Why You Should be Worried About Student Loans Even if You Didn’t Go to College
Over the past few weeks, I’ve seen person after person attempt to frame student loans as some sort of object lesson in personal responsibility. It is a smug and superior viewpoint. It is also one that demonstrates that the person that says things like, “student loan forgiveness is a slap in the face to people that struggle to pay off their loans,” does not understand the full magnitude of the problem.
People not understanding the necessity of student loan forgiveness is not surprising. Most people have next to no comprehension of the US financial system. A Wikipedia page of information found on the first PowerPoint slides of an undergraduate intro to econ class is not going to cut it. Additionally, most people cannot comprehend numbers past $1 million. The average person really has no frame of reference when it comes to talking about billions or trillions of dollars.
However, this topic is important, so I am going to attempt to explain how even if you paid off your student loans or you never had any in the first place, you are still in a lot of trouble right now.
I am going to start this article with a primer on the 2008 financial crisis. It will help you to understand everything I am about to explain about the seriousness of the student loan situation in the United States.
Most people do not understand the mechanics of their mortgage. Here is the quick and dirty.
1. Contrary to popular belief, residential mortgages are usually not sourced just from deposits. The money comes from various sources including investors.
2. Banks take that investor money and use it to create an asset called a mortgage, which is a special kind of loan that is secured on real estate.
3. When you go to close, the cash is disbursed by the terms of the sales contract, and the buyer incurs a monthly financial liability to the bank. That liability is a cash flow to the bank, which is what makes a mortgage valuable.
4. Since a mortgage is a contractual obligation for a regular cashflow, its value today can be calculated using third grade math that every business school student and financial professional on the planet learns.
5. The bank (usually) then sells the mortgage. Most people are somewhat familiar with this in that a month after close, they will get a letter informing them that their mortgage has been sold, here is your new servicer, have a nice life. The bank takes the cash from the sale of the mortgage, pays whatever expenses, and pockets the difference.
6. Here is where it gets crazy. Yeah, you though it was done. Nope. Individually, those mortgages are not worth enough for anybody to really care about. So, what happens is those mortgages are purchased from smaller banks by larger banks.
7. The larger bank buys a bunch of mortgages. Thousands. Tens of thousands of mortgages. It takes those mortgages and bundles them into a new asset which also has value. Since those mortgages are made up of people with different credit profiles, the math used to value them is PhD level.
8. The bank then takes the new asset and sells it to a global market of hedge funds, pensions, mutual funds, and municipalities. Yes, your tiny $200,000 mortgage can wind up in the hands of Reykjanesbær.
9. The buyer of these mortgages depends on this cash flow to operate, so if you do not pay your mortgage, congratulations, you just helped bankrupt a small Icelandic city.
That is the full, simplified story of your home loan. Do you see how everything is interconnected? This interconnectedness between the little nickels and dimes you make to the rest of the global financial system is why everything went to hell in the US in 2008.
If you’d like a much more entertaining but accurate explanation of what happened in 2008, I highly recommend the movie, The Big Short. For now, I will break it down like this.
1. The process I described above had become corrupted. Debt rating agencies were giving bad paper higher ratings than the math suggested because they had a financial incentive to do so.
2. Mortgage brokers, for reasons that reach back decades, started pushing loans on people that had no business having a mortgage. Believe it or not, this actually was not the real source of the problem.
3. The real problem was real estate investors. Entities and individuals that held multiple properties. These people were also getting loans when they shouldn’t have.
4. Many of these loans had payments that got bigger or smaller according to the market. When the payment got bigger and these guys stopped being able to pay the mortgages on their properties, the first domino fell.
5. I am sure you know the rest. Credit markets froze. Banks failed. Businesses could not get cash to operate. People lost their jobs. People stopped buying things. Revenues fell. More people were laid off and the cycle became self-perpetuating.
To understand why people lost their jobs because strangers could not pay their mortgage, you have to understand the economy at a basic level.
If the United States were a human body, cash would be the blood flowing through its arteries. Just like the circulatory system, the US financial system depends on cash moving from the heart, central banks, to the extremities, every human using US dollars to transact business within the borders of the US. Just like the circulatory system, if the cash does not flow, bad things happen.
The circulatory system is an excellent metaphor because cash does the exact same thing as blood. It pools. It clots. It gets occluded. In all these cases, terrible things happen if the situation is not corrected. Student loans are a heart attack waiting to happen.
The current balance of student loan debt in America is $1.56 trillion with a T spread out over 45 million borrowers. Yes, I am one of them. Before you open your mouth, I need to inform you that, based on the plans on the table, I will not be able to take advantage of student loan forgiveness. I make too much and have a balance so high that forgiveness would not even move the needle. That said, I am all for loan forgiveness for others because I am not a huge fan of being homeless and unemployed again. That and I can see the whole board and understand loan forgiveness is not just about me.
People will say that you should be an adult and pay off your loans. The question I have is, with what money? Perhaps you are not aware of current economic trends. But here, let me share a few tidbits.
1. I have already written about how we live in a brave new economic world. You can read my thoughts on that here.
2. Wages have been flat for decades. That means, in real terms, people are actually making less today than they did 20 years ago. This alone is a serious issue but beyond the scope of this article.
3. The cost of college is soaring. You know this. You have heard this. But you really do not understand what it means.
4. Despite everything, it is still the case that people with college degrees make more than those without. Do not be fooled by anecdotes about how your uncle’s cousin’s brother’s sister-in-law became an electrician and now makes six figures.
5. Housing cost are on the rise in places other than LA, San Francisco, and New York.
6. The gig economy is on the rise. More and more people are being expected to provide their own benefits in terms of health insurance and retirement funding.
7. Gig economy jobs are necessary because basic living expenses have far outstripped what a single job will pay.
8. A college degree is still the minimum requirement for many jobs including those jobs that do not technically require four years of education.
9. Over half of Americans have no retirement savings or even money in the stock market.
10. Trade school still has a very limited upside.
These loans are stopping people from achieving standard life milestones the irony being that the loans were taken out with the intention of achieving those very same milestones. You hear all the time about people delaying marriage, delaying children, having less children. There is no money left over for retirement savings. The big one is the loans are delaying people from buying houses.
US home purchases are so important, there is an economic indicator called housing starts that is used to track it. When we use the phrase, “the American Dream,” what we’re really talking about is home ownership. For the average American, the overwhelming majority of their net worth is tied up in home ownership. With fewer Americans in a position to own a home that means less cash flowing into the housing industry, which has a large ripple effect into other industries. It also means fewer Americans making it to retirement with the amount of wealth needed to sustain life in their retirement years.
Just in case you thought it was just these silly millennials being irresponsible, let me be the first to inform you that there are people over 60 paying off student loans. Yes, these people went to school later in life. This only underscores the fact that, despite the wisdom that comes with age, these people are still suffering under the same rigged and unjust system as people a third their age. They did not blindly sign documents without understanding the full import of what they were signing, and yet, they singed them anyway because they did not have another option.
The United States government has become a loan shark. The interest alone on my loans is $40,000 and running. If you don’t pay your loans, you can get thrown in jail. Your career could get ruined. Your ability to earn a living could get taken away. You can be denied social security benefits or your tax refund. You could have your wages garnished without proper notification. I even found out recently that the government can lay claim to a portion of the interest you earn in a savings account. All these things can happen to you, and they are all 100% legal.
Student loans sourced from the federal government stay on the government’s books even in default, which is insane and practically financial malfeasance. Any other organization in this position would discharge the loan and sell the paper in the secondary market to recover the investment. Loans that go into default could be sold for pennies on the dollar instead of just sitting there becoming less and less valuable over time. However, since the government wrote the check initially, and the government has the ability to print money, these loans are not the real problem. The real systemic weakness comes from privately sourced student loans. Private loans work just like a mortgage mechanically. The money comes from investors expecting a cash flow. The loan itself is an asset that can be traded. When enough of these loans go into default, it’s the financial crisis all over again. Institutions fail, credit markets lock up, and we’re all back out on our collective butts wondering how we are going to survive this one.
So here is where we are heading. A large segment of the US population is injecting less and less cash into the economy in the critical places it needs to go to keep America running smoothly. These same people are also not building wealth at a rate necessary to have a secure retirement. What is worse is, since these people will not have any money in retirement, they will have to rely on social security. Except these people will not have access to social security because it is all being seized by the government to pay off a loan whose net present value is notably less than the face value of the note. That’s a fancy way of saying, you are losing money on the loan. All that before even starting to talk about the impending recession caused by another collapse of a segment of the US banking system.
Do you now see how this is more than just a personal problem?
The cash must flow. We can continue to walk around sure in our moral superiority and insist that people pay off their crushing student loans that they probably did not want in the first place. In the alternative, we can do the sensible thing, charge off these loans like any business would, and give people the same bail out we were so eager to give banks in 2008.
Additional reading suggestions:
More Student Loan Borrowers Are Getting Their Tax Refund Seized
