By Zach Gorwitz.
I read a book by Vandana Shiva called Earth Democracy. In her work, Shiva calls for the end of privatization and a return to the days of the commons. I also re-watched Inside Job and discussed the role capitalism played in the collapse of the financial industry, and subsequently, the world economy.
The author and the filmmakers are very liberal. I am, too, albeit to a lesser degree. But political orientations aside, the course got me thinking about the role of the financial industry and whether it learned its lesson after the 2007 crisis. After learning about student loans and their ever-expanding bubble, I had a clear answer: the banks and their partners either had not learned from past mistakes or were deliberately perpetrating another financial crime.
In 2004, there was $240 billion of outstanding student loan debt. Today, there is over $1 trillion. This rapid growth is reminiscent of the growth of mortgages a few years ago, and sure enough, student loan debt is the 2nd largest source of household debt, behind mortgages. At the current rate, student loan debt will double to $2 trillion by 2020.
In 2007, the world got a clearer picture of the trend of the past couple decades. Interest rates were low and terms were favorable, so there was an incredible increase in loans from the banks. The banks made incredible profits by packaging these loans into collateralized debt obligations, engaging in credit default swaps, and speculating on the success or failure of the new homeowners. The profit was all theirs, but the risk all fell elsewhere, why not continue lending? As a result of this perverse risk-free, profit-heavy practice, loans were made to people who probably would not be able to pay them back. People whose best decision was probably to save longer, rent a home, or downsize. Inevitably, when enough of these people defaulted, the system collapsed in on itself.
But the blame is not entirely on the shoulders of the bankers. Citizens looking for a quick buck preyed upon on the price inflation of the housing market buy rapidly buying and selling houses. In the student loan case, the public sector also deserves sizable blame. The Federal government has issued about 80% of student loans today, and that number is increasing. Regulators have been late to the game in preventing the risky loans, and most importantly Congress has yet to take decisive action that downsizes and separates banks, making them no longer “too big to fail.” Dodd-Frank doesn’t quite have the teeth.
Scarily, the inflation of the student loan market closely mimics that of mortgages. Private lenders and the U.S. government made loans on loans on loans that ostensibly invested in America’s future. We refused to face the harsh reality that student loans would not always pay off—not every college is worth the cost and not every student is in a position that would allow him/her to succeed after graduation and pay back that loan. With stubbornly high unemployment (especially with recent graduates), and low graduation rates, these burdensome loans are forcing young adults to default, preventing them from buying homes, cars, etc. and slowing down the economy even further (all this in mind, it is time we reexamine the traditional four-year, liberal arts education and ask ourselves if it’s right for all of our students).
It’s cyclical and it’s a sad cycle to be stuck in. Students and graduates saddled with lifetime debt slows and shrinks the economy, which in turn forces the federal and state government to shrink their budgets, which directly affects education subsidies. Without the same level of government support, schools are turning to tuition hikes for students. And students, convinced college is the obvious American step after high school, borrow more and more to finance their dream. But their dream is quickly devolving into an American nightmare
The easy lending alone was similar enough to housing bubble to cause concern. Then came the news that student loans were being packaged into SLABS, or Student Loan Asset Backed Securities. In other words, these loans were being paired with other assets as underwriters and sold by investment banks to under-informed investors. And when students default on their loans, guess what happens to those investments… If this process sounds familiar, Google “mortgage backed securities.” You should find something about an $800 billion government bailout.
The warning signs were there. As if the 2007 collapse wasn’t deterrent enough, papers like this one from the Federal Reserve Bank of Cleveland caution against the inflation of the student loan bubble. Yet again, systematic negligence by the private and public (the U.S. government has about $800 billion in student loans out there) has threatened the health of the economy.
Overall, this situation is yet another collective action failure. Yes, the banks valued profit over financial security, but regulators and Congress turned a blind eye, while students made financially imprudent decisions. We’re too deep in this mess for a quick fix, so I’m expecting another bailout and hopefully a review of lending and borrowing practices that realizes that easy money is not always smart money.
More broadly, the housing crisis, coupled with this one, begs the question: what kind of dream is the financial industry selling?