Tuesday, December 6, 2011

The Mortgage Bubble and the Student Loan Bubble: Similarities and Differences

Many of today's college students and recent graduates have accumulated debts beyond their apparent abilities to pay. In a number of ways, their debt is similar to the massive housing debt that led to the collapse of the real estate market beginning about 2007. In both instances, federal subsidization of borrowing encouraged easy loans to poor credit risks.  Behind this subsidization lay the idea that social policy  could collaborate with private investment to engineer an ever-expanding middle class. In the case of housing, the federal government promoted the idea that home-ownership would simultaneously push individuals into middle class financial prosperity and benefit supplying institutions, notably real estate firms and lenders. In the case of student loans, the federal government encouraged the idea that extending college credentials to a larger part of the population would stimulate upward mobility for individuals and also provide funds to colleges and sources of student loans. In both situations, the borrowers engaged in what they believed were reasonable speculations.  In both cases, subsidies encouraged rising prices, in the form of real estate values and tuition costs.  Borrowers of funds for houses and education engaged in speculation, encouraged by the ideology of forever growing opportunities. Those who borrowed for homes believed that however much debt they assumed, the future values of their properties would be even greater. Borrowers of money for college believed that the pay-off of their credentials would always be larger than their loan amounts.  Extending both homes and college degrees to more people fed speculative frenzies. This is clearest for the former, since putting more buyers into the housing market drives up the market values of houses, at least temporarily. But it is also true for education, since the more widespread college credentials are, the more critical they become in securing desirable employment.
Now, the speculative value of both homes and degrees appears to have been illusory, with some similarities in responses. Home owners with properties that are "under water," with loan amounts greater than the market worth of their houses, have begun either walk away from their loans or simply cease paying as impending foreclosures become too numerous to readily enforce. Similarly, indebted students and graduates have begun threatening to refuse to pay their college loans.  However, these similarities in responses call attention to some of the differences between the two kinds of indebtedness.
While many have debated the ethics and practical consequences of walking away from a mortgage, it is clearly legal to do so. When someone takes out a mortgage, the borrower takes a risk on the value of the home and on the borrower's own future ability to pay, but the lender (or the guarantor behind the lender) also takes a risk. As a matter of contract, if borrowers do not pay for any reason, including simple unwillingness, then the house belongs to the lender. If the house is worthless, then the lender has made a bad bet.
In the case of the student loan, though, there is nothing to give back to the lender. While colleges might be encouraged not to recognize the educational credentials of defaulters, no transferable asset exists. However great or small the value of a college degree, no one can hold it except for the individual to whom it is awarded. This is why student loans typically have no "walk away" option. When government essentially took over educational lending in 2010, it received nothing but lender promises to pay, backed only by the power of future wage garnishments and tax confiscations.  Houses may be sold at a discount. They may even eventually recover some of their purchase value. But there is no compensation for taxpayers or anyone else for an educational loan that a borrower refuses to pay if payment is not somehow enforced.
The other big difference is that extending home ownership can influence market values by pushing up the cost of homes and then producing a crash. But the intrinsic worth of the home remains the same. The quality of the building remains the same, assuming upkeep, whether people will pay $500,000 for it or $500.  An education, though, is worth only what people put into it.  By pushing more people who are unprepared not just financially but intellectually into institutions of higher education, we have moved ever closer toward expensive degrees that are not just worth less than their cost, but meaningless in their content.

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