Student Loans: The Next Big Economic Bubble?

By: Chitanya Ajjarapu

A chronic increase in the costs of education suggest another bubble has formed.

It’s been more than a decade since the great recession of 2008 rattled our financial markets and economy, and when we are asked what caused the recession or the factors that lead up to it, one answer remains infamous: the housing bubble. Long story made incredibly short, the housing bubble refers to a very fast paced and large increase in the value of houses. A trend that continued until 2006. The bubble “popped” when these housing prices fell back down back to their regular values. The crash then occurred because so many financial flows were connected to the prices of housing. As economist Alan Blinder describes it, a bubble is a “large and long-lasting deviation from an asset’s fundamental value.” Because of the subjective nature of the description, many economists have trouble identifying bubbles in foresight, and can only recognize one after it pops. However, with the housing bubble still relatively fresh in our minds, many are trying to identify and curb bubbles before too many factors rely on it and they pop. Many are starting to speculate that a new bubble that is existing in our times is student loans.

First, to be recognized as a bubble, at least in Blinder’s eyes, the asset’s change in value needs to be able to be defined within the three criteria: large, long-lasting, and deviation from the fundamental value. Let’s start with large: using 1940 as a reference point, the yearly tuition to attend the private university Yale, one of the highest ranked universities in the world, would have cost $450 per year, adjusting with inflation to about $8,200 in current times. This is a far cry from the $53,000 it costs each year to attend Yale today, more than five times the previous amount. It’s been nearly 80 years since the blissful days of cheaper education, and the price arguably had to rise as consumer tastes changed and started to view education as inelastic and necessary, but whether or not this warrants a five times increase is up for debate, which moves into the next question, what is the fundamental value of an education?

It’s hard to put a price on the fundamental value of an asset, especially if that asset is education. With all assets, a “fundamental value” requires looking at the historical costs of the asset, the yields it procured, and people’s rapidly changing views on it. If we take a different approach and value the education based on what the students give up, the opportunity cost of the education, we can ask what the fundamental value of an education should be. In addition to the tuition that students have to pay, they also give up the opportunity to work for four years instead of going to college. Such work averages out to $35,256 per year. Combining this with the average cost of tuition $34,740 gives a bachelor’s degree an economic cost of about $280,000 over the four years. Therefore, theoretically speaking, the value for bachelors education has to exceed this cost in order to have some kind of return on investment, and it definitely does. A bachelor’s degree can’t expire, and is capable of pulling an average of around $60,000 per year, meaning that on paper such a degree is paid off in 5 years. An unfortunate truth that is looming over all of us is that the sacrifices made are a lot more complex than this.

Experts suggest that nowadays 8 million students are defaulting their federal loans. The balance for the whole nation has reached $2 trillion, and a lot of that money won’t get paid back. The pressure that is put on such students is immense. While in the housing bubble, sleazy mortgage lenders were enticing financially illiterate families to buy houses they couldn’t afford and then selling them off up the derivative chain to investors, now it is the government that is holding on to the loans, and a multitude of factors pushing students to take the loans. When these loans are defaulted, student credit scores are butchered, and many will find trouble being able to finance cars and houses. Sacrifices that definitely deviate from what the fundamental idea of an education should be. The last point is also equally as hard to define: long-lasting.

What year should we use as a reference point? At what point did the price of education stop reflecting the real value that comes along with it and start riding the psychological euphoria that causes a rise to bubbles in the first place? These are all questions that are easier to answer about a bubble once it has popped and its damages have spilled over onto the economy, but that hasn’t happened yet, and might not happen for a long time. Till then, we can only use historical data to see how much prices have risen over the years.

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Indeed, even viewing the prices relative to more contemporary times, the fact that price is greatly deviating from the financial returns is staggering.

You may be asking yourself, will the student loan bubble give rise to problems the same way the housing bubble did? Luckily, the silver lining to the incredibly large and dark cloud is that it “probably won’t”. The key difference between the two bubbles is who the beneficiary to these assets are. In the housing bubble, unscrupulous practices and incentives drew in crowds with minimal regulation and responsibility allowing them to run amok and collectively leave a razed economy in its wake. The federal government holds student loans, with a sole, inherently altruistic purpose of providing educations to those who cannot front the money themselves. Furthermore, the loans are not being packaged and sold off the same way mortgages were, and the fact that it is in the hands of the government gives it an implicit insurance that defaults of such loans won’t financially ruin colleges and universities across the nation. Our economy can sleep easy at night knowing this fact, but what about our metaphorical homeowners; the students who borrowed so much and fearfully may get so little?

A key factor in the housing crisis was that when the housing value fell below their mortgage, even prime homeowners walked out and chose to default. This is much harder to do regarding student educations. Can a student walk away from all the work they put into their education already? Can they decide that an education is simply not worth the financial costs anymore, and walk away from their degree. These are questions that are simply too hard to answer, and are questions that many of us hope not to have to answer in the future. A bitter truth that is becoming realized is that the costs to keep oneself educated is growing increasingly steep, but it is as Barack Obama once said, “You think education is expensive? Wait till you see how much ignorance costs.”

Works Cited:

Blumenstyk, G. (2013, July 25). Post navigation. Retrieved from https://www.chronicle.com/blogs/ticker/ignorance-isnt-bliss-when-it-comes-to-quotations-about-ignorance/63681

Costs. (n.d.). Retrieved from https://finaid.yale.edu/costs-affordability/costs

CPI Inflation Calculator. (n.d.). Retrieved from https://www.bls.gov/data/inflation_calculator.htm

Hardiman, K., Gazette, C. P., & Ap. (2018, October 22). The student loan bubble might be about to pop. Retrieved from https://www.washingtonexaminer.com/red-alert-politics/the-student-loan-bubble-might-be-about-to-pop

Josephson, A. (2018, May 15). The Average Salary by Education Level. Retrieved from https://smartasset.com/retirement/the-average-salary-by-education-level

Miller, D. (2017, February 22). Student Loans – A Multi-Generational Curse. Retrieved February 23, 2017, from https://milleronthemoney.com/student-loans-multi-generational-curse/

Sourmaidis, D. (2018, September 25). Rising Tuition Costs and the History of Student Loans. Retrieved from https://www.studentdebtrelief.us/news/rising-tuition-costs-and-the-history-of-student-loans/

The $1 trillion student loan market begins to implode – Department of Education shows two-year default rates at for-profit colleges up to 15 percent. Student loan debt increasing at a rate of $170,000 per minute. (n.d.). Retrieved from http://www.mybudget360.com/one-trillion-dollar-student-loan-market-begins-to-implode-student-college-debt-for-profit-debt-lower-wages-higher-costs/

The NCES Fast Facts Tool provides quick answers to many education questions (National Center for Education Statistics). (n.d.). Retrieved from https://nces.ed.gov/fastfacts/display.asp?id=76

Wage and Hour Division (WHD). (n.d.). Retrieved from https://www.dol.gov/whd/minwage/chart.htm

Photos retrieved from:

Student Loans – A Multi-Generational Curse