Feb 13, 2013

Posted in Education

The Housing Bubble and the Higher Education Bubble

Duke LawProf Paul Carrington offered some interesting history lessons about law school reform in the 1970s, including some thoughts from then-White House staffer, and future Senator Daniel Patrick Moynihan:

The third year of legal education is a waste of time that raises the cost of legal services. Better to cut the third year, according to the study, and to shorten the path to law school with the admission of students who have completed only three years of college. That way, only five years of higher education would be needed to become a lawyer.

“I still think those are pretty good ideas,” Carrington said Saturday during a public hearing sponsored by the ABA Task Force on the Future of Legal Education. Proposals for a two-year legal education are back in the news today amid calls to reduce the cost of law school to reduce the burden for graduates struggling to find jobs. The task force, created last summer, heard from more than a dozen speakers during the ABA Midyear Meeting in Dallas. Its aim is to issue a report by the fall and bring its recommendations to the policy-making ABA House of Delegates in February 2014.

Soon after his study was completed, Carrington told the task force, he had a chance encounter at O’Hare International Airport with Daniel Patrick Moynihan, then a White House staffer. Moynihan observed that the guaranteed student loan program was “a national disaster” that would drive tuition through the roof, causing higher education to get drunk on borrowed student money.

Last week in property class I covered mortgages, and offered a discussion on the subprime mortgage crisis. I took some time to explain to the students the similarities between the housing bubble and the higher education bubble (grossly oversimplifying).

Fannie Mae sought to give home mortgages to anyone, regardless of how poor their credit was. This led to subprime lending (what some dubbed predatory) where people who had no prospect of paying back the mortgage were given lots of money. This guaranteed lending led to increases in the price of what properties were worth. This market could only sustain itself so long as the prices of housing continued to increase, and interest rates were kept low. Once the housing prices plummeted, and the interests rates were increased, the bubble burst, and the entire market imploded. People walked away from home mortgages, because it was cheaper to default. The federal government had to bail out Fannie Mae, and countless houses were left abandoned on the market for foreclosure.

This is a forecast of what will happen with student loans.

As Moynihan wisely observed decades ago, Sallie Mae (Fannie’s student-loan-lending sister) will guarantee mortgages to anyone, regardless of whether or not they will be able to pay it back (measuring likelihood to repay a home mortgage is substantially easier than measuring likelihood to repay a student loan). Similarly, guaranteed lending, as Moynihan remarked, drives tuition through the roof.  This market can only sustain itself so long as graduates can continue to obtain jobs that allow them to make ends meets with their debts. My friend Jim Chen observed that “Law graduates need an annual salary equal to two thirds of their law school debt to make law school viable.” However, if this trend ends (and signs are, that is is probably on its way out), and graduates can no longer pay off their debts, the entire market will fall apart.

However, unlike defaulting mortgages, graduates can’t walk away from the loans because the debts are not dischargeable in bankruptcy. This loan continues after death.

The reactions from my students were interesting. A number of the students were quite aware of the situation, and one cited recent articles in the New York Times. This was reassuring. Many other students had absolutely no idea. This was troubling.

I explained to them that student loan debt was not dischargeable in bankruptcy, a thought that many of them had never considered. I also told them that if they need extra money during the year, that it was better to go into credit card debt (which can be discharged in bankruptcy) than take unsubsidized student loans (that cannot be discharged, and collect interest during law school).

This will not end well for students and schools.

Print Friendly
  • http://www.facebook.com/anthony.bruno.35110 Anthony Bruno

    This really is *the* issue for people under 35. It’s a shame that Romney and the GOP failed to make this an issue in the last election, especially since Obama only promised more government backed loans, more crippling debt, and repayment plans that offer extreme negative amortization (how wonderful!). (For those of you who don’t know what negative amortization is, it is a plan where your monthly payments on your loan are not big enough to cover the accrued interest for that month; as a result, your debt actually increases as you make payments. Anybody in “income based repayment” (IBR) likely has negative amortization).
    Not once did Obama offer a credible vision to reduce the cost of tuition and I suspect he has little interest in doing so since academia is in many respects an arm of the DNC. That said, I am not so sure that people under 35 do not deserve to be in this pickle, given their long history of voting for Democrats who have supported policies that have only caused tuition to rise at artificial and unaffordable levels.

    • http://joshblackman.com/ Josh Blackman

      Thank you for this comment Anthony. I have roughly $120k in student loans from undergrad and law school. I pay $1,600 a month–and that is basically the minimum payment, not much going to principal. I pay more for loans than my rent and car payment combined. I am grateful that I can afford to pay for these loans, but many of my colleagues cannot. IBR is crushing debt that one cannot escape from. Though I have one friend who made the decision to never pay his student loan debt, and will remain on the IBR minimum for the rest of his life.

      • http://www.facebook.com/anthony.bruno.35110 Anthony Bruno

        I am actively trying to pay off my debt, which is large but manageable (around 80k). Others I know, on the other hand, are opting for the “IBR now and hope for forgiveness later” plan.

  • http://www.facebook.com/anthony.bruno.35110 Anthony Bruno

    One thing I forgot to mention – although the debt is not dischargeable in bankruptcy, you can have it forgiven. Under the income based repayment plan, if you remain in the plan for 20 (or 25 years – not sure which), and make your payments, the debt is supposed to be forgiven at that time.

    While this may provide students an exit down the road, I don’t see how the government affords the costs of forgiveness, since the gov’t is now the direct lender.