Tuesday, June 7, 2011

Student Loan Debt: Karl Denninger, “Heroin Is Great For Your Self-Esteem!”

 "Student Loan Debt:
Heroin Is Great For Your Self-Esteem!”
by Karl Denninger

“Look what we got from the Higher Educational Establishment on Student Debt...

COLUMBUS, Ohio – “Instead of feeling stressed by the money they owe, many young adults actually feel empowered by their credit card and education debts, according to a new nationwide study. Researchers found that the more credit card and college loan debt held by young adults aged 18 to 27, the higher their self-esteem and the more they felt like they were in control of their lives  The effect was strongest among those in the lowest economic class.”

Yes, because it's far more important to feel important and in control than it is to be in control. Of course when you're deeply in debt you're not in control.  In fact, if you're in debt at all you're not in control.  All it takes is the loss of a job and, if you've used debt to substitute for savings, you suddenly are in default. Now you're not in control at all.

When you're a student and don't have to pay because you are "allowed" to accumulate student debt without having to make payments, of course, you "feel" very much "in control."  That $20,000 annually seems too abstract since you're not required to make payments. Of course if it's a net $60,000 over four years when you leave school at a 5% average blended interest rate and 10 year amortization (reasonably typical) the $633.25 you must pay each and every month becomes rather concrete.  That's more than a decent rent payment and double that of a decent car payment. More importantly, it consumes the entirety of the spread between a 28 and 36% DTI (front end and back end ratio) on a $150,000 house if you make as much as $95,000 a year.

To put this in perspective, that means that if that $60,000 in student loan debt is all you have - no car payment, no credit card debt, nothing else - and you make $96,000 a year coming out of school at your first real job, you have consumed all of your non-mortgage debt allowed. If you make less?  You can't buy a house.

How many Bachelors graduates make $96,000 a year right out of school?  Almost none, right? So herein lies the problem - consuming your earnings capacity in such a form and fashion is idiotic.  It is not "empowering", it is destructive beyond words.  Yet we have counselors in High Schools and colleges, along with "financial aid" officers, who simply refuse to say "No."

Our young people are not particularly-well versed in the mathematics of finance.  That's intentional.  This deficit in understanding of basic exponential functions and how they apply to the financial world that we all live in comes about as an intentional consequence of our "educational system" both at the secondary and post-secondary level.

The paper written by Ms. Dwyer says in its abstract: “Debt has been little studied by sociologists, even though it is increasingly important in financing both attainment and a middle-class lifestyle, especially for youth in the transition to adulthood.”

Huh?  You cannot finance a "middle-class lifestyle."  Debt when used to consume something can only pull forward demand from tomorrow into today. The "attainment" that is gained is thus both transitory and illusory.  It is a fraud.

“It is by now clear, however, that debt plays an increasing role in supporting consumption among American families at the turn of the 21st century.” (Leicht and Fitzgerald, 2006).

No it does not. Again, that which I buy today "on the come" is something I cannot buy tomorrow.  This alleged "support" is a scam.

“The current generation of young adults enters into college and early adulthood at a time when minimum wages are near an all-time low and college tuition is at an all-time high (Slesnick, 2001). In this context, young adults are being lent what they might have been paid in previous generations and many will start their careers carrying significant debt (Leicht and Fitzgerald, 2006; Manning, 2000). Banks, educational lenders, and credit card companies have aggressively made themselves available to facilitate rising debt. The consequences of this new reality of entering adulthood with debt are uncertain.”

Oh no they're not. The consequences are concrete, measurable and known.  A young person who graduates with a Bachelor's and $60,000 in debt - which is not uncommon - enters the world of work with an obligation of over $600 a month, each and every month.

“Scholars disagree about the consequences of debt for youth’s self-concept in the sense of mastery and self-esteem, with some expecting positive effects as debt facilitates investment in status attainment and others expecting negative effects because of the financial stress of consuming beyond current income.”

There is no "status attainment."  To attain the status that is claimed the excess earnings capacity attributed to that debt is easily computed. A person with no debt that wishes to buy a median price home at approximately $150,000 with 20% down must first save $30,000.  If we presume that a young person would require ten years post-high school to do so, that is a savings rate of $3,000 a year. That is $250/month, and is attainable if one foregos the $100/month iPhone and $150/month in dates and beers eaten out.  There are few young people who cannot attain this, should they ditch the debt-based consumption.

That leaves us financing $120,000 for 30 years.  If we presume a 5% interest rate on a fixed mortgage we have a payment of $641.51.  Applying a conservative 28% "front end" ratio to this payment and adding $300/month for hazard insurance and property tax we find that the 28 year old who wishes to buy that house requires a gross household income of $3,362 a month, or about $40,000 a year before taxes.

To put this in perspective that's a $25/hour job on a standard 50 week 40 hour/week job and in fact is almost attainable for a couple that has a minimum wage job each.  I note that the average hourly wage, according to the BLS, is $22.98.  One person can thus easily earn, at the average hourly wage which resolves to about $45,000 in pre-tax household income, enough to buy a $150,000 house provided he or she first saves that 20% down payment and does not go into debt.

Now here's the ugly - you need to earn more than three times as much with a simple Bachelors degree in order to buy that same house if you come out of college with $60,000 in student loans and other debt (including cars, credit cards, etc.) That is an absolutely indefensible position to be in and any party that advises a young adult to do this ought to be locked up in prison as an accessory to an attempt to enslave.

“This leaves the typical graduating senior with $15,123 in federal loans, which even at subsidized interest rates can grow through substantial interest charges each year (Lewin, 2009).”

That's a 2009 graduate.  Today it is not uncommon for tuition and fees, ex books and supplemental charges, to be $20,000 a year at public colleges.  A person who has a scholarship of $7,500 a year will almost certainly wind up trying to finance close to $15,000.

“The concept of debt as a necessity for securing the future focuses on how credit allows people to move toward goals their current income could not support and can thus be a vital instrument of status attainment. It is widely accepted that access to credit is a key social good in modern capitalist economies, and lack of access is a significant form of social exclusion (Anthony, 2005; Klawitter and Fletschner, forthcoming).”

Baloney.  It can be said that a heroin pusher sees access to heroin as a key social good too. Who's funding this sort of crap claim?  Young adulthood is about learning how to achieve with what God gave you and you're able to develop with those gifts, not stealing from tomorrow and personal enslavement. Of course when you build an "educational edifice" that cannot be reasonably attended by someone self-financing through their work (e.g. flipping pizzas or similar during their time in school) you wind up with these "necessity" defenses.  This is exactly identical to the argument that the Heroin Pusher makes - his drugs are "necessary" (because he got you hooked on them!) and thus "you must have them" to succeed (in making him rich.)  He doesn't mention that you're odds-on to destroy yourself in the process.

“Viewed as an investment in the future, credit is particularly important for young people in the transition to adulthood because they are likely to have lower incomes and relatively few accrued assets to support their aspirations. A college education is an investment in human capital that is crucial to improving one’s life chances (Attewell and Lavin, 2007; Bowen et al., 2009; Morris and Western, 1999).”

It is?  There's a bald assertion.  Yeah, it's footnoted.  So what?  It is only "crucial" if the return on that investment results in a reasonable rate of return in excess of its financing costs with a high degree of certainty. This was certainly true when you financed your education with current income - that is, through savings or jobs.  It is nowhere near as clear today, when the "education" is financed through debt yet median incomes, adjusted for inflation, have not risen at all in the last decade. In point of fact for most professions financed education is objectively a net lose.

“It may be quite rational to encumber future income if taking on debt will ultimately result in a larger income stream (Friedman, 1957). Education loans may also generate limited stress during the college years as these debts are relatively invisible because they do not demand monthly payments.”

The first shot of heroin never seems to create stress at the time it's taken.  It's the jonesing later that presents a problem.

“Positive effects of debt on self-concept may also may be rooted in the ability of consumer goods to provide tangible symbols of ‘making it’ (Zaloom, 2009).”

That iPhone and Gucci handbag are so important as a "symbol" of having "made it", even if you can't actually afford it. This, of course, is why early on in Obama's Presidency we saw a woman in a line for a soup kitchen taking a picture of Michele Obama with her cell phone!

And are the banks and other lenders predatory in their acts?  You betcha: “There are more significant effects for lower-class youth than for middle- and upper-class youth and the effects are similarly positive for both mastery and esteem. Strikingly, the significant effects for lower-class youth are for the amount of debt held rather than whether any debt is held, suggesting that lower-class origin youth taking on more debt may view their activities as guided by purposive planning – like an investment – and not primarily a financial stress. Debt thus appears to play an important role for lower-class youth with fewer family resources and worse labor market prospects than for their more advantaged peers.”

In other words, the more likely you are to be completely and totally screwed in life by taking on debt, the more attracted you are to it and the more likely you will become habituated. And guess what?  The banks and educational institutions stand ready to act as the pusher, making damn sure you get that "first hit" for free (or nearly so) with their "educational loans" and other means of roping you into a ruinous set of choices, even though you will feel good about having done it. After all, isn't that the best sort of slavery - the one that someone enters into of their own "free will"?

“In summary, there are strikingly different effects of debt for youth from different class origins. Mastery and self-esteem are buoyed by both education and credit-card debt for the lower class – those who have the least access to credit and the fewest alternative resources. The middle class also gets a lift in their mastery and esteem from holding credit-card debt. The upper class, however, is essentially unmoved by debt, with no effect on their self-concept. The impact of debt thus appears to vary by the amount of other resources available, which affects the relative value of debt as a means to achieve investment or consumption goals.”

But this is a fraud upon those lower and middle class people, because debt taken to consume does not actually achieve a goal, it merely time-shifts it and applies a penalty.  Since all lending comes with interest, the consumption you take on today through debt cannot be taken on tomorrow and you pay a penalty rate for your enjoyment today.  This "aspirational achievement" is thus a fraud; it is not real.

As an "investment" there is more of an argument for it, but only if the investment pays.  And as I noted early on in this piece, that's a problem. We can easily compute the impact for any graduate in delta.  Remembering that the baseline scenario is that someone who borrows $120,000 for a house needs about $40,000 in income to do so with a reasonable reserve and safety along with a 20% down payment saved (that is, the house is $150,000 of which $120k is financed)

We do this by taking the difference between the front and back end ratios and discounting it by the amount of student loan payments post-graduation.  The amortization for student loans is typically 10 years and we can use a blended subsidized and non-subsidized interest rate of 5%. So if the "average" 2009 graduate comes out with $15,000 in debt that amortizes to $158.44 a month; discounted at 8% (front and back end ratio differential) you now need to earn $1,980 a month more having gotten the degree in order to simply cover the differential financing cost, or almost $24,000 a year.

Does this work for the average Bachelor's degree holder?  Maybe.  But remember that you must also manage to save the 20% down payment, and with the debt service that's going to be tougher.  Discount as appropriate for that; let's simply add another $3,000 annually to make $27,000 in additional earnings straight out of college. That might work but if the debt you take is four times that, or $60,000, it simply will not work.  You now need well north of $100,000 in initial salary coming out of college in order to make the math add up and for someone starting out with a four-year Bachelors it is a near-certainty that they will not achieve this salary.

The paper concludes: “Our finding that debt is experienced as a boost to one’s self-concept in the short term in no way implies that there will not be long-term negative consequences of debt holding. Indeed, the results of the age analysis showing that the oldest members of this cohort experience negative effects on self-concept from total educational debt suggest that the positive emotional effects of debt may wear off over time.” ... and ...

“More broadly, the sociological implications of the new debt society extend beyond the travails of the individuals caught up in this transition and their behaviors, stresses, and adjustments. The debt society also has important implications for the broader political economy of contemporary society. State and Federal policies that reduce tuition supports and substitute college loans for affordable tuition all but guarantee that current generations of college graduates will enter the labor force with significant, sometimes grinding, debt (Jacoby, 2002). Spiraling debt is thus not accidental or the result of a failure of character by the current generation. The privatization of college loans and the windfall profits accruing to lenders charging relatively high interest rates on loans that are guaranteed by the government and thus have limited risk is not an accident either. It is a result that has been directly engineered by political appointees to Sallie Mae and other government lending agencies that represented the interests of lenders over those of borrowers – including students (Schemo, 2007). These actions have implications for our nation as a whole, not just for young people, not the least of which is the privatization of what are in fact societal-level problems and shortfalls and the furthering of a society that mortgages the future rather than pays forward.”

Indeed.”

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