Are Bachelor's Degrees Worth the Debt?

Jeffrey Selingo warns in the Wall Street Journal that, increasingly, they are not, depending on where you go. In that, he agrees with I wrote just last week.

Some, like Ben Bernanke, claim that student debt is not inflating a higher education bubble that will cause a financial crisis, because the vast majority of student loans are backed by the U.S. Government. So the taxpayers are on the hook and not the banks. Banks will not be in financial distress if students default.

Bernanke’s claim is revealing in that it is clear he views the financial system as the economy. It seems that if the financial system is afloat, everything is okay. Such reasoning ignores that what helps people achieve their ends is not money per se but the actual producer and consumer goods that are produced throughout the social economy.

This fact points to the economic problem with government guaranteed student loans. Investment made possible by subsidized loans of newly created money contributes to an unproductive use of resources.

In the first place, it is not at all clear that the educational payoff matches the expense. According data from the Collegiate Learning Assessment, 45 percent of students its sample demonstrated no significant learning in their first two years of college and 36 percent demonstrated no learning in four years. According to the National Assessment of Adult Literacy, from 1992 to 2003, literacy among college graduates declined at about the same rate that enrollment grew; All the while government grants and guaranteed student loans significantly increased.

This dismal educational payoff is largely because a much of the greater tuition payments made possible by government student loans have been absorbed by increases in personnel. For example in 2007, colleges utilized 13.1 percent more employees to educate the same number of students than they did in 1993. The vast majority of growth has been in administrative staff. In fact, over a fifteen-year period postsecondary administration grew more than twice as much as instructional staff. From 1976 to 2005, the number of administrative staff per student more than doubled; from 3 per 100 students to more than 6 per 100 students. The financial effect of administrating bloat is magnified by the fact that the average mid-level and senior-level administrative salaries are noticeably higher that the average faculty salary.

Not surprisingly the largest increase in college employment expenditures is for administrative staff. Between 1993 and 2007 expenditures per student for instruction increased 39.3 percent, expenditures in research and service increased 37.8 percent. At the same time, however, expenditures per student for administration increased by 61.2 percent

Making available the college experience, many resources must be used. Land, labor, buildings, desks, computers, energy, all sorts of amenities, etc. These are resources that could be used elsewhere. If they are being used to provide education merely due to government subsidies, they are actually more valued in other uses.

For a lot of students college is more a consumption good and less an investment. Multimillion dollar facilities designed to satisfy student recreation need. These include 53-person jacuzzi’s; massage and pedicure services; movie theaters, and ballrooms.

That student debt is fueling malinvestment is indicated by the rising delinquencies. Like the Old Gray Mare, the College Wage Premium ain’t what she used to be.

Increasing default rates prove this. What matters is not only the level of a post-college salary, but the level of that salary relative to the cost of college. Value of the product is not as great as anticipated. Increasing number of students put at risk of not paying off loan.

Additionally, many students who have borrowed money for college do not complete it. Six-year college completion rates at public four-year institutions have remained just below 55 percent for a decade. At the same time the four-year rate has been stuck around 30 percent.

Colleges, universities, and their students are caught in a costly game of Leap Frog. The perceived need for financial aid and loans results in more government subsidies. More debt results in more demand for college and higher tuition. Higher tuition increases perceived need for more debt. More student debt increases the demand for college which increases tuition price. On it goes. The only solution would be to get the government out of the business of subsidizing student debt so at least decisions of students to borrow and banks to lend, and colleges to set tuition will be made based on economic reality and not the shifting sand of monetary inflation.

Bernanke Is Killing Savers

Financially that is. Interest rates hit another all time low this past Monday. Yield on the 10-year Treasury note reached a whopping 1.46%. The average interest rate on a 5-year CD was 1.09%. It is as the Fed passed out to all of its governors t-shirts that read, "PLEASE do not save and invest."

10 Year Treasury Rate data by YCharts

Sadly, increases in savings and investment is precisely what an economy trying to recover from a bad recession needs more than ever. The malinvestment that culminated in the bust of 2008-09 resulted in massive capital consumption. What the economy needs is for our stock of productive capital to be rebuilt. This can only occur out of savings and investment. If the Fed is basically telling people not to save by keeping interest rates so low and by attempting to prop up unwise investments, we have should expect nothing other than anemic economic performance in the near future.

How Fed Stabilization Policies De-Stabilizes

One of the commonly-cited reasons for the existence of the Federal Reserve is to stabilize financial markets and thereby the economy. Ben Bernanke repeated this claim during one of his recent lectures at Georgetown.

Those who understand sound capital theory recognize, however, that the Fed is actually in the de-stabilization business. At the macroeconomic level, the Fed, when it acts to lower interest rates, bankrolls artificial credit expansion (lending not funded by voluntary savings), this stimulates malinvestment by encouraging too much investment at production stages away from consumption and not enough investment at stages closer too consumption. The stock of existing capital goods gets stretched both ways, until a crisis occurs, resulting in recession and liquidation.

A story from Bloomberg news last month documents a certain path some of the malinvestment takes at the microeconomic level. Because the Fed has done everything it can to drive interest rates into the ground, individual investors are taking on more risk is search of higher returns. No doubt this behavior is encouraged because the U. S. Government has a recent track record that clearly communicates it is ready to bail out any investment that is big and bad enough.

What Malinvestment Looks Like: Spanish Edition

The malinvestment in Spain falls mainly on the plain (or words to that effect). I have already blogged about photos, satellite and otherwise, documenting ghost towns and empty, sometimes only partially completed, and abandoned construction projects in Florida and China. These projects are what they are because their builders ran out of money and there were not enough potential buyers to make the projects salvageable.

Business Insider has a collection of satellite photos of new Spanish airports (one of which forced into bankruptcy) and several towns with eerily similar empty, sometimes partially completed, housing developments. One of the towns featured in the collection is Soto Del Henares, where more than 13,500 homes have been built while only 3,000 people live there. Prudent Investor kindly posted a 4-minute video tour of Soto Del Hanares back in April.

These photos and video are further testimony that money cannot buy prosperity. Those who think that merely boosting nominal spending will usher in economic expansion mistake GDP for the social economy. They are tangible evidence of what is wrought by artificial credit expansion: wasteful investment and capital consumption. They also provide an answer to those who wonder why an economy cannot adjust from malinvestment back to productive investment as fast and as easily as entrepreneurs can undertake the initial malinvestment. During inflationary booms, some capital is sunk into capital goods that are not easily convertible to other uses. These photos and video should be a lesson to us all.

Economic Recovery Versus Financially Fragile

The Wall Street Journal reports that "nearly half of Americans are financially fragile." It cites an NBER study using data from the TNS Global Economic Crisis survey. It asked, among other things, how easy would it be to come up with $2,000 for an unexpected expense within the next 30 days. The survey indicated that "46.5% of all respondents are living very close to the financial edge." They include those who were certainly unable to get the money and those who could do so only by taking "extreme measures."

The story notes that it is not only lower income households that are on the precipice. Financial fragility is determined by more than income levels. It also has to do with indebtedness. Nevertheless, it is further evidence that, as I wrote almost two years ago,  Keynesian economic policy is a failure. Massive fiscal and monetary expansion has propped up the stock market, wall street investment firms, and large commercial banks, but has done little else except prolong the readjustment process necessary to right the tremendous amount of malinvestment still in our economy.

Ghost Town: U.S. Edition

It turns out that China is not the only nation with a boom in ghost towns. A surprising number of cities in the United States has significant areas where a majority of houses are unoccupied. Douglas McIntyre reports that

There are several counties in America, each with more than 10,000 homes, which have vacancy rates above 55%. The rate is above 60% in several.

The story features the top 10 counties, all of whom have populations greater than 10,000, with occupancy rates from 54% to 66%.  The photos accompanying the story illustrates the reason why capital cannot painlessly be reallocated in a bust, as Paul Krugman would have us believe.

During booms fueled by credit not funded by voluntary savings, some malinvestment is sunk in non-convertible capital goods. Many of these structures now have very little if any economic value and the scarce capital goods used to produce them cannot easily be extracted and converted to other uses. This capital, consequently, is lost and can only be built up again by an increase in voluntary saving.

GDP Growth through Economic Waste

Last December I blogged about malinvestment in China manifesting itself in ghost towns. Now, thanks to Isreal Curtis, I've been made aware of a stunning and revealing news report documenting the same phenomenon.

You may have already seen this, but in case you haven't, this fascinating report is definitely worth watching. SBS Dateline, an Australian news program went to China and explained how the Chinese state, in an effort to continually expand GDP, continues to build building complex after building complex, even though several are virtually uninhabited.



In the report, real estate analyst Gillem Tulloch is interviewed and reports that there are 64 million empty apartments in China and they are still building!

Important takeaways from this story:

• GDP is merely a measure of net income and spending flows, not wealth.
• Productive investment is investment on goods people actually want, not wasteful government spending on whatever boosts GDP.
• Central planners can waste a tremendous amount of scarce factors of production (I know this is not exactly news, but it something to see it so starkly portrayed).

Extraordinary Speculative Activity Means There is a Bubble Somewhere

Dallas Federal Reserve Bank President Richard W. Fisher said in a speech in Berlin yesterday that the Fed does not need to expand the monetary base any more because right now he sees "Extraordinary Speculative Activity" in our economy. As he put it, "There is a tremendous amount of liquidity sloshing around." That could explain why stock prices have increased like they have since Money Printing 2 was announced. Economist Gary Shilling is seeing what he calls "bubble-like characteristics" in the stock market.

We can maintain nominal spending all we want, but if this spending is on wasteful investment, it will make us poorer, not richer. Due to malinvestment, capital is being consumed, not accumulated. This will make us less productive, not more, and we will enjoy a lower standard of living not higher.

What Malinvestment Looks Like: Chinese Edition

Back in October I blogged about aerial photos of unfinished and abandoned real estate developments in Florida.  They are a pictorial manifestation of capital malinvestment undertaken in the housing bubble.

It appears that similar activity may have been taking place for awhile in China. A few days ago Business Insider published photos of, at most, barely occupied developments in various regions of China. Below is a picture of a residential apartment complex in Zhengzhou New District. It is completely empty.

  

Banks in China have now been told by banking regulators to cease lending to companies for the purchase of fixed assets, including real estate. It sounds as if Chinese authorities are beginning to suspect a bubble.

Inflation Cannot Undo the Effects of Malinvestment

A common policy suggestion in times of financial crisis is for central bankers to pump large sums of money into the economy. The hope is to fix the problems associated with recession through increased aggregate spending. Quantitative easing, however, never fixes the problems resulting from malinvestment, because the problem is a capital structure that is out of balance. Inflation certainly does not undo the depression in those markets where malinvestment was the worst. Look at the some of the effects of monetary inflation undertaken by the Fed at the end of 2008.

Everyone knows that the housing bubble made up a large part of the inflationary boom that brought about the Great Recession. As the housing bubble burst, mortgage backed securities began to lose value and the financial crisis was on. The effects of quantitative easing on the housing market has been negligible.

Meanwhile, the new money that has been created by the Fed is being invested wherever their is a pulse of positive yield. One of this year's popular investments are in emerging market bond funds, as shown in this chart from Business Insider.

The moral of the story is that reflation is inflation and new inflation does not undo the negative consequences of past inflation. It results in further wealth redistribution and further malinvestment.

What Malinvestment Looks Like: Aerial Photo Edition

Thanks to Greg Ransom for posting a link to these stunning photos of Florida real estate malinvestment on the Mises Economics Blog. They provide literal pictures of capital consumed in projects that could not be completed due to entrepreneurs being led astray by the strange woman of artificial credit expansion. As the original post states:

The images of half finished (and barely started) developments are strangely beautiful, with a geometric symmetry that belies the state of human misery these developments represent: Lost deposits, bankruptcy, mis-allocated capital. 

Appropriately, Ludwig von Mises used the analogy of a builder to explain the fundamental nature of the malinvestment that causes the business cycle. Entrepreneurs are led astray by artificially cheap credit to undertake investment projects for which there is not enough real capital goods to bring all of them to completion. Many of these projects will fail, with some ending in bankruptcy. In Human Action Mises likened the situation to a builder who tries to build a building with too large a foundation, only to realize much later that he does not have enough bricks to complete the building.

The whole entrepreneurial class is, as it were, in the position of a master-builder whose task it is to erect a building out of a limited supply of building materials. If this man overestimates the quantity of the available supply, he drafts a plan for the execution of which the means at his disposal are not sufficient. He oversizes the groundwork and the foundations and only discovers later in the progress of the construction that he lacks the material needed for the completion of the structure. It is obvious that our master-builder's fault was not overinvestment, but an inappropriate employment of the means at his disposal.

These pictures illustrate one hundred and eight words.

What Malinvestment Looks Like: Forever Empty Office Buildings

Mark Thornton has justly received notoriety for his work on the Skyscraper Index as a harbinger of recession following an inflationary boom. His thesis is that record-breaking skyscrapers are most often undertaken toward the end of an inflationary boom and the beginning of their construction is a good sign that recession is not too far around the corner. He provides empirical evidence as well.

Well, Bloomberg News just published a piece about the Dubai commercial real estate scene that corroborates Thornton's theory. The global boom fueled massive office construction, including the newly-christened tallest building in the world, The Burj Dubai. Presently office space in Dubai is only 40% occupied with another 20 million square feet of space that is scheduled to be complete over the next four years. There is so much office space available that some buildings will be vacant forever. Ladies and Gentlemen, THAT's malinvestment.

Of Gravy and Doughnuts

The government gravy still keeps flowing. On the same day that the Obama Adminstration forecast a record high annual budget deficit of $1.4 trillion (that's trillion! with a tr in front, not a b as in billion), President Obama called for the establishment of a $30 billion small business lending fund. The stated goal of the program "is to make sure the people who are looking for a job, can find it." The idea is that the government would invest $30 billion dollars in community banks who would then find it easier to loan to small businesses. It seems that the official line is that there is no economic problem that can't be solved by throwing billions of dollars at it.

It's understandable why the Administration might be advancing this particular policy. It is pretty clear from the data that the Great Recession was accompanied by commercial lending falling off a precipice.

Don't forget, however, that if commercial lending collapsed dramatically (although note that it is still greater than in mid-2006, not all that long ago), there is a reason for it. One thing holding lending back is the current regime uncertainty I've discussed before, fostered in part by the very budget deficits and government debt to which this program contributes. Another is the fact that massive malinvestment during the 2000s resulted in large scale capital consumption and financial institutions are still working on rebuilding their capital.

No matter how much we'd like it to be otherwise, capital cannot be created out of thin air. Capital goods don't come into being by clicking our ruby slippers together and chanting "There's no place like D.C. There's no place like D.C." No, capital must be accumulated through the allocation of real savings. Government loans and subsidies to small businesses merely give them the ability to bid the ownership of such goods away from their most highly valued use. It does not add to the capital stock, it merely redistributes the existing capital stock. We should never assume that investments made possible only due to government subsidies will wisely use the capital invested.

A case in point is the story of how the lives of inhabitants of a small Iowa town were forever made more dismal due to our friends at the Small Business Administration who were there to help. Many years ago this town had a lively doughnut shop that was one of the townspeople's favorite meeting places and served the best glazed fried cinnamon rolls on the planet. The firm maintained a profit because in addition to the retail shop it also daily serviced a very large account at the town's largest employer.

One day a businessman who owned a doughnut shop somewhere else received an SBA grant to also operate a wholesale doughnut bakery in town. Because of the grant, he was able to underbid the established firm for the account at the large employer.  He won the bid and the other doughnut maker had to close up shop. A couple of years later the SBA grant to the second doughnut maker ran out and he was not able to profitably operate either. He had to shut down and the little town in Iowa was left with only holes where the doughnuts used to be. The moral of this true story is that whenever government intervenes with commercial subsidies, resources are misallocated from the point of view of society. Scarce land, labor, and capital goods were used less efficiently than they would have been without the intervention, and the community was left worse than before the government stepped in to support commercial activity.