the banks. In order to avoid financial collapse, the government paid $770 billion to bail out the banks and keep our economy afloat. We are now six years removed from the 2008 recession and some big banks are slowly getting back into the subprime mortgage lending practice.

The average annual tuition increase at colleges has been 6% a year. Since 2005, average tuition costs have increased 35%.3 That has surged the total outstanding student loan debt in this country to $1.3 trillion. That’s nearly double the 2008 bailout of $770 billion. Undergraduate students are graduating with an average of $40,000 in debt, while students with Master’s Degrees and higher level education are entering the work force with $100,000+ in debt.

What’s behind this consistent increase in tuition? Universities realize there is an ever increasing demand for a college degree and that brick and mortar schools are still the primary means of achieving that degree. Universities are starting to apply the same business practices of big banks to higher education. While some may argue that a college degree isn't vital to a high paying job, the data says otherwise. “Higher levels of educational attainment are associated with higher earnings. In 2009, adults with professional degrees earned more than any other education level, with mean monthly earnings of $11,900 for full-time workers. On average, adults with a master’s degree earned $6,700 per month and those with a bachelor’s degree earned $5,400 per month. Adults with an associate’s degree earned $4,200 per month on average while those with some college but no degree earned $3,600 monthly.2" Bottom line: education remains vitally important to future economic growth.

So what are the benefits to this increased tuition? Are students actually receiving a higher quality of education or improved quality of life? Some would argue: why not increase costs? Either students will pay off their loans or the government will. It makes sense they would keep raising tuition if they knew they were going to get paid anyways. If you could make the same product, charge more for it, and still see an increase in demand, wouldn't you?

It remains to be seen how this will play out over the next 5-10 years. While there is no immediate concern or call to action, it is a potential roadblock to economic growth that we are keeping a careful eye on. While there is no immediate solution, there is enough awareness of the issue that should help prevent another 2008-style setback.

(1) “Telling Students to Earn Less.” April 24, 2014. The Wall Street Journal. http://online.wsj.com/news/articles/SB10001424052702304279904579517934206301354?mod=trending_now_2 ) (2) “What It’s worth: field training and economic status in 2009.” Current Populations Reports. Stephanie Ewert. Census.gov. http://www.census.gov/prod/2012pubs/p70-129.pdf (3) “Congratulations to Class of 2014, Most indebted ever.” Phil Izzo. May 16, 2014. The Wall Street Journal. http://blogs.wsj.com/numbersguy/congatulations-to-class-of-2014-the-most-indebted-ever-1368/?mod=WSJ_hps_MIDDLE_Video_second )

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.