The Madness of Student Loans

I read an amazing article in today’s US print edition of the Wall Street Journal. The article was titled, ‘Parents are Drowning in College-Loan Debt‘. The front page article explored data that suggests new record levels of delinquency on college-loan debts associated with a government-managed program called Parent Plus. 

Apparently this program allows parents to borrow money to support educational costs over and above the maximum a child can obtain from federal aid. The article suggests that there is no limit to what can be borrowed via Parent Plus (created by Congress in 1980 when Jimmy Carter was president); and that the most information needed to qualify is a social security ID. Apparently there is no credit check or any other required qualification.

Excuse me? I had to read that part again. What idiot approved this policy? Talk about idiot. This is just the kind of lunatic policy that contributes to unsustainable price increases in secondary education that the droves demand for more subsidies, loans and debts. This is as close to nuts as the same socialist and left-leaning policies that suggested expanding home ownership for those that cannot afford it was a good thing. This is madness.

Not every child needs to go to college. But every child should have the opportunity. There is a distinction between those two points; and the result should not lead to governments controlling access by funneling loans to those that cannot afford it. Attendance should be based on merit. Thus fewer would attend and so prices would not rise as fast and so fewer loans would be needed. But socialism informs uneducated parents that they have a right to a college education and so Uncle Sam has to bend over and make crap up and print more money and screw everyone as a result. Nice.

Now we are again in another financial pickle. But I can’t stop and write about how to fix it. I am going to rush off to go apply for my free Parent Plus loan.

US Economy Not Out of the Woods – Beware the Hype that Says Otherwise

You would think that, given the press coverage, much of the US economy is making great progress.  Apparently interest rates will continue to rise in response to the Fed’s feeling that the economy is doing well; near-full employment, GDP recovery, stock market growth, bond and dollar strength and all that jazz.  But these data points mask some other troubling items that suggest any recovery will likely be lopsided and even short-term based.  You only have to look under the covers at, say, unemployment, credit, or housing.  

• Unemployment: despite low levels of reported unemployment many economists are concerned that the participation rate is at very low levels.  In other words, there is a lot of unemployed that is not being reported in the official KPI.  Some economists suggest that real effective unemployment maybe nearer 6 or even 9 percent.  Thus the result of economic growth may not lead to wage price pressure so soon, since the participation rate may improve the so pick up some of the slack.  This is good news overall but not if the Fed believes that they need to head off wage inflation likely to appear due to pressure on a really tight labor market
• Consumer Credit:  Student and auto loans are running ahead at full steam, and mortgage debt continues apace.  While many firms have cleared their balance sheets of bad debts, consumers – which drive a massive part of the US economy – are amassing debt easier than looking for a hot meal.  On February 27th the US print edtion of the Financial Times carried an article, More US car owners behind on loan payments than at any time since 2009.  What is realy funky here is that if you go into the market now to look for a new or used car, you will be offered a loan for repayment now past the 5 year window.  It used to be that 5 years was the maximum and this was only a few years ago.  Now you can get a loan over 6 years or longer.  So the consumer part of the market is building up a nice bad-debt situation.
• House prices: Yes, house prices have recovered, so we are told, to near pre-crisis levels.  So that part of the market is secure, right?  Wrong.  Home ownership is a its lowest levels in years.  It turns out that the buyers that are driving up prices are investment firms and conglomerates that are snapping up property then leasing them to. So first time buyers are being squeezed out.  The housing market has not recovered in the way we would want it or need it to for effective sustainment.

So we have a very lopsided economic recovery.  It is not stable and even the strong shoots are some challenging weeds hiding just under the covers.  Even if Trump can delivery on +2% GDP growth, I am not altogether sure that woudl mask the issues that are building up today.

My Top 5 Biggest New Year Risks to the Global Economy

In order or scale, priority and impact, here are my picks for the five most critical trigger-points that may impact, negatively, a return to ‘old normal’. Currently we stand at the edifice of a new normal, the great stagflation, but the anti-establishment and populist changes taking place seem to suggest a knew-jerk reaction by nations fed up with socialist dressed-up-as-market politics that have led the West for 20 years.

1. China’s economy stagnates or crashes. Debt levels are above EM levels and are now among the largest, approaching the incredulous Japanese levels. This dynamic is not sustainable for a nation whose currency is not a reserve currency. However the economy is the world second largest even without the development and emergence of whole swathes of other sectors such as healthcare and leisure, which may offset contracting first world growth over the next year or two. So the risk is there and there is no clear leaning one way or the other, yet. But debt is growing faster than these new sectors; exchange reserves at $3bn are limited (though huge), and currency value management is not market-bases. So greater risk is with the downside. China’s growth flags, currency sinks, counterbalancing US growth and confidence, creating a massive imbalance in the global economy. Europe watches on as global GDP sinks under its own debt weight. KPI’s to avoid/watch out for: China GDP falls to or below 4.5%; China’s debt load surpasses 300% of GDP.
2. Trump quits after 18 months due to intractable political limitations that prevent policy changes he seeks related to healthcare, regulatory complexity, tax reform and trade. Trump’s political rhetoric is being replaced with solid business-based policy. However not all such policies have ever been tested at a national level and scale. Some efforts will fall foul to physical, social and political limitations. This may prove frustrating for Trump. As growth will return short term, such medium term frustration will lead Trump to claim, “My policies worked, see? But now the system has reached its limit and there is nothing I can do until the country agrees with me to shut down the whole government system! Since they are not ready, yet, I am ‘outa here’ until they are!” Markets crash, interest rates balloon, inflation rages all within a year. World economy sinks into the abyss. KPI’s to avoid/watch out for: US GDP 1H 2017 reaches 4.5% but Congressional conflict leads to policy deadlock ; vacancy in position at Whitehouse. 
3. Emerging Marker currency crisis as massed capital investment is siphoned away towards a resurgent US economy and dominant dollar, as well as a stable and even growing China economy. This situation is already underway. The risk is that what is currently a reasonably ordered trend becomes a financial route. This is possible since the financial markets are starved of yield due to the collective policies of central banks to keep interest rates very low for too long and for the build up in their massive balance sheets. If the trend becomes a torrent, EM’s will have to yank up interest rates far beyond what their local economics can support and economic disaster will follow. This will ferment more political instability and drive increased destabilizing ebonies to ruin. Though the US may be growing well, compared to its peers, it’s the imbalance they tips the ship over. KPI’s to avoid/watch out for: dollar index, the weighted value against basket of currencies, surpasses 115. It is currently at 103.33, which is a 14 year high; EM interest rate differential balloons.
4. Hard Brexit forced through by intransigent Europeans who think the EU experiment is more about political union than economic liberalism. A new trade deal, legal framework and social contract can be negotiated within a two year window. But only if politicians and civil servants want it too. Continental politicians however, under the strain from populist pressures, will equate intransigence over Brexit negotiations with an improved politicos standing with their electorates. Fool for them as this will actually create the opposite response for such behavior will simply worsen the economic climate. The lack of any sign of return to old normal will lead to political paralysis and the clock will time-out. Hard Brexit will be forced upon a supplicant Britian. Europe and UK economies will tank; currency wars will wage; global trade will collapse further. This will not sunk the global economy short term but will act as a dead weight slowing its resurgence down. KPI’s to avoid/watch out for: no agreement at end of two year period lost triggering of Article 50. 
5. Latin or Indian debt or economic crisis. Much like with other EM’s, growing sectors of significant size around the world may blow up- India being the best example. India’s growth is different to China. It is more integrated socially and politically with the west, but it’s corruption levels are far greater than what one can see or observe in China. It is possible that local economic difficulties, hard to observe today, may trigger a collapse in confidence that leads to a destabilizing debt or currency crisis. Brazil’s economy is certainly in the dock currently; Argentina is struggling. India’s economy looks like paradise right now but the growth across the country is extremely uneven- you only have to look at public sector infrastructure investment. So should two such countries suffer local difficulties, the combination may result in significant risk to the global financial system. KPI’s to avoid/watch out for: two simultaneous financial/debt crisis afflicting EM or India.

These are my top 5 risks the global economy faces in 2017. I hope I am wide of the mark, in a positive way. I left Japan off the top 5 list yet their economy remains anathema to growth. The Japanese market invented the whole new normal cycle with a anaemic growth, massive debt, low inflation, and demographic contraction. And Japan has an amazing debt load that refuses to spook investors. Things may yet have a Japanese tinge before the year end. Does Japan, along with the US, lead the global economy back to the old normal!
What potential risks do you see?

Near or below zero interest rates do not encourage investment

Central Banks around the world have got it wrong.  During near-normal economic cycles, lowering interest rates altered (through signaling) how businesses funded planned investments.  But those investments are driven by business strategy, not market economics.  Firms are not sitting there saying, “Well, with near zero interest rates- what innovations shall we come up with today?”  Just ask business leaders!

Lowering interest rates just signals a different potential pattern of sourcing of funds, if investments are ready to be funded.  But in this high-regulatory and low-inflation economy, with cheap money funding easy stock buy-backs and a stock market rally, there is no need to innovate as much or make the big or medium size bets that such capital investments need.  Firms are achieving their EPS goals without them.  Just look at the data.
The central bank’s have got it wrong.  Just look at the data.  Capital investment is flat when, according to central bank thinking, it should be ballooning.  Has any central banker actually spoken to any number of business leaders?  Or if so, are they confusing political sycophants for real leaders?

The only way to encourage investment in capital programs for innovation is to return the market dynamics to near-normal settings.  That means that counter intuitively central banks now need to raise rates and curtail quantitative easing.  And quickly.

Why can’t central banks see the obvious?

The problem now is that central banks are looking for even more fuel for the fire.  The Bank of Japan is now reportedly looking at even more extreme measures of the same medicine.  The bond market is about to go the same way as the stock market as in massively distorted.  If we are not careful we will enter the twilight zone and no one will be able to control a thing.

Biting the Hand that Fed Us

Mr. Kevin Warsh, a former member of the Federal Reserve board, now a distinguished visiting fellow in economics at Stanford University’s Hoover Institution, pens a damning Commentary of the Federal Reserve in today’s US print edition of the Wall Street Journal.   

In “The Federal Reserve Needs New Thinking“, he slams the Fed for “….[T]he economics guild push[ing] ill-considered dogmas into the mainstream of monetary policy. The Fed’s mantra of data-dependence causes erratic policy lurches in response to noisy data. It’s medium term policy objectives are at odds with its compulsion to keep asset prices elevated. It’s inflation objectives are are far more precise than the residual measurement error. It’s output-gap economic models are troublingly unreliable.”

If that were not enough he adds: “And it expresses grave concern about income inequality while refusing to acknowledge that its policies unfairly increased asset inequality.”

Wow- this is a damning perspective from a ex-member of the Fed. I have to say that I tend to agree with his perspective. However the Comment falls short of the title: there is little new policy offering or suggestion to warrant any ‘new thinking.’ The challenge is to query what could or should the Fed and other central banks do differently.
One odd idea I toyed with a few months ago (see The ghost of Keynes haunts our global leaders and economic conditions today) is to globally reset interest rates as if a new normal had been established. What I mean to say is that central banks around the world should all raise their interest rates at the same time by an agreed amount in order to:

• Preserve current interest rate differential between central bank authorities
• Establish a more natural rate in order to reestablish normal market and investment operations

If we had nearer-normal interest rates the following would happen:

• Private capital investment decisions might once again take on a normal demand curve and pattern, thus contributing and steering toward increased productivity
• The cost of money will rise and so private firms will stop issuing bonds or taking out cheap loans only to increase share buy-backs, thus decreasing the inequality in invest class assets
• M&A levels would fall to more normal competitive levels
• Consumers will start to save again
• Pension funds will have their unfunded portion of their liability reduced

All in all that would be a good day at the office. But it only works if the Fed and central banks in UK, Canada, Europe, Japan, and China agree and collaborate closely.  Additionally the IMF probably needs to leed this effort.

The other problem is the large overhang of debt that central banks now have on their balance sheets. These acquisitions represent government (and some private) debt. These enlarged balance sheets also distort the market. The problem is that central banks have no idea how to jettison these debts without completely upsetting the market again.  

So I guess the only option might be to collaborate with other central banks and agree some kind of normalized write-off. If all central banks agreed to write-off 75% of the government debt they hold, it would free up government spending (since they can start up again, hopefully on the right things this time like education and infrastructure) and the market prices will be balanced. This is of course a silly idea. But how else can we make progress with this challenge?

Yes, new thinking is needed. And a lot more collaboration. The solution will not be found in one central bank. We are too connected. We need a new Bretton Woods 2.0 agreement.

The Next Emerging Bubble (and crisis?) Is Underway

Both the US weekend print editions of the Financial Times and Wall Street Journal reported on what I consider to be the nextfinancial bubble and potential global financial crisis. Let’s ask ourselves – what would the source of the next financial crisis be?

•  Japan, with its massive public debt that might, should the market ever give up on Japan, swallow up government spending with unyielding interest payments (should interest rates need to be hiked to defend the loss of confidencet in the economy)?
• Europe, with its weakened and twisted euro, now bereft of the stability of Britain, at the hands of the profligate consumer south of Europe stretching away from the conservative and producer norther states? It maybe the bailed-out Italian banks fall?
• US, with its “exorbitant privilege” of reserve currency status but with huge watches of government debt held by China, decides to dump it in order to drive the dollar to he floor as a step to push the yuan to reserve status?

No, none of these three challenges are going to blow-up any time soon though they are clear risks. They are all slow burners.  But what might just snap enough to cause a global financial crisis that can overwhelm the monetary policy and reserves of the world? I think it’s emerging markets. 
You see, there is a finely balanced investment model that is ticking and it slips and slides every day – trillions of dollars – and right now the shift is back toward investing in emerging markets.

• Financial Times: Emerging Markets back in vogue as yield-hungry investors feel the squeeze
• Wall Street Jounral: Emerging Markets’ Bill Coming Due

This is how it works: Yield is globally very low. This is due to (mainly) low and near- or negative interest rates. As such, the trillions of dollars in the world that represents currency exchange combined with hedge fund investments move around the globe daily in search of yield. When the US Fed suggests that interest rates will rise in the US, it is clearly a vote of confidence in the US economy and so funds are attracted toward the dollar. This then puts pressure on the dollar (since everyone wants dollars) and so the value increases with respect to other currencies. This then leads to increased export prices thus depressing US exports. 

But where does that money come from that would move toward the US? The answer is from everywhere around the world and specifically wherever the money is most liquid. Guess what, that means emerging markets. Right now the US is signaling to the market that interest rates are not going to rise immediately, so yield is slightly more attractive in emerging markets. Thus, as the reports in the two newspapers show, funds are flowing freely towards them. This puts pressure on those economies much as the same funds would do to the US. They stoke currency valuation, inflation and weaker exports (over time).  But short term they hep fund construction and keep the recycling of dollars and funds around the world.

As you probably noted in the last two years, as the Fed sneezes with respect to changes in interest rates, even hints of changes to interest rates, trillions of dollars move back and forth between the US and EM in the search for the greater yield.  US interest rates will raise and when they do, the yield will shift to the US.  And we are talking of razor thin margins hence the nervousness of the market.
From the FT article:

• Equity funds saw inflows of $5.1bn during week ending August 17, the seventh straight week of inflows, according to data from EPFR
• Over the same seven weeks, a record $20bn was invested in emerging market bonds, with investors taking money out of US and European bonds in favor of the riskier assets

From the WSJ article:

• The Bank for International Settlements warned Thursday that a corporate-debt binge for emerging-market countries that starts in 2010 is starting to come due now. Between this year and 2018, repayments will total $340bn, it’s estimates show, which is 40% more than during the past three years

Thus the global system of equity and currency trade and investments are finely balanced. Should the dollar suddenly look more attractive, and funds then flow towards the US, at the exact same time as emerging markets need to recycle their debt, there will be a big problem. Emerging markets will have to jack rates up in an attempt to strengthen their currencies which could choke their own growth, thus reducing the markets confidence in them, and so a spiral takes shape – downward. If EM have to jack up interest rates, the US may have to reciprocate. Either way the balance is finely tuned and the great weight of funds will flip-flop between EM and the world supremely quickly. That will create huge complexity and volatility.

Hang on, everyone!

The Pride and the Fall of University for All and Student Debt

In the US the size of the outstanding student debt bubble is second only to mortgages. It is increasing in size, shows no sign of contracting, and worse, political solutions to the problem will only make it worse. To cap it all, the entire system is a socialist game and little to do with a capitalist free society.

First some data, culled from a Comment piece in today’s US print edition of the Wall Street Journal titled, “Clinton’s Bailout for the College-Industrial Complex.” Total debt now equals $1.3tn. Yes, trillion. The article reports, “The average four-year education at some public colleges, including tuition and fees, can surpass $200,000 for out of state students.”
From the article:

• Two thirds of students now borrow to pay for their education, up from 45% in 1993, according to a New York Times analysis of Federal Data
• At the end of 2014 the average student-loan borrower owed $26,700, according to analysts at the New York Fed
• At the same time, 4% of students owed more than $100,000.

The author of the article, Charles Sykes, author of “Fail U: The False Promise of Higher Education”, asked “Where has all this money gone?” And he nicely explains all the lovely new buildings and support staff etc. added over recent years.  

The reason why student debt is out of control is heavily driven by government subsidies. The US policy of “education for all”, originally conceived in terms of opportunity, has been executed, misconstrued and abused into “everyone should go to college.” I read an article a year or two ago in the UK Daily Telegraph newspaper site that reminded us that universities were never designed for all; they were designed for those among us who had the talents who could excel. Yes, everyone has (or should have) equal opportunity to attend. But that ideal is very different from giving money away to children and young adults who are not suited to college.

The article highlights some more disturbing data:

• Some 40% of students fail to get a degree within six years
• The drop-out rate, whereby students end up leaving after determining that they went to the wrong college, is near all time highs

In summary the system is inefficient in several ways, and the ‘disease’ is now systemic only a major overhaul of the system or a disaster, most likely a financial melt down, will fix it. No political leader cares to seek a solution.

• The process by which students select colleges and studies are now well aligned and neither are they (an old problem, to be fair) well aligned to industry needs
• Subsidies have distorted the price/cost mechanism and led to a price/subsidy spiral
• Social policy, seeking to encourage the idea that everyone should go to collage rather than seek a professional or vocational qualification also distorts the demand/supply aspect of the market

Overall capitalism has been twisted into a mess in the ‘interests’ of the people. Time we wised up:

• College is not for all
• Have colleges increase their oversight and curriculum and programs led by more industrialists
• Align public funding to those students who qualify properly for their chosen studies, and not given away freely to anyone just because they feel like going
• Align public funding with “college completes” as opposed to “student sign-up”. This will delay payment but encourage colleges to select students who really will finish the degree  
• The current debt should be mutualized at a student level so that industry’s and benefactors can cover the cost of the debt by buying future shares in individual productivity
• For those students lumbered with debt for courses and studies no insist wants, you are in your own
• Try to implement these programs at state level, not Federal level, where folks are never the jobs, careers and homes of the students and employers

This is a hot and ongoing topic. Even my son wrote a paper on this topic that was selected for publication. Some of his ideas are listed above. See If I Were In Charge. Even some of the students understand the issues better than the politicians.