Fishbein popping the higher education bubble; how to navigate the impending student loan crisis (2014)

What causes a bubble?In the case of a financial bubble, estimates of intrinsic value can increase as a result of increasedexpectations of future price, overestimating intrinsic value, or

Popping the Higher Education Bubble How to Navigate the Impending Student Loan

Table of Contents

Introduction…4

1 Definition of an Economic Bubble 7

2 Current State of the United States Economy 14

3 Is Higher Education a Bubble? 20

4 Comparing Higher Education and Student Loans to

Housing and Mortgages 22

5 Harmful Effects of The Higher Education Bubble 35

6 Causes of the Higher Education Bubble 40

7 What Will Cause the Higher Education Bubble to Pop? 48

8 Potential Effects of a Higher Education or Student Loan Collapse 59

9 How to Profit From The Higher Education Bubble 70

10 Problems Facing the Higher Education Industry 76

11 Potential Solutions to The Higher Education Bubble 85

12 Why Corporations Should Open Schools 94

13 How Not to Solve The Problems 105

14 What Prospective Students and

Graduates Can Do to Prosper in the “New Economy” 107

15 The Future of Higher Education 121

Conclusion 127

I fear that America be facing a bubble relating to the price of higher education It has many

similarities to the housing bubble and proceeding collapse in 2008 Cheap credit, coupled with

widespread beliefs of ever-increasing returns on investment, have caused college tuition to vastlyoutpace inflation and family incomes From 1976 to 2010, commodities prices rose 280% and houseprices rose 400%, while private education rose an incredible 1000%

While the price of education has skyrocketed, the value of a degree has not kept pace The increase insupply of degree holders has created an imbalance in the labor market In 1940, only one in 20

Americans held a college degree By 1977, that number had soared to one in four

Over the past 30 years, higher education has gone from facilitating upward mobility to exacerbatinginequality For the first time in history, the majority of unemployed Americans attended college, andit’s more expensive than ever to go attend college

Student debt is now greater than $1 trillion; many graduates are unable to secure employment

sufficient to replay their student loans

This book covers causes of the higher education bubble, the harmful effects it's had on students andthe economy, potential solutions, and more

About the Author

It’s May of 2009, the peak of the recession caused by the housing bubble The stock market hit recordlows, home prices plummeted, and hiring was limited

The class of 2009, and the years closely surrounding it, faced mounding student debt and a difficultlabor market College was “what you do” after high school - it was one of the best investments tomake Having a degree would help graduates stand out from the pack to get the job of their dreams

Many of my fellow graduates soon realized that their degree from a mid-tier school, may be actuallylimiting their upward mobility than contributing to it Some degrees actually made me implicitly

ineligible for certain employment opportunities It didn’t matter how capable I was of excelling at agiven role, I was instantly removed from the stacks of resumes, without even a chance to interview

I applied to hundreds, if not thousands of jobs in the Summer of 2009 Because the economy was sostagnant, and because so many other people with degrees, many from schools more prestigious thanmine, were competing for the same positions, it was nearly impossible to get a job Most of my peerswere having the same trouble Many were “underemployed,” working less hours than they desired orworking a job that they were overqualified for, such as waiting tables

It was around this time that I began realizing the many problems with higher education, the labor

market, and the economy I’ve been studying the problems and trends ever since

I wrote this book to summarize all my research and learning and share it with others to create moreawareness for the problems

In 2014 I started an education company called Startup College (stpcollege.com) It’s doing it’s smallpart to solve one of the many problems with education I’ve written and self-published four otherbooks: “How to Build an Awesome Professional Network”, “Customer Development for

Entrepreneurs”, “Growth Hacking with Content Marketing”, and “Do More Better Faster & Happier”

My writing has been featured in Huffington Post, Entrepreneur.com, Lifehack.org, and more You canlearn more about me and connect with me by visiting my personal blog at http://mfishbein.com/ and

on Twitter at https://twitter.com/mfishbein

1 Definition of an Economic Bubble

This section defines economic bubbles in broad terms and give examples outside of higher education.Later in the book you, will see how this information applies to higher education

What is a Bubble?

A bubble is a period in which the price of an asset is inflated far beyond the intrinsic value of theasset Price is equal to the collective market’s estimates of intrinsic value Intrinsic value is equal tothe net present value of future cash flow Cash flow comes in the form of profits, dividends, costsavings, and/or sale Prices increase as estimates of intrinsic values increase

What causes a bubble?

In the case of a financial bubble, estimates of intrinsic value can increase as a result of increasedexpectations of future price, overestimating intrinsic value, or market interferences that alter one’sevaluation process or opportunity cost, or change in belief about the consequences of one’s actions.Here are illustrations of each of these:

If an investor expects the price of a given stock to rise, the investor may purchase the stock to earn areturn If the investor buys simply because others are buying and expects to to be able to sell at ahigher price in the future, regardless of the asset’s intrinsic value, prices can rise beyond intrinsicvalue Once investors realize that price and value are out of sync, they stop buying and prices fall (thebubble bursts)

If an investor overestimates the intrinsic value of an asset, the investor may be willing to pay a pricethat matches it’s estimate of intrinsic value (above actual intrinsic value) The intrinsic value of anasset is equal to the present value of future cash flows from the asset Cash flows come in the form ofprofits or dividends, or selling the asset For example, during the “dot com bubble,” many investorsbelieved technology companies would generate cash flow in the future, despite in some cases notgenerating revenue When companies did not become profitable, estimates of intrinsic value

decreased, as did price

If price is manipulated by forces other than market forces, it can become detached from intrinsicvalue, as the purchasing decision less dependent on intrinsic value For example, lowering interestrates Interest rates can be understood as the price of money When rates are at nothing, market

players may chase risk to avoid capital erosion When money is cheap, many risky investments

become more favorable than they would be otherwise

Lower interest rates caused by market forces indicates increased savings, likely indicating pent updemand This would be a signal to a producer (i.e entrepreneur), to produce because it’s less

expensive to borrow and because there is unmet demand If the low rates were not correlated to

excess demand, the entrepreneur would lose money

A person's belief that they are responsible for the consequences of their own actions is an essentialaspect of rational behavior If one believes that he/she will lose money from making a bad

investment, he/she will not make that investment If one does not believe that he will lose money frommaking a bad investment, he/she may still make that bad investment For example, if a hedge fundbelieved that if an asset would be supported by the government to certain prices, or that the hedgefund itself would receive government funding if it’s investments did not perform well, it could take onmore risk

What are the signs of a bubble?

It’s hard to tell if the price is inflated beyond intrinsic value because it’s often difficult to evaluateintrinsic values Bubbles are often identified only in retrospect, when a sudden drop in prices

appears Signs of a bubble can be more qualitatively measured than quantitatively

When there is a near widespread belief, it can be a sign of a bubble For example, if every marketinvestor believed a given stock was worth more than it’s current price, every market investor wouldbuy Once the buying occurs, there would be virtually no one left to act on that belief and continue tocarry that trend any further in the same direction

Indications that a widespread belief is held, especially as it pertains to an investment opportunity,would include people with little experience evaluating investment opportunities recommending theinvestment

If you ask most people if they think a college degree is a good investment, they will give you a strong

“yes.” If you tell people not to go to college, or that it’s a bad investment, many will look at you likeyou just told a five year old that there’s no Santa Claus

What causes a bubble to burst?

A bubble bursts when the collective market’s estimate of the asset's intrinsic value falls below theprice At which point, investors would begin selling the asset because if they don’t expect the price orintrinsic value to increase beyond it’s current price, it would not be a good investment holding

Estimates of intrinsic value can change for a number of reasons

In the example of the "dot com bubble," investors overestimated the future cash flows of technologycompanies, some of which were not even generating revenue Once investors' estimates of intrinsicvalue decreased, stocks were sold to match price to value In the example of higher education, peopleare finally realizing that their earnings potential won't increase enough to warrant the investment atcurrent prices In the example of the tulip bubble, ("tulip mania") people stopped believing that

people would continue to buy tulips at higher and higher prices, so estimates of intrinsic value

decreased, and so did price

What are the effects of a bubble?

Price bubbles and the corresponding drops in prices can cause many problems

During Bubble

a Excess Demand

During a bubble there is usually an exuberance over the continually rising price The continuallyrising prices can have the effect of making people think that prices will continue to increase This cancause people to over-allocate capital to certain assets and under-allocate capital to alternative

investments which might help the economy For example, instead of investing in a college degree, onemight invest in a business which would create jobs

Market participants with overvalued assets tend to spend more because they "feel" richer For

example, someone who owns a house that’s being priced higher, would perceive their total assetvalue to be high With a higher asset value, one might spend more on discretionary goods If theprice of the house then decreases, the homeowner may have overspent and may experience a

deteriorating financial condition

After Collapse

a Failing Companies

Once the price decreases, an industry contraction or consolidation has to occur to alleviate the excesssupply Companies that had forecasted prices to be higher when making the decision to invest in

production, may not have made the same decision during current market conditions At lower prices,the business may no longer be profitable and would therefore fail

b Decreased Spending

The crash which follows an economic bubble can destroy a large amount of wealth and cause

continuing economic malaise When the bubble inevitably bursts, those who hold on to these

overvalued assets usually experience a feeling of reduced wealth and tend to cut discretionary

spending at the same time, hindering economic growth or, worse, exacerbating the economic

slowdown

c Taxpayer Risk

The government may decide that prices shouldn’t decrease further and that it should intervene Onestrategy might be to begin spending more taxpayer dollars on the risky assets During the housingbubble, the government used Fannie Mae and Freddie Mac to transfer mortgage risk from privatebanks to taxpayers With the support of the government, mortgage lenders didn't have to care about theriskiness of the loans they made The risk was in part passed on to taxpayers

2 Current State of the United States Economy

The housing bubble caused one of the biggest recessions in US history Credit markets froze and theFederal Reserve instituted “quantitative easing” with the intent of fixing it

Quantitative Easing

What is Quantitative Easing?

During the financial crisis of 2008 caused by the collapse of the housing bubble, The Federal Reserve(Fed) and it’s Chairman Ben Bernanke began purchasing assets such as mortgage backed securitiesand treasury bonds from banks To purchases the assets, the Fed added dollars to the monetary supply essentially, “printing money.” It was intended to help by ensuring that banks have sufficient

reserves, and to encourage them to lend money to stimulate the economy There is much philosophicaland economic debate around the use of quantitative easing

Why Did the Fed Do It?

Quantitative Easing (QE) has the effect of lowering interest rates Buy buying assets, prices go up andrates go down It has a few effects that are intended to spur economic growth First, it makes it lessexpensive for producers to borrow money For example, an entrepreneur can borrow money at lowerrates to invest in the business that may create jobs Second, investors who might have parked theircash in bonds are faced with poor returns Therefore, investments in businesses that create jobs

become more attractive Third, when the Fed buys assets from banks, the banks have excess reserveswhich can theoretically be loaned to businesses

Jobs may theoretically be created by all these dollars being injected into the financial markets

However there is also an inflationary effect of printing trillions of new dollars The inflation has theeffect of reducing the value and purchasing power of the money we own and earn

Potential Harm of Quantitative Easing

a Devaluing the Dollar

Per basic economics, increasing the supply of goods or services decreases their value To illustrate,

if more restaurants started opening on your block, they would need to compete for your business Ifthere was only one restaurant, they may be able to charge a higher price because it’s the customer’sonly option

b Inflation

By encouraging spending, prices may rise An increase in prices means a decrease in purchasingpower all else equal To illustrate, if it costs $10 per week to live, then making $20 per week wouldenable someone to live a “healthy lifestyle.” If it costs $30 per week to live, then making $20 perweek would not be enough

c Government Debt

In order to fund its expenditures, the government in part relies on debt financing from foreign

countries Increased spending means increased debt When a consumer has more debt, such as studentloans, it makes it harder for the consumer to buy goods services Government debt could make it

harder for it to fund its other initiatives or provide support in the event of a future collapse

What Happens Next?

The Fed will eventually have to 1) stop buying billions of dollars worth of assets each month, and 2)sell the assets that it has acquired via QE

Will the economy be able to run on it’s own without the support of trillions of dollars of QE? Will thesale of these assets cause market volatility? Has QE solved the problems it was intended to solve?

Tapering Quantitative Easing

If the Fed reduces its securities buying, attitudes may change Investors may become more cautiousbecause there isn't a steady cash supply flowing in to securities

Consumers who have more debt and in many cases are underemployed or unemployed while hardlybenefiting from the rise in the stock market will need to be a new source of economic stimulation

In order to keep interest rates low the Fed has been buying new debt that the federal government mustissue because of it’s trillion dollar deficit The federal government is spending more per year than ittakes in The government get this money from the supply the Fed creates with QE The government isessentially borrowing money from itself and spending more than it has

If the Fed attempts to maintain bidding in markets with few other buyers, it could end up owning

trillions of dollars in worthless assets

Asset Liquidation

There is risk that if assets are sold too quickly, it might destabilize markets The Fed could run intoliquidity issues, causing them to be unable to sell at desired prices If the Fed owns too much of anyclasses of assets, it could essentially become the market for those assets Therefore, significant effort

to sell those assets could send prices down, yielding losses for the Fed The Treasury market is veryliquid, but the Fed owns over $1 trillion of Treasuries

If the Fed doesn’t reduce its balance sheet for a long period of time, it reduces the resources it has toput to work in a future crisis The Fed’s ability to play that role of “backstop” depends on its ability

to create liquidity and improve its balance sheet Without the markets’ faith that it will be able to playthat role of backstop, there could be negative consequences It could make investors less confident ininvesting.

The New Economy

The current state of the economy is unique We’ve experiencing technology and housing bubbles justten years apart College degrees used to differentiate job seekers, and enable significant upward

mobility Degree holding job seekers are now abundant in many fields Jobs are being automated bysoftware and outsourced to offshore companies The wealth gap is widening

Many Americans have continuing concerns over the strength of the economy and the future of thecountry

The have personally experienced the crashes of the technology and housing bubbles, and ensuinglayoffs and hiring freezes,

Key Economic Indicators

Below are a few important considerations to make when considering the state of the overall economy

Inflation

Quantitative Easing kept housing prices from dropping to where they may have otherwise It

prevented the US economy from “bottoming out.” Therefore, one could presume that prices are

inflated vs what they would have been otherwise

3 Is Higher Education a Bubble?

What is a bubble?

To recap and summarize, the earlier chapter, an economic bubble is a state where the price of anasset is inflated far beyond its intrinsic value Price is equal to the collective market’s estimates ofintrinsic value Intrinsic value is equal to the net present value of future cash flow Cash flow comes

in the form of profits, dividends, cost savings, etc

Historically bubbles have commonly occurred as result of a near unanimous belief about an asset’sincreasing value For example, before the financial crisis of 2008, there was widespread belief thethe value of houses could only increase

What are the signs that higher education is a bubble?

Higher education shows symptoms similar to that of historical economic bubbles: price has increasedrapidly, become decoupled from intrinsic value, and there is near unanimous belief about it’s value

1 Price

The price of higher education has increased by about 1000% since 1976, far outpacing average

inflation Students and graduates now have a total of over $1 trillion in student loan debt

2 Value

The gap between wages that someone with a degree earns and someone without a degree is

narrowing, therefore lowering the intrinsic value of the degree In 1940, only one in 20 Americansheld a college degree By 1977, that number had soared to one in four The increase in supply oflabor with college degrees, lowers the value of the degree

3 Widespread Belief

There is near universal belief in the United States that everyone should go to college It’s “what youdo.” If you tell someone that people should stop going to college they look at you the way a five yearold might look at you if you told him there was no Santa Claus There is such high demand for highereducation that schools can charge just to apply! The Stanford Daily reported that the University’sadmission rate Stanford’s admission rate for 2016 was just 5.07%

Key Takeaways

The price of higher education may have inflated significantly higher than its intrinsic value This can

be illustrated by comparing the price and value between different schools For example, some

schools have tuition rates comparable to some Ivy League universities but typically do not lead tosimilar career opportunities for graduates

4 Comparing Higher Education and Student Loans to Housing and Mortgages

The collapse of the housing bubble and corresponding financial crisis of 2008 happened just six yearsago as of this writing (2014) There are many similarities between these two events Its important toconsider the causes and outcomes of the housing bubble to help understand what might happen inhigher education

9 Striking Similarities Between the Housing Bubble and The

Higher Education Bubble

1 Same Players

The same “players” that were in the housing “game” are also in the higher education game: lenders,student loan borrowers, producers, and, perhaps the biggest player, the U.S government

a Borrowers

In housing,some of the borrowers were first time time buyers In higher education, some the

borrowers are the first members of their families to attend college.students In both cases, borrowerstake on loans they can’t afford to pay back They become swamped with debt on assets they can’tafford and that won’t generate a return large enough to be able to pay off “Owning” a house worthless than the mortgage is similar not earning enough to be able to pay off the debt

Poor decisions were made by borrowers, in part because of being unable to value assets properlyand/or forecast returns

b Producers

In housing, the producers were home builders In higher education, the producers are schools In bothcases, the producers over produce and take payment in debt assuming their customers will be able topay them back

Because of the abundant capital and corresponding demand, supplying a house or school seems

attractive as prices continue to rise However supplying the house or school means decreased supply

of other goods or services The reduced supply of other goods and services leads to an increase inprice of other goods and services

Schools, with poor cost management, are investing in fixed assets, not anticipating a declining priceand revenue If the prices decrease significantly they may be unable to continue to supply education, aservice which our country needs The reduced supply could prevent prices from dropping too low

c Government

The government’s role in the housing bubble of accepting risk from lenders and encouraging or

restricting lenders is similar in the housing bubble

In the 1990s, the government encouraged banks to expand access to housing by reducing down

payments and other risk reducing measures Lenders’ concerns were eased because two

quasi-governmental agencies, Fannie Mae and Freddie Mac, were created to guarantee the loans, reducingthe original lender’s risk

In 1996, the Department of Housing and Urban Development encouraged Fannie Mae and FreddieMac to make more than 40 percent of their loans to low-income borrowers

With the government using Fannie and Freddie to transfer mortgage risk from banks to taxpayers,mortgage lenders didn't need to take as much consideration for the riskiness of the loans they made.Lenders could make loans, profit, and sell the loans to someone else where the government wouldpick up the proverbial “tab.”

Simultaneously, the Federal Reserve pushed interest rates to historically low levels, making

mortgages cheaper, encouraging people to borrow money to buy houses

In the case of education, the government is actually the biggest lender of student loans In addition, thegovernment is essentially subsidizing schools, by giving them tax breaks The subsidization

discourages competition which would help students What seems like a noble objective, encouragingpeople to go to college, may actually be predatory as students take on debt to buy an asset that won’thelp them enough to be able to pay it back

d Lenders

In both housing and higher education, lenders are “guilty” of lending irresponsibly, putting themselves

at risk despite their services being necessary for the economy to function, the government, the

economy, and taxpayers on the hook In the case of housing, because banks took on too much risk,when people began defaulting on their mortgages, there was a risk that they could lose their

customer’s reserves In part to prevent a run on the banks and/or banks losing everyone’s savingsaccounts, the government announced the bailout, giving massive amounts of taxpayer dollars to banks

I don’t blame them for lending irresponsible because they are profit seeking entities In some casesthey were actually forced by the government to make bad loans (such as laws requiring lending to lowincome families or with reduced down payments) In the case of higher education, the biggest lender

is actually the government

2 Excess Capital

In both housing and higher education, easy access to debt capital at low rates and with lax borrowingrequirements, encourage borrowing and purchasing, which increases prices In both cases, banks areessentially ensured by the government and it’s taxpayers, incented to make risk loans, and/or

prevented from refusing to make risky loans In the case of higher education, the government is

actually one of the biggest lenders The government is lending with taxpayer money In both cases,interest rates established by the Federal Reserve are at record lows

In college, it’s something along the lines of “I have to get a college degree, regardless of the cost,because a college degree is the only path to prosperity, and I won’t be able to succeed without it.”The fact that if you tell the average person not go to college they look at you like a crazy person is asign that there is near universal belief about higher education

4 Overvalued Assets

The combination of readily available debt at low interest rates along with a universally held beliefabout the value underlying asset, leads to significant increases in price In the cases of education, thedegree can be overvalued if the abundant capital and universal belief lead to an increase in the

number of people graduating from college and entering the workforce The additional supply of

graduates, leads to a decrease in price (wage) if there is not a correlating increase in demand forlabor Therefore, the degree may be overvalued

In the case of a degree, it can’t be re-sold like a home In addition, a degree only has value (in theform of increased wages) because employers (the parties paying those wages) believe it does

5 Weak Lending Standards

Just as mortgage lenders lead borrowers to think they could afford a house way outside their pricerange, student lenders and schools tout the promise of more job opportunities and higher wages

Lending standards for student loans may even be lower than mortgages

In housing, borrowers often had to pay a certain percentage the price of the house as a down payment.Borrowers also often had to show a history of employment at compensation sufficient to pay back themortgage Students do not have to pay any down payment, and do not have much history of

employment The lack of down payment leaves lenders with even more risk on the table

6 Securitization

Just as mortgages were being securitized into mortgage backed securities, student loans are beingsecuritized into student loan asset backed securities (SLABS) Securitizing loans can be a good wayfor lenders to reduce their risk

However, if too many of the securities are not owned by the lender, the lender can reduce their

lending standards In addition, if an investor, such as a bank, allocates too much of their capital to thesecurities and the underlying loans default at higher than expected rate, it could cause harm to theinvestor, and therefore impair the investor’s ability to make future investments

7 Poor Ratings and Risk Assessment

During the housing bubble, many investors and ratings agencies did not properly assess the risk ofdefault in mortgage backed securities There may be similar problems with student loan asset backedsecurities

Student loans are often based on credit score However, evaluating the credit score of someone whohasn’t entered the workforce, won’t for at least four more years, and with unemployment as high as it,may not make for the best assessment

Many student loans have parent co-signers who have higher credit scores than their children

Therefore the credit score may not properly reflect the ability of the actual borrower to repay thedebt

8 Large Market Value

According to Fiscal Times, the mortgage backed security market reached about $7 trillion, while thestudent loan asset security market has topped about $2.6 trillion

While the student loan market may not be as large as the mortgage market, it’s still sizeable,

especially in an already fragile economy that’s still recovering from the housing bubble

9 Speculation

Housing had and higher education has a long history of providing a strong return on investment

College graduates have historically earned more than high school graduates Housing provided greatinvestment returns for years, as housing prices actually did continue to rise for many years

However, investors in both degrees and houses failed to consider that the past is not always an

accurate predictor of the future At some point, the rising price of education offsets the increased

earnings potential, especially if earnings potential declines because of an increased supply in thenumber of graduates Similarly, in housing, once the significant amount average investors have theirmoney in housing, there’s not much more money left on the sidelines to continue to raise the price.

6 Reasons Popping the Higher Education Bubble Could be Worse Than the Housing Bubble

While there are many similarities between the housing bubble and the higher education bubble, thereare also some differences The differences might make matters worse, were the higher educationbubble to pop

1 Underlying Assets (or lack there of)

Houses always have some value People have wanted shelter since the dawn of time Unless thatchanges, there will always be some price people are willing to pay for the underlying asset (the

house), regardless of its expectations for investment returns For individual investors, the expectation

of return in housing may not be high as the expectation in the stock or bond markets However, there

is high probability that people will perpetually want shelter and therefore be willing to sacrificereturn for a home

A degree is worth buying because of the additional career opportunities and increased wages it ispresumed to enable A degree enables career opportunities and increased wages simply because anemployer decides to hire people with degree If employers were to decide that a degree is no longer agood indicator of whether or not someone is able to perform at a given job, the additional wages andopportunities would decrease Therefore, the value would decrease Theoretically, a degree couldbecome worthless It would only be worth as much as the paper on which its printed

The underlying value of a house means that there is undervaluing value to the mortgage In other

words, even if the borrower defaults on the loan, the lender can repossess the home You can not possess a degree

re-In addition, for the borrower, if capital is needed for other investments or expenses, or if the housesimply becomes overvalued, he or she can sell the house You can not re-sell a degree

When the housing bubble began to burst, and banks like Bear Stearns started failing, the governmentstepped in with what was at the time nearly unprecedented The government announced the TroubledAsset Relief Program (TARP) to purchase up to $700 billion in assets and equity, especially

mortgage backed securities from financial institutions to keep them from failing The federal reservelater announced two more rounds of “quantitative easing.”

In addition to the government’s large amounts of outstanding debt and potentially troubled balancesheet, there continues to be economic uncertainty Unemployment rates are high and inflation rates arebelow 2% despite the massive capital injections i to the monetary supply Therefore the governmentmay be less capable of stopping a future collapse, and consumers may be less capable of handlingadditional hardship

4.Lower Lending Standards

In housing, lenders often required borrowers to make down payments of a given percent of the price

of the house, primarily to reduce risk Lenders also required borrowers to show a history of

sufficient employment and compensation

In higher education, it appears lending standards may be even lower Students do not have to pay anydown payment, and do not have much history of employment With unemployment rates as high as theyare and with the supply of graduates seeking employment increasing, repayment risks on student loansmight be even higher than mortgages

6 Need for Rebuilding

After the housing bubble popped, the underlying product, homes, remained sound People have

wanted shelter since the dawn of time and continue to want to homes The bad debt had to be

unwound, and prices adjusted, but the crisis didn’t demand that we completely re-invent housing.Higher education on the other hand may need radical reconstruction

Effects of The Housing Bubble

The collapse of the housing bubble started with an increase in foreclosure rates, lead to a crash inmortgage backed securities, caused contagion to other markets, and ultimately lead to the 2008

Financial Crisis Based on the results of the housing bubble and mortgage market, it seems reasonablethat the higher education bubble and student could have a contagious effect as well

Once news started coming out that homeowners could no longer afford their mortgages, it signaled tothe market that there were other economic indicators at play The inability to pay mortgages was anindication of low incomes This began to influence the home building and construction industries todecrease production Losses on mortgage backed securities hindered banks’ ability to make loans

The mortgage crisis showed the global economy how interconnected all the financial markets are, andthe significant and prolonged damage that collapsing bubbles can cause Just six years later with theeconomy arguably still not recovered, it seems the effects of the higher education bubble have thepossibility to be even worse

5 Harmful Effects of The Higher Education Bubble

The rising price of higher education and decoupling from intrinsic value has caused harm to students,lenders, schools, government, and the economy as a whole

Students

The most obvious harm has been caused to graduates and prospective students

a Debt

Because of the increased price, students have had to spend massive amounts of money and often take

on massive amounts of debt in order to go to college The money spent on higher education couldhave been spent any number of things that could improve their lives and happiness

Student loan are an exceptionally challenging kind of debt to have They’re inescapable throughbankruptcy, have no expiration date, and collectors can garnish wages, social security payments, andeven unemployment benefits

Debt can also diminish credit scores Having a strong credit score is needed in order to make somebig purchases Some employers even require certain credit scores

b Price and Availability

Increased prices makes higher education less affordable It’s getting harder for prospective students,especially lower income students, to be able to afford to get educated

c Unemployment and Wages

Increased supply of graduates lowers the value of a degree When there were fewer people

graduating from college, having a degree was a distinguishable accomplishment Now going to someless prestigious colleges can actually be a disqualifying factor for many jobs

Government

a Risk

By lending student loans and backing them, the government is taking on significant risk If the

government were to crowd out other lenders, or if the assets turned out to be worthless it would end

up owning trillions of dollars in worthless assets and liabilities.

b Mis-allocation of Resources and Labor

Economic bubbles can create excess demand and production For example, seeing the price of

housing continue rise may have made investors more likely to believe that prices will continue to go

up Producers would therefore be more motivated to produce a house than another resource that theeconomy would need The result is that the price of the alternative are more expensive than theywould have been if the producer supplied it

In higher education, excess credit encouraged people to go to college and supply the correspondinglabor instead of other forms of labor The economy needs supply of labor in all areas, not just for

jobs that require degrees The result may have led higher prices for labor not requiring college

degrees

During the mortgage bubble, people could refinance and use the money to buy more stuff, the

companies selling the stuff they were buying hired more people, and so on

6 Causes of the Higher Education Bubble

This sections describes factors that have contributed to the increase in price of higher education

and/or the decrease in value of higher education relative to it’s price

The Economy

The economy is not only harmed by the higher education bubble, but actually a contributor to it aswell

a Poor Job Market

Graduating from high school and not being able to make sufficient money means you need to go toundergraduate school Graduating from undergraduate school and not being able to make sufficientmoney means you need to go to graduate school and take on even more debt

The jobs people are in search of might not open up as quickly, because more parents are delayingretirements perhaps to help pay for their children's student loans

In addition, many jobs are being automated by technology and/or outsourced to foreign countries,further decreasing demand for labor

Students

a Speculation

Just as home buyers took out loans to speculate on houses they could not actually afford, students havetaken out loans to pay for higher education which may not actually help them earn enough to be able topay off Students have succumb to societal pressures to attend college, despite it not always being awise investment

Lenders

a Selling the Dream

Students have been lead to believe that taking out student loans will lead to greater prosperity bylenders However higher education may actually do more harm than good

b Poor Ratings Standards

Many student loans seem to have been made without proper consideration for a student’s ability topay them back For example, it is harder for someone majoring in philosophy at mid-tier school thatcosts forty thousand dollars per year to be able to earn enough to pay off those loans, than it is forsomeone majoring in software engineers at MIT.

Employers

a Requiring Degrees

By requiring applicants to have degrees in order to work in certain positions, employers put a burden

on people to go to college The result is an increase in demand for higher education and thereforeprice

The Morrill Land-Grant Act, passed in 1862, established a series of colleges to teach agriculture,engineering, and the liberal arts A century later, the GI Bill made it easier for veterans of World War

II to attend college The GI Bill was later broadened into the Higher Education Act of 1965

The Federal Student Loan programs were established in the mid twentieth century Banks were able

to issue student loans at virtually no risk because of the government’s guarantee

The Higher Education Act established further subsidies for the higher education industry These

programs later grew into Pell Grants, Stafford Loans, and Federal Work-Study programs

The Affordable Care Act of 2010 allowed the government to make student loans directly The

Taxpayer Relief Act of 2011 provided tax breaks to student loan borrowers During this same periodfollowing the collapse of the housing bubble, the Federal Reserve has kept interest rates at

historically low levels, making college loans cheaper

a Public K-12 Education

Despite, educating students for twelve or more years, many students still can’t even earn a “livingwage.” If public education leading up to college was stronger, perhaps there would be less need forhigher education

c Stimulating Demand

By issuing student loans at below market rates, demand for student loans is stimulated By stimulatingdemand, the government is essentially funding the production of labor that there’s not enough demandfor Therefore it hasn’t created value If a gold mining company were to mine more minerals thanthere is demand for, it would lost money and potentially go out of business

d Restrictions and Enforcements

The government instituted laws preventing lenders from denying Stafford and Perkins loans based onthe borrower's credit or employment status Think about that from a lender’s perspective When youlend someone money, there is a certain risk that the borrower will “default” on the loan, and not beable to pay it back The lender must then charge an interest rate in accordance with the risk of loss, toensure that it can stay in business The lender analyzes items like the borrower’s credit rating andemployment status to determine the chances of the borrower defaulting.

By preventing lenders from denying loans to borrowers with high risk of defaulting, the lender musteither charge significantly higher interest rates, or reduce its’ chances of sustaining it’s business Ifthe chances of making money in the student loan lending business decrease, or if the potential upsidedecreases, there is less incentive for new lenders to enter the market If there are less lenders in themarket, the interest rates students pay lenders increases, as bargaining power shifts to the lenders

i Strengthening incumbents College endowments invest in a variety of assets, including stocks The

increase in stock market value, therefore increases the value of endowments The increase in thevalue of the endowments helps existing universities make money, and therefore less sensitive to

competition Competition that would help drive down prices and/or improve quality

ii Increased donations The Boston Globe reported that giving to colleges and universities was back

at pre-recession levels, with a record $33.8 billion in charitable contributions during the 2013 fiscalyear, almost a 10 percent increase over 2012 The Council for Aid to Education credited most of theincrease to the rebounding of the stock market The stock market rise increases the asset values ofpeople who own stock The increase in asset value would encourage donations

iii Increased borrowing The combination of increased consumer confidence and low interest rates

would encourage people to invest in a degree Seeing the stock market rise would indicate that theeconomy is doing well and that companies are hiring Unfortunately the rise was at least in part adirect result of QE itself

In addition, rising stock prices does not necessarily correlate to more hiring Companies who feareconomic uncertainty and see stock prices rising may be better off investing in stocks than in newproduct development or expansion Decreased hiring lowers the value of a degree Students and theparents who pay for the students’ education who own stocks would feel more wealthy and therefore

more confident in making the investment in college Low interest rates make it easier to borrow

student loans to fund college

iv Increased lending The Fed’s goal with QE was to encourage banks to lend Student loans are a

form of lending With more reserves, a bank may be more likely to make students and/or make them at

a lower rate, despite the risk In addition, lower interest rates and potential for inflation make holdingcash a less promising investment opportunity than other investment opportunities, student loans

included

g Guarantees

Under the Federal Family Education Loan Program, the US Treasury backed private loans to collegestudents This meant that even if facing massive amounts defaults, the government would bail themout In 2010 President Obama ended the Federal Family Education Loan Program, after it had grown

to a $60 billion per year program

7 What Will Cause the Higher Education Bubble to Pop?

People are finally starting to become conscious of the fact that the price of higher education is

inflating beyond it’s intrinsic value and becoming a bubble People are becoming concerned over thegreater than $1 trillion in outstanding student debt Despite the concerns, lenders, borrowers, schools,the government, and employers don’t seem to be taking much action to prevent potential problems

What will be the trigger that causes this bubble to come to an end? With comparisons to the mortgagecrisis, this section describes how the student loan bubble might begin to unravel The section afterthis will discuss potential profit opportunities

10 Potential Triggers

1 Increase in Interest Rates

An increase in interest rates would make it harder for people with outstanding student loans to payback Many private student loans have variable rates that are tied to the interest rates set by the

Federal Reserve This would lead to default

An increase in interest rates would also make it more expensive for prospective students to get loans.This would result in a decrease in demand for education

2 Increase in Unemployment

If unemployment rates increased, it would be harder for people to gain employment and/or earn

enough to pay off their loans

3 Decrease in Demand

A decreases in demand for higher education could began to reduce bubble like prices in higher

education Given the widespread belief in the value of higher education, it seems there’s not muchopportunity for demand to increase In the housing bubble, once a given portion of professional andamateur investors had spent their savings on housing, there wasn’t much money left to continue toincrease prices Below are four more specific factors that could trigger a decrease in demand in theshort term

a Increase in Interest Rates

If interest rates on student loans increased significantly, prospective students might be more hesitant

to take out student loans Increase in rates could be a result of lenders demanding higher rates toaccount for risk, and or increase in demand relative to supply

b Increase in Price of Higher Education

If the price of higher education increase further, or potentially if it simply doesn’t decrease, peoplemight see higher education as a less attractive investment opportunity

c Wage Depreciation or Unemployment

If wages of degree holders decreased, those who were counting on it to afford their student loansmight decide to skip college The decrease in wages could be caused by a general economic

downturn or an oversupply of degree holders competing for the same jobs

d Economic Downturn

A downturn in general economic activity or employment would lead to decreases in disposable

income and or confidence, which could decreases the demand for higher education

A decline in stock market values could lower wealth and consumer confidence of adults, who oftenco-sign for their children’s student loans

students into massive amounts of debt and taking them out of the labor force If the students begandefaulting on the loans they received from the government, the government might see student lending

as a less attractive investment and therefore decrease or discontinue

5 Increase in Default Rates

When homeowners began defaulting on their mortgages it caused the loans themselves and their

corresponding asset backed securities, collateralized debt obligations, and credit default swaps todecrease in value The result was a decrease in demand for houses, an increase in supply of houses,and illiquidity in credit markets

The same could be true for higher education and student loans If default rates increase it would make

it more difficult for lenders to hound borrowers If borrowers realized that it could spiral

6 Tapering of Quantitative Easing

The Federal Reserve has been printing and pumping about $85 billion per month in to financial

markets to keep interest rates at zero and provide liquidity Quantitative easing makes it easier forbanks to hold toxic assets on their books because they’re not being valued by the “real market.”

By giving banks additional reserves, quantitative easing makes it easier to make student loans Bankshave exchanged Treasury bills and mortgage-backed securities for cash, which they have used to play