PART OF THE 2022 FINANCIAL FUNDAMENTALS SERIES
Editor’s Note: We are in the midst of a dozen year bull market in the US, creating an environment in which fundamentals are less in focus. This series of posts explores the less complex tactics of the personal finance playbook.
At one time, the practice of charging interest when loaning money was outlawed.
If you lend silver to my people, to the poor person among you, you must not be like a creditor to him; you must not charge him interest.
Exodus
At other times, there are examples of a ruling body permitting its own constituents to lend and charge interest only to outsiders.
You may charge a foreigner interest, but you may not charge your brother interest, that the Lord your God may bless you in all that you undertake in the land that you are entering to take possession of it.
Deuteronomy
And thus begins the long, strange history of debt.
🔸🔸🔸
Student debt is a unique brand of this financial instrument. That’s because education is almost universally considered a good thing; something any and all people should invest in.
In November of last year, the Wall Street Journal published a scathing piece on the subject of student debt, specifically keying in on the University of Southern California’s social-work graduate degree program.
Recent USC social-work graduates who took out federal loans borrowed a median $112,000. Half of them were earning $52,000 or less annually two years later. Compared with other master’s-degree programs at top-tier U.S. universities, the USC social-work degree had one of the worst combinations of debt and earnings.
As the WSJ points out, this USC program is but one example of a risky, to say the least, investment in education. And it’s a glaring one.1 There are several heartbreaking examples of recent graduates with crippling debt in the article.
The median debt created by the USC program is $112K. The article highlights four students with debt owed to USC ranging from $131K to $200K.
While these individual outcomes are horrifying, in the macro, the scale of this particular USC program is breathtaking. Graduates between 2015 and 2018 collectively borrowed more than $500 million dollars in federal student loans,2 more than those at any other graduate program in the country. This is a big business and business has been booming.
🔸🔸🔸
The federal government requires colleges to report how much, on average, students in different income brackets are charged after scholarships and other discounts. This is commonly called the net price paid.
These data are publicly available so we have below a list of the most expensive undergraduate universities with a greater than $1B endowment for students with income less than $30K.
The University of Southern California does squeak in at the bottom of this dubious list. Again, this is not about USC specifically, but USC and its peers on this list are in the envious position of having a desirable brand and tremendous pricing power. For universities in this group, over the last two decades, the business of higher education has been booming. In aggregate, the top 120 university endowments have grown from $194B to $502B over this time.3
Buy now, pay later (i.e., student loans) is almost certainly a contributing factor to university pricing power and thus a driver of endowment growth.
🔸🔸🔸
The US government is responsible for more than 90% of student loans. In a free market, loans associated with a degree with a price tag of over $100K and an average salary of $52K could be seen as quite risky.4 Said another way, the loans provided to the students of the USC social-work program would likely be considered “subprime” if not for the fact that it’s the government on the other side of this transaction.
If student loans were a fully private market without the federal government’s involvement, the market might look quite different.5 As it stands today, the market generally assumes all student loans are created equal.
Students, often young and less financially savvy, have been willing to take on large loans in the noble pursuit of education. This has left the government with a fast approaching $2 trillion of student loans, that it seems it has started to realize might be less likely to be repaid than originally thought.
🔸🔸🔸
Universities are exempt from paying federal taxes. Tax-exempt organizations are also colloquially known as “not-for-profit” organizations. To my eye, this public relations shift away from having profit in the industry name was intentional. These organizations, universities and otherwise, did not want to be forced to not turn a profit. Some profit is certainly desirable to allow the organization to flourish. That said, this shift highlights something else in a glaring way — the lack of contribution to the country’s tax system. That ends up being a bad look when balance sheets (i.e., endowments) are increasing at growth rates that Silicon Valley tech companies would envy.
Universities find themselves in a unique market. These institutions are acting like most other organizations in a capitalist economy. They are pushing the limits of pricing to enhance the health of their respective institution. The problem is — these are tax-exempt organizations. Not only are these universities not paying taxes to Uncle Sam,6 you could argue Uncle Sam is ultimately the customer of these institutions. The students clearly can’t afford the tuition charged by these universities, so it’s the federal government footing the bill.
There’s a clear argument to be made that this industry is no better than “big pharma” or “big tech” — at the very least it does not nearly get the correct portion of scrutiny given the carnage it has profited from.
🔸🔸🔸
It’s outcomes like those published in the WSJ piece that bring people7 to be anti-college. It’s a poor investment, they say. The mantra of “follow your passions” is a classic piece of advice from members of this group.
As a first generation college student in my family, the mantra that was beat into my head was, “You go to college because that’s what you do after high school.”
It was as if my mother wrote that line in the 2002 cult classic Orange County.8 College has historically been the best path to not having to do mind-numbing and/or backbreaking labor.9 If the average outcome changes, resulting in other paths to rewarding careers, universities will be forced to repackage and reprice their offerings.
One would think with all this involvement from the government, officials would have some power to balance this market to some sort of equilibrium where the institutions can still profit without students getting buried in debt. As it currently stands, the federal government is being fleeced by these institutions. And it’s all behind the guise of furthering education.10 Sadly, it looks like it will be tax-payers that are going to be left holding the bag.
🔸🔸🔸
Ultimately, nothing is completely black and white. Not all debt is evil bad. In part two, we will focus on how the less financially savvy can also miss out by not using debt to their advantage. Some debt has, historically, helped the average American create wealth more effectively than any other vehicle.