Student Loans: The Next Financial Crisis? (Revised)

As I have been browsing the news the last couple of days, an article on the WSJ got me really thinking about student loan debt and the uncanny parallels shared with housing debt in the mid 2000’s. To preface, mortgage standards in the US were lowered in the early 2000’s in a push by the Clinton Administration to get people into houses. Loans that were issued by banks were sold to entities like Fanny & Freddy and then bundled into securities that were bought up and sold by different banks and hedgefunds around the US. Obviously we all know how this ended, but the issue as I see it, was two fold on the banking side of things. The first issue was the relaxed standards set by Washington for loans to be given out and the second issue was the moral hazard represented by the banks writing the loans because they could turn around and sell them just as fast as they could write them.

Almost 6 years now after all of the events of the financial crisis happened, I see a striking parallel between another type of debt and mortgages: Student loans. One of the bigger facets of Mr. Obama’s presidency has been the lowering of the barriers of entry for people to goto college. In 2011 the president enacted a program in which students can attend college and then pay after the fact as they earn at whatever jobs they may find– this program is aptly titled, “Pay As You Earn”. Under this plan, you would attend college at the cost of the government, and then 10% of your total discretionary income per year after school would be taken as repayment for the loans. If you find a job in the private sector after school then you pay for 20 years and then the remaining balance is forgiven, 10 years if you work in the public sector. (Student Aid Website)

Unsurprising to any market failure monitoring economist though, this plan is backfiring, even despite noble intentions. In an article from the WSJ we see that the plans have expanded to over 1.3 million people (originally less than a million before changes to debt forgiveness were enacted) and total debt balances rising to $72 billion from $52 billion before the easing in forgiveness measures were enacted. A moral hazard exists here between the tax payer and the schools who are now incentivized to raise their tuition prices and pay for more of the students bills because the government will pay them back regardless after 20 years and as everyone attending this great University of Michigan knows; tuition has been rising.

So the first ingredient in a recipe for financial crisis obviously being bad debt, the time must have seemed perfect for a dash of bundling; the bundling of asset backed securities. In another WSJ article, we see SLM Corp who happens to be the largest student lender in the US selling over a billion dollars worth of student loan backed securities (SLBS). The interesting part about this and other SLBS sales is that the majority of the demand for the offerings is for the riskiest parts (the most likely to default) of the securities. Why this appetite for risk? Low interest rates may be the answer. Thinking back to the early-mid 2000’s there was a refusal by Alan Greenspan to raise interest rates and people were hungry for yield; the mortgage backed securities promised a rate of return higher than what anyone could find in the bond market and was still rated AAA to top things off. Many believe that the mix of moral hazard and systemic risk present in the banking structure combined with the low rate environments was the catalyst for the financial bubble to blow up and eventually burst. These student loan offerings show that investors are indeed searching for yield wherever they can today.

With default rates on these loans continuing to rise, the government needs to act now to reform this pay as you go expansion for the student loan program. The best solution I think would be to work with colleges to lower tuition rates and quit forgiving the debt that these students take on. Because as long as people can have something for nothing, or rather, a college education at the expense of the US Taxpayer, they will continue to do just that until we are in the midst of another massive asset bubble.

The Balancing Act of Online Presence

For my last post, I wanted to write an opinion piece about a person’s online presence. For the semester we’ve been writing posts about news that relates to the economy. This brought out a wide range of topics. We got to divulge our opinions and tried to argue for one case or interpretation over another. Assuming that there’s enough people out there who actually care(this is a VERY important assumption for the rest of this article), it’s tough to decide how opinionated you want to be. You might come off as a tyrant or a fool with poor writing.

Online search results can be a deeper look into someone’s life or even be first impression, and first impressions are sometimes the most important. I’d assume that all of us want different impressions for our family, friends, and professional life. So give it a try: Google your name. Do you like what you find? What would you’re parents think? Friends, boss, dare I say personal adversaries? This makes me want to compartmentalize, Facebook for friends, LinkedIn for professional life, etc. But your employer could find your Facebook, your friends can find your LinkedIn (and tease you!!). The issue with your public Internet presence (i.e. these blog posts) is that it’s hard to tailor this type of first impression since you can’t use privacy settings. Compartmentalizing your life cannot be done if it’s on the public domain.

Solution 1: Remain invisible

  • They say in this day in age that if its not online, it doesn’t exist (or its not important). The same applies for people. If you don’t like the Internet spotlight or attention for strangers, this is a good option.

Solution 2: Be adventurous!!

  • You’re always bound to upset someone if your sample size is large enough. This post really motivates this argument. The wall between acting professional and acting human is crumbling down. Think about it, people love other people who balance both these qualities over a goofball or a emotionless automaton. The fear of doing something poor written, uninteresting, or unprofessional is simply just a fear of failure. By letting go of this fear, you might be able to do some wonderful things.

As you might be able to tell, I’ve had trouble decided how loud/daring I want to be. I never wanted to tackle controversial issues like politics/religion (well I did write about Obamacare once but it was rather objective and mostly just reporting). But then I might come off as an appeaser with no spine. I’ve decided to be a little more adventurous in the future. Not mindlessly posting offensive material, but instead blogging about my experiences and showing a little personality online. This is not an overnight process by any means, but this class (and Miles Kimball) has motivated me to get out there a little more.

In addition to my closing remarks, I wanted to say that I hope to continue to improve my writing, be it through the blogosphere or anywhere else, letting go of any reservations I have of looking foolish. I surprised how well everyone else and I improved over the semester. Seriously I’ve noticed. Congrats to all of us on a job well done!

Perry 2016; New and Improved

Its not quite time for midterm elections, which for American politics, means that its time to start thinking about who each party is going to run for president and what the primary’s will look like. Most of what I have read makes it seem that Hilary Clinton will have no major opposition to securing the Democratic party nomination leaving only the formality of winning the primaries and caucuses and choosing a running mate. The Republican side, on the other hand, is looking much more interesting for 2016. While Chris Christie, the governor of New Jersey, was an early favorite, his bridge closing scandal has left him hurt but not entirely out of contention. Out of the last round of Republican nominee hopefuls from 2012, Rick Perry didn’t seem to be in a position to make a serious bid but this time it seems as though a new and improved Rick Perry is taking national spotlight.

His 2012 run was characterized by far right religious positions that didn’t sit well with many Americans as well as some gaffes that made it difficult for him to be taken seriously. With ads like this one as well as not being able to remember the third government agency he wanted to end, it is no surprise that he wasn’t destined to win the nomination. But that was 2012 Rick Perry. 2016 Rick Perry seems to be a much stronger candidate with better preparation and in better health (he was recovering from back surgery the last time around). In 2012, not only did he come off as unprepared but unintelligent. While he hasn’t officially announced that he would run in 2016, he has been visiting talk shows and states who vote early in their primaries, winning over many voters. He has also been discussing his stances on Russia and other issues that he wouldn’t need to worry about if he wasn’t looking past his duties as the Governor of Texas.

Aside from his refined ability to speak publicly, he does have an impressive track record, including being the longest serving governor of Texas. Under his leadership, Texas didn’t bear the burden of the recession as badly as much of the country either. Both of these factors will be important for his candidacy. Despite his blunders in the 2012 race, Rick Perry appears to be gearing up to run a much more successful campaign. While it is much to early to say if he will be a viable contender, adding a new serious politician to the running will inevitably have a strong impact on how the race will look as a whole.

 

Effective federal fund rate forecasting

The effective federal fund rate plays a key role in the U.S. economy. It is not only the benchmark interest rate underlying financial instruments in the financial market, but also the pivotal factor in pricing of assets in other industry. Therefore, effective Federal Fund Rate has always been the focus of forecasting activities performed by academy and businesses. However, since December 16th, 2008, federal fund rates have been targeted within a range of 0%-0. 25%. Effective Federal Fund rates, which center on the target rate, become less unpredictable. However, as the economy recovering, effective federal fund rate will very likely resume its current role. Given this, it is still of profound significance to forecast fed fund rates.

Effective federal fund rate is determined by the federal fund market, where Financial institutions trade federal fund with each other overnight. Financial institutions and the Federal Open Market Committee (FOMC) are the major market forces that ultimately decide the effective fed fund rate.

There are a lot of forecasting models for effective federal fund rate. Hauwe, Paap and Dijk(2011)used a Bayesian forecasting model for federal funds target decisions using large set of macro economic predictors . Although this model initially is used for federal fund target rate prediction,it can be adapt to predict the effective federal fund rate. This is because effective federal fund rate is forced to stay close to federal fund target rate by the Trading Desk at Federal Reserve Bank of New York, see Taylor (2001). The Trading Desk performs Open Market Operation (OMO) and counteracts large deviations of effective federal fund rate from its target. In the meantime, financial institutions will also react to federal fund target changes immediately, given that they anticipated the OMO will bring the effective federal fund rate to new target rate very soon. Therefore, predicting effective federal fund rate can be roughly substitute for predicting target rate, which is determined by FOMC. Hauwe, Paap and Dijk examined the minutes of FOMC meetings and discovered that a large set of macro-economic indicators is used in determining the target rates.

 Thorton (1998) proposed a model using the 30 days federal fund future rate as predictor. Federal fund futures rate can help predicting the target rates because futures market participants make commitments that are contingent on what they believe the federal funds rate will be and look to factors they believe will influence its course. The Fed targets the funds rate, and the overnight federal funds rate stays close, on average, to the Fed’s target. Hence, the federal funds futures rate naturally embodies the market’s expectation of what the Fed will do.

Theory suggests that model averaging can improve predictability. Ravazzolo, Dijk, and Verbeek (2007) discovered that averaging yield higher predictive gains than selecting the best model, and time varying model weights have higher statistical and economic values than other averaging schemes.  Therefore, we can take the average of the above two models.

What to Pursue; Money or Fulfillment?

Barack Obama was recently berated in the Wall Street Journal’s opinion section in regards to his federal debt forgiveness programs related to student debt. One such program is a limit on how many years after graduating that your debt can follow you. For some jobs sectors, such as government employees, this can be as little as ten years. Another aspect of Obama’s program is limiting the percentage of your income that has to be paid towards student debt. With the numbers of those enrolling in this program increasing, the articles main criticism of the program is that it is becoming increasingly costly for the taxpayer.

While the author has a point in that the more people who sign up for this program, the more expensive it is, this is the case for many government programs including food stamps, welfare, etc. The writer also claims that it is a negative point that such programs incentivize going into lower paying fields if the government will forgive their student debt faster. While this may be the case, isn’t it better to have people in some positions who otherwise wouldn’t have been able to afford to take a lower paying job if that is what they want to do for work? I know some grad school students and phd candidates not only get their tuition covered, they get a stipend for living expenses. While this isn’t the case for any undergraduate programs (that I know of), going easier on their student debt can incentivize and allow more people to pursue fields with lower pay that they find more fulfilling even though it may not require an advanced degree.

The article takes a tough stance on fields of study that don’t have high pay and whose graduates are likely to need help paying back their student debt because their chosen career doesn’t allow them to make enough money. I took issue with this because for many people, their preferences are such that personal fulfillment and happiness at work is much more important than earning a high salary. Most of these people understand that when they choose their field of study in college that they may not make as much as an engineering or finance major. My point is that high levels of debt is a major cause of unhappiness and stress, and while programs that help forgive debt can be expensive, they are a drop in the bucket in terms of the United States’ federal budget and federal debt but if they allow students to pursue passions that they otherwise wouldn’t have, then isn’t it money well spent?

It is Nike’s responsibility

In recent article, Wall Street Journal told a story about how multinational company, in particular Nike, search suppliers worldwide in searching for least possible cost. One of the countries featured the cheapest production cost of apparels is Bangladesh.

However, the last year tragedy of Rana Plaza, where more than 1100 persons dead in the site has sent an effective message to the world about safety standard in many factories around developing world where most of stuffs sold in developing countries produced.  Some corporations relocate their productions while many others still stay in the country. Many multinational retailers such as Walt Mart, Hennes & Mauritz AB, and 170 others that decided to stay collaboratively funded a project in a search to improve factory safety in their factories the country. Unfortunately, Nike was not participating in that effort by saying that it can better use of its resources somewhere else where it has a bigger investment.

On the issue, Nike cut a tie with its partner in the country Liric Industries, with which Nike had worked for more than a decade, after a team visited the factory and found that the company could not guarantee a safe working condition. Nike is not a new player in outsourcing practice to developing countries in an effort to produce quality footwear at lower cost.  Since it was founded in 1964, it has done such practice when only 4 percent of U.S. footwear was imported, compared to recent figure at 98 percent.

Thus, its reason that it has not known the poor working condition in its partners seems implausible. Multinational companies such as Nike are known with tight quality control over their products even though all are produced in many locations all over the globe. Certainly they have required their partners to comply long list of procedures and systems in order to meet their standard. So, if Nike looks like surprised with the fact just found in its long-time-partner’s factory, no one will trust it. It is weird. It seems that Nike has only tried to clean its hand from that matter.

It is the responsibility of multinational companies operating in developing countries to set a minimum standard of sound production management and they cannot just blame their partners. Their search for low cost production for sure benefits both parties, but they cannot pile up profit while putting their labors in danger. Again, it is part of their responsibility to fix the problem. Just leaving the problem to be fixed by local government or industries is not a good idea since low labor is just a comparative advantage for them.

Affirmative Action

On Tuesday, the Supreme Court decided to continue Michigan’s decision in ending affirmative action at its public universities. It was a 6-2 ruling, however the justices were very strong in their opposing opinions- suggesting that there is still uncertainty lingering over the topic. The ruling means that racial preferences will not soon return to the University of Michigan- or any other public university in states that have chosen to end affirmative action as well.

Eight states have ended affirmative action since 1996. However, affirmative action is still used by many selective universities to promote diversity within the student body. Some Ivy League schools, the US military academies, and flagship public institutions such as the University of Texas at Austin and the University of North Carolina at Chapel Hill.

On Tuesday, the fact that the opinions of the justices were so far left and right brings up the idea that the issue of affirmative action may come back to the table in the future. The closest consensus were spearheaded by the opposing opinions of Justice Kennedy, Chief Justice John Roberts, and Justice Samuel Alito. Justice Kennedy held a more moderate opinion and acknowledged that the US has had a painful history of racial exclusion, which indeed still serves many repercussions that can still be seen today. It was interesting to read his opinion- “The electorate’s instruction to governmental entities not to embark upon the course of race-defined and race-based preferences was adopted, we must assume, because the voters deemed a preference system to be unwise on account of what voters may deem its latent potential to become itself a source of the very resentments and hostilities based on race that this nation seeks to put behind it”.

I understand either part of the situation. I understand that one side claims that affirmative action is like fighting fire with more fire. The way to end racism is not with more racism. I also understand the side of the argument that claims that not all opportunities in America are created equal- structural differences are the ones that we were born with and have no control over, but yet account for how we live our lives. Having the privilege of attending a competitive high school, I was given very good guidance from my high school counselor who also helped lead me through the college application process. The school also provided help with standardized tests. On the other hand, my dad teaches at an inner-city high school in Detroit. The differences are vast. The students are not provided with very good high school counselors nor do their counselors even have expectations that they will attend college. Frequently I would hear my dad complain that the school hadn’t provided his classes with enough books, so many times it wasn’t even feasible for him to assign homework. Differences like these definitely add up over a four year span, and take a toll on the student when the time comes to apply to college. But honestly… I feel that socio-economic status and high school location play a more dominant role in the affirmative action argument than race. Solely focusing on race can create the scenario in which an exceptional non-minority student attending a predominantly minority-populated institution would be overlooked on college applications. I believe the affirmative action situation will later be refined… it seems inevitable. I think differences like these should be accounted for in some shape or form because the fact that I was sent to a high quality high school was inherently for reasons outside of my control. That is of course not to say that students who work hard and come from privileged backgrounds do not deserve to be admitted to certain universities. At the end of the day, the student (“privileged” or “unprivileged”) needs to show that he or she exhibited an exceptional work ethic in comparison to their peers.

Latest from the Fed

Some have been questioning projections made by Janet Yellen on whether or not rates will actually rise in 2015. Apparently, her last speech left investors questioning when the central bank plans to raise short-term interest rates. The Fed is still on track to reduce their monthly bond buying to $45 billion at their meeting this month, but some investors still feel that Yellen gave her audience a vague projection last month.

At the Economic Club of New York last week, Yellen commented, “While monetary-policy discussions naturally begin with a baseline outlook, the path of the economy is uncertain, and effective policy must respond to significant unexpected twists and turns the economy may take”. The vagueness of this statement has left many confused, given that the Fed usually tries to provide concrete information about the outlook of short-term interest rates.

However, now that she has switched to a more mysterious approach, this seems to suggest that slow economic growth, low inflation, and poor measures of unemployment are beginning to slip back into the picture. This contrasts with her statement last month that the Fed may wait six months after the bond-buying ends before raising rates. In regard to the trading markets, investors have reacted relatively calm to the news. Yields on 10-year Treasury notes have remained between 2.5 and 3%. A possible reason that they haven’t moved is because the Fed hasn’t announced any bad news- just somewhat neutral news. As long as a definite position isn’t taken, I don’t think that we should anticipate too much movement.

Another piece of the puzzle related to productivity level- “U.S. output-per-hour worked, a standard measure of productivity, grew just 0.5% in 2013 and appeared to grow slowly again in the first quarter”. The bad thing about slow productivity is that it makes it harder to calculate the amount of slack in the economy level. Slack is a key part of measuring uncertainty, and without the ability to measure of uncertainty it is clearly more difficult to predict the right time to raise interest rates.

In my opinion, I don’t think there’s anything wrong with the projections that Janet Yellen has given. Many keep pressing her to give a concrete date of when to expect rates to rise, but at the end of the day there really are too many factors that control the outcome. Ms. Yellen is not clairvoyant, she’s really doing the best that she can as far as looking into the specific elements that may cause rates to change. We can see this through her decision to drop the unemployment rate target because she believed there were many other forces at hand. In sum, I believe that those doubting Ms. Yellen should sit back and realize that if she were to give a concrete date and then unforeseeable measures caused her to re-adjust her position, the public would be even more displeased. Naysayers need to realize that we have slowly been inching our way out of the recession, the future still looks promising.

American Middle Class – No Longer the World’s Richest

The American middle class which has long been recognized as the most affluent in the world, now lose that distinction. According to New York Times, citizens of other developed countries have received considerably larger raises over the last three decades. Figures shows that after-tax middle-class incomes in Canada now appear to be higher than in the United States; in addition, the poor in much of Europe earn more than poor Americans.

The findings have been tricky because most commonly cited economic statistic, such as per capita gross domestic product, continue to show that the United States has maintained its lead as the world’s richest large country. However, those numbers reflect only the average level. We may need to know more about the variance in order to capture a whole picture of the income distribution. The recent data shows that a large share of wealth flow into the high-earning households, leading to a broader variance of the rich and the poor.

Many commented that the tax system in the United States was cutting the middle-class and that the tax relief for middle-class and small businesses show that the US government has realized this. It would be interesting to see whether the tax relief will actually be effective.

Why is there a weak income performance in the United States? Firstly, the educational attainment in the United States has risen far more slowly than in much of the industrialized world over the last three decades, making it harder for the American economy to maintain its share of highly skilled, well-paying jobs. In the Labor Economics class, we learnt that there is a positive relation between education and earnings. More educated people tend to earn more on average compare to those with less education. Therefore, if people in the United States do not get as much as education attainment as other industrialized countries, it is very likely that the average earning in middle class also fall behind them.

A second reason is that companies in the United States economy distribute a smaller share of their bounty to the middle class and poor than similar companies elsewhere. Also, as taught in Labor Economics class, top executives make substantially more money in the United States than in other wealthier countries. This also explain why the income gap is quite large in the United States because the spread is increasingly larger once reaching a certain level in the hierarchy.

The last reason is that governments in Canada and Western Europe take more aggressive steps to raise the take-home pay of low-and-middle-income households by redistributing income. It would be necessary for the United States to think over the benefits of the take-home pay because many commented that the tax system has been cutting the middle class domestically.

Online Advertising: A big kid’s game?

Online advertising is an important tool for business today – having a presence on the web can do a few very important things for a business. First, it gives the customer a direct link to provide feedback, troubleshoot, and share with friends. Second, it can greatly enhance sales and revenues. Finally, advertisements can be segmented to areas of the web which will capture a target audience. With all of those great attributes, why wouldn’t a company advertise online?

A Wall Street Journal article today outlined how small businesses are having a hard time getting returns on their online advertising investments, especially on search engines. For those unfamiliar, search engine advertising is done through an auction style marketplace, where clients place bids on certain keywords to appear on users’ screens. The easiest way for small businesses to access these auctions and be successful in winning the auction is to hire a marketing firm such as ReachLocal, Inc., who will “provide hands-on, personalized support.” (Safdar & Loten, WSJ) Small business owners, on the other hand, say that they are filed away and can’t get the same attention or customer support as the bigger players. Of course, this sounds remarkably similar to what happens in investing – where it is in the manager’s best interest to monitor the accounts which have more earnings potential.

So what are the options for a small business owner looking to find online advertising space? The answer, in my opinion, comes through word-of-mouth. While search engine advertising, if done properly and in the right industry, can be effective, it doesn’t compare to a five-star review. For some, the social media space, such as Facebook pages, have been effective for advertising promotions and gaining loyal followers. For most industries, however, users aren’t interested in following a company that will encroach their news food. Instead, small businesses can lean on customer feedback oriented websites and applications such as Yelp to attract new customers. Yelp is just one example of a way for companies to get the word out without spending a fortune – restaurant customers seem to be happy to leave a good review at a place they thoroughly enjoyed. Another interesting strategy was taken by a car dealership in my hometown. For car buyers, accumulating 100 likes on a photo of you and your new vehicle will pay off in the form of the dealership covering your first payment. This innovative strategy has worked extremely well so far, as friends feel obligated to help out with just a click of the “like” button.

Due to the high volume of demand for adspace and the overall low rate of hits, online advertising is a hit or miss affair. For some, advertising an application or one-click purchase on Twitter’s app for mobile devices may be the next solution. Maybe there is an innovative social media solution that companies can use to spread promotion and gain followers. But for most, it may be time to go back to basics – providing a high quality product or service and in return having widely-used and respected platforms such as Yelp available for that word-of-mouth to get around.