The Student Loan & Credit Bubble

I know many of you real estate investors have college bound or kids in college. Doesn’t the image of young students playing with bubbles bring back some fond memories for many people? When one thinks of bubbles and students together, a person may imagine a young child playing in a sandbox while blowing bubbles during their earliest years of Elementary School. In this same imaged situation, one may also see the bubbles eventually popping a bit too soon for the young Preschool or Elementary School student. Sadly, the same young student may then throw a tantrum because their bubbles popped too early, and soaked them with oily bubble residue.

In the 21st Century, a person may now envision a “Student Loan Bubble” which continues to “snowball” in size each and every single year, and soaking the students or older workers with massive amounts of Student Loan Debt, which may haunt them for many years or decades. Per The Consumer Financial Protection Bureau (CFPB), both private and federal Student Loan debt has far surpassed the Trillion Dollar mark in recent years. After the purchase of a new home and the corresponding mortgage debt, typically Student Loan debt is at least the #2 most expensive type of debt that a high percentage of Americans are financially burdened with today.

To better understand why interest rates costs and fees are increasing for Student Loans as well as to understand why tuition costs are increasing partly due to weaker state budgets which supposedly can’t help subsidize many of their respective state colleges and universities as in previous “booming” economic years, a person needs to truly comprehend why our financial markets are so convoluted and nonsensical today. Why don’t all of these billions or trillions of dollars of bailouts go instead to students who will represent the future of America?

Bubbles and Bailouts

To best understand why the “Student Loan Bubble” continues to grow in massive dollar amounts each year, one must better understand how our oxymoronic “Fiat Money” (or money or assets backed by a seemingly quite contradictory “thin air”) System really seems to exist and operate. The Federal Reserve by way of the Federal Open Market Committee (FOMC) creates “Fiat Money”, and then Banks leverage these funds in some of the following ways:

1.) If our government is supposedly cash poor, then the U.S. Treasury issues Bonds or “IOUs”. The FOMC may then approve these new Treasury Bond purchases on the “Open Market”, and then third-party Bond Dealers will then sell them in order to raise new cash for our government.

2.) If the Fed hopes to improve the money supply, they may purchase more Bonds themselves.

3.) In order to purchase these Bonds, the Fed will provide electronic credits to banks as payment for these Bonds. The vast majority of “money” found in the USA today originates in the form of computerized digits or credits.

4.) With our “Fractional Reserve Banking System”, many of the largest banks may then loan them out to their banking customers or invest in the Derivatives Markets (i.e., Credit Default Swaps, Interest Rate Option Derivatives, etc.) in amounts leveraged upwards of between 10 and 50+ times the amount of their actual cash deposits on hand. Sadly, a high percentage of the largest U.S. banks have been using either their banking customers’ funds or bailout funds from the Federal Reserve to invest in the more speculative and risky Derivatives Markets in recent years in order to try to create much higher yield returns for their financial institutions.

5.) The Fed may also create more money “out of thin air” for the banks by modifying or changing the reserve requirements for banks nationwide. When the Fed reduces the reserve requirements for banks, this means that they may lend out more of their cash on hand or in their computer systems.

6.) When banks reach cash reserves limits which may be considered too low, then the Fed may give them “Discount Rate” bank loans for short periods of time at incredibly low rates of interest. Since the start of the ongoing “Credit Crisis” back in 2007 and the near financial implosion in the Fall of 2008, the Fed offered billions and trillions of dollars of “bailouts” or “credits” to many of the largest banks, insurance companies, and investment firms in America, and even to foreign investment firms in order to allegedly “save” both America’s and the world’s financial system.

7.) In recent years, banks have been paying their customers somewhere in the range of just 0.5% (or below) to 1%+ rate ranges for checking and savings accounts. After factoring in taxes, inflation, and bank fees, many of their investment returns are truly negative. Tragically, many of the largest U.S. financial institutions are not lending the majority of their billions and trillions of dollars of “Bailout” funds to consumers. Instead, they are investing in the complicated and highly risky Derivatives Markets, which is somewhat of a glorified “financial and insurance bet” like a person may bet at their local gambling Casino. For example, a “bet” on the directions of future interest rates is one of the most favored “Derivatives Bets” for financial institutions around the world.

8.) While the “Student Loan Bubble” may seem staggering at $1 Trillion Dollars plus today, it is relatively miniscule when compared with the size of the world’s “Derivatives Bubble” which may now be at all-time record highs worldwide in amount estimates ranging from $1,000 to $1,600+ Trillion combined worldwide, depending upon various wide-ranging financial estimates.

QE Infinity, Assets, and Loan Prices

What type of an impact do QE (Quantitative Easing) strategies have on the rampant rates of inflation we have all seen in recent years? More Americans are attending colleges or universities today than ever before in the history of our nation, but college tuition costs are also reaching all-time highs. In spite of the ongoing sluggish U.S. economy since 2007, inflation costs have absolutely skyrocketed as noted by much higher college and university tuition costs, gasoline costs, food costs, and rent costs.

Historically, a sluggish economy tends to lead to a reduced demand for consumer products or loan requests, which may then drive down the prices even further. Yet, the U.S. has experienced skyrocketing asset appreciation and inflation directly linked to the years of QE Strategies in which the Federal Reserve has been purchasing upwards of $85 Billion per month of assets such as stocks, bonds, and mortgages. When the “Fed” magically creates more money “out of thin air” at a much faster pace than in past years, then “too much money” chasing “too few goods and services” typically leads to much high rates of inflation as taught in Economics courses at various colleges nationwide.

The Dow Jones index increase of 10,000+ points between the March 2009 market lows (near the 6,500 range) and the more recent 16,500+ Dow Jones levels seen in 2014 are a prime example of increasing assets prices for the stock market directly as a result of QE strategies. Additionally, the 6% – 35% plus annual rates of median home price increases in various metropolitan regions (i.e., Phoenix, Las Vegas, Los Angeles, etc.) over the past few years are tied to QE strategies, which are artificially boosting asset values and reducing interest rates to near or all-time low levels.

The Fed is truly the primary buyer of stocks, bonds, and mortgages. Over the past several years, something like 97% of all funded residential home mortgage loans were either government backed or insured loans by way of FHA, VA, USDA, Fannie Mae, and Freddie Mac. Historically, investment options which are driven more by supply and demand in the private sector are usually more affordable for U.S. consumers than government backed products or services.

Hyperinflation and College Tuition Costs

The cost of attending colleges and universities has risen dramatically over the past few decades. As compared with the Consumer Price Index (CPI), college tuition costs may have increased by almost 500% between the years 1985 and 2011 as compared with the much lower 114% plus CPI index estimate during the same time span, per the www.inflationdata.com website (updated June 14, 2012).

Some of the reasons associated with the increasing costs of college tuition and corresponding Student Loans is related to the artificially created demand for government backed or guaranteed Student Loans by way of “Sallie Mae.” The increased access to more government loans has made students less price sensitive to the “sticker shock” associated with various schools’ $10,000 to $50,000+ annual tuition fees for undergraduate college programs.

Why can’t the Fed magically “create money out of thin air” and bail out the young students and small “Mom and Pop” business owners instead of the multi-billion dollar business conglomerates, banks, and investment firms which don’t seem to need the money as badly as the young student or small to mid-sized business owner today? What’s the difference today between a high school graduate and a college graduate?

ANSWER: About $100,000 to $200,000+ in debt.

Which “bubble” may pop first? Will it be the highly leveraged financial markets, or the person paying outrageous monthly Student Loan payments? In a much more perfect financial world, education would be much more affordable or even free. Hopefully, we may all one day see more reasonable tuition and School Loan costs as well as a more healthy economy, job market, and financial system so that these same students or former students may be able to find the best paying jobs and / or solid investment options like Real Estate in order to one day pay off their consumer debts and improve their overall Net Worth.

We know many of you real estate investors have college bound children or kids enrolled in school – so hope this post helps and good luck with your real estate investing!