In the last 10 years, outstanding student debt in the United States has grown from $240 billion to an astonishing $1.2 trillion today, driven in part by rapidly accelerating tuition rates. At the same time, labor demand has stagnated, keeping many graduates from paying down this debt. In fact, JP Morgan deemed the student loan market so overladen with risk that in October of 2013, the firm stopped issuing any additional student loans. To me, the student loan market is eerily similar to the housing market before the Great Recession – there are too many bad investments and not enough good ones. And as was the case in 2008, my fear is that the student loan market is about to crash.
Before examining a solution to the student loan issue, it is important for us to first understand the route cause of asset bubbles. In A Random Walk Down Wall Street, Burton Malkiel makes the cause of asset bubbles very clear in his explanation of the tulip-bulb craze that plagued Holland in the early 1600s. After the mosaic virus created “bizarres” (ie: striped tulips) in the late 1500s, Dutch citizens desperately wanted the most unique tulips in their gardens, and they were willing to pay a handsome premium for “bizarre” bulbs. As more and more people started bidding up the price of bulbs, hoping they would yield unique flowers, more and more people saw tulip bulbs as a smart investment. Indeed, by the 1620’s people were selling their jewels, furniture, and even land to buy tulips! Nevertheless, no bubble can grow forever, and in February 1637, Dutch public opinion changed. The price of bulbs fell more than 20-fold that month, and despite the government’s best attempt to prevent a sell-off, the bulb bubble burst, leaving an abundance of disappointed and bankrupt investors (Part 1 – Section 3 – “The Tulip-Bulb Craze”)
The Tulip-Bulb craze perfectly illustrates the result of what Malkiel refers to as “Castle-in-the-Air” investment theory. Under this theory, an investment’s value is based on public opinion, and decisions to buy and sell are based on random guesses about changes in public opinion. When public opinion changes, bubbles can burst and investors can suffer huge losses. In my opinion, the “Castle-in-the-Air” investment theory applies perfectly to college education; many people attend college because public opinion dictates it is the “smart” thing to do. But as I point out in “Why College Graduates are Useless,” data does not confirm this opinion, as many students cannot find jobs, even after investing thousands of dollars in student loans and higher education. It thus seems that it is simply a matter of time before the student loan market goes the way of Dutch tulips and crashes.
I’d argue, and I think Malkiel would agree, that a switch in investment theory could reduce the risk of asset bubbles. In addition to “Castle-in-the-Air” theory, Malkiel also explains “Firm-Foundation” theory, which is an investment strategy based on the intrinsic value of one’s investments. When the price of the investment is less than its intrinsic value, you should buy. When price is more than intrinsic value, you should sell. Because this form of investing is based on data and not public opinion, it is arguably less susceptible to speculative attack. Indeed, Malkiel points out that firm-foundation investing is how Warren Buffet made his fortune.
It therefore seems that to deflate the risk of a student loan bubble, we need to switch investment in higher education from a “Castle-in-the-Air” model to a “Firm-Foundation” Model. But how? I believe the answer lies in a recent Wall Street Journal article. In “Colleges Are Tested by Push to Prove Graduates’ Career Success,” author Melissa Korn points out a trend in prospective students requesting information on graduates’ salaries. Given that college is an investment (that should generate a real return after an initial payment), this request seems extremely logical! Indeed, why would anybody spend $200,000 on out-of-state tuition at UM without assurance (or at least data supporting) a sizeable income stream after graduation?
If firms are required to release GAAP-audited financial statements to aid prospective investors, I believe universities should have to do the same. While there is currently significant push back from universities to release this data, I think that reporting graduate salaries based on school, major, GPA, etc. is an essential step in changing college education from a “Castle-in-the-Air” investment to a “Firm-Foundation” investment (the implications of this are consequential indeed, as it would likely force the cost of high-paying majors like business and engineering higher than the cost of low-paying majors like anthropology and agriculture. That said, this is a consequence that I am comfortable with). Personally, I believe if we can successfully alter the way that students choose to invest in college education, we can effectively reduce the risk involved in student loans and prevent student debt from repeating the Dutch Tulip Crisis and pushing America back into recession.