Better Late than Never

In the Chronicle of Higher Education, Joseph Cronin and Howard Horton ask, "Will Higher Education Be the Next Bubble to Burst?" (Hat Tip: Dr. Paul Price). Readers of this blog may recall that we raised this question in a post on October 1^st of last year, and later noted two subsequent Forbes articles on this question.

"Saving Capitalist Banking from Itself"

In addition to his weekly newsletter, John Mauldin¹ occasionally e-mails articles written by others as part of his "Outside the Box" series. Today's "Outside the Box" e-mail included a couple of good ones (both of which can be read in full here). To keep this post from getting too long, I'll post an excerpt from the second one in a separate post. The graphic above comes from the first, "Saving Capitalist Banking from Itself", by PIMCO Managing Director Paul McCulley². McCulley starts with a recap of the basics of fractional reserve banking and continues with a description of the shadow banking system. The excerpt below is from the "bottom line" part of his essay:

The United States government now has both the tools and the will to save the private banking system, and more importantly, the real economy, from its own debt-deflationary pathologies. Not that it will be easy. But it can be done, notwithstanding the catcalls that greeted Secretary Geithner last week.

And the essential game plan is clear: use the power of the Fed, the FDIC and the Treasury to create government-sponsored shadow banks, such as the Term Asset-Backed Securities Lending Facility (the TALF) and the Public-Private Investment Fund (the P-PIF).

The formula? Take a small dollop of the Treasury's free-to-spend taxpayer money (there is still $350 billion left) to serve as the equity in a government sponsored shadow bank, and then lever the daylights out of it with loans from the Federal Reserve, funded with the printing press. That's the formula for the TALF, to provide leverage, with no recourse after a haircut, to restart the securitization markets.

The same formula applies for the P-PIF, with the addition of FDIC stop out loss protection for dodgy bank assets that private sector players might buy. With such goodies, such players, it is hoped, will be able to pay a sufficiently high price for those assets to avoid bankrupting the seller bank.

Unfortunately, Secretary Geithner hasn't laid out the precise parameters of how to mix these three ingredients, which is driving the markets up the wall. But make no mistake, these are the ingredients, along with continued direct capital infusions into banks where necessary.

¹JohnMauldin@InvestorsInsight.com

²You may recall McCulley's name from a previous post where we excerpted one of his essays, "Breaking the Paradox of Deleveraging".

"The Great College Hoax"

In a post on October 1st ("The Next Bubble to Burst in the Deleveraging Process: Higher Education?") I wrote,

Like housing, spending on higher education has been fueled by cheap credit facilitated by a government sponsored enterprise (Sallie Mae, in the case of higher ed). As with housing (up until the burst of that bubble), all this cheap credit has led to higher prices (interestingly, politicians who call for increased spending on higher ed every election year never seem to consider that this increased spending may have helped drive up tuition costs). Now, the common sense observation that, for many, college is a waste of money and time has started to seep into the mainstream.

[...]

How long until a clear-eyed consideration of the return on investment (of time and money) of college educations becomes part of the conventional wisdom?

Later that month, as I noted in another post ("The Coming College Bubble"), Forbes published an article with a similar thesis. The current issue of Forbes features another article on the topic, "The Great College Hoax", by Kathy Kristoff. Below is an excerpt from it.

Higher education can be a financial disaster. Especially with the return on degrees down and student loan sharks on the prowl.

As steadily as ivy creeps up the walls of its well-groomed campuses, the education industrial complex has cultivated the image of college as a sure-fire path to a life of social and economic privilege.

Joel Kellum says he's living proof that the claim is a lie. A 40-year-old Los Angeles resident, Kellum did everything he was supposed to do to get ahead in life. He worked hard as a high schooler, got into the University of Virginia and graduated with a bachelor's degree in history.

Accepted into the California Western School of Law, a private San Diego institution, Kellum couldn't swing the $36,000 in annual tuition with financial aid and part-time work. So he did what friends and professors said was the smart move and took out $60,000 in student loans.

Kellum's law school sweetheart, Jennifer Coultas, did much the same. By the time they graduated in 1995, the couple was $194,000 in debt. They eventually married and each landed a six-figure job. Yet even with Kellum moonlighting, they had to scrounge to come up with $145,000 in loan payments. With interest accruing at up to 12% a year, that whittled away only $21,000 in principal. Their remaining bill: $173,000 and counting.

Kellum and Coultas divorced last year. Each cites their struggle with law school debt as a major source of stress on their marriage.

The clever picture above, by Alex Nabaum, is from the article.

Breaking the Paradox of Deleveraging

This essay by Paul McCulley, the head of PIMCO's money market desk, is worth reading: "The Paradox of Deleveraging Will be Broken". Below are a few excerpts.

[T]he genius of banking, if you want to call it that, is simple: a bank can take more risk on the asset side of its balance sheet than the liability side can notionally support, because a goodly portion of the liability side, notably deposits, is de facto of perpetual maturity, although it is notionally of finite maturity, as short as one day in the case of demand deposits.

It’s the same alchemy that permits mutual funds to commit to next-day redemption at tonight’s NAV, even though all reasonable people know that a mutual fund – with the possible exception of a money market fund – could not possibly liquidate all assets on the wire tomorrow at tonight’s NAV marks. Systemically, it’s the illusion of liquidity [...]

Yes, liquidity for all at last night’s marks is an illusion. But for banks, unlike mutual funds, it’s not so much an illusion after all, for two simple reasons: banks have access to deposit insurance underwritten by fiscal authorities and to a discount window underwritten by the monetary authority (and one step removed, the fiscal authority). Thus, banks are unique institutions, providing a “public good:”

[...]

I could regale you yet again about the power of the analytical thinking of Hyman Minsky, complete with his Forward Journey turning into his Moment, followed by his Reverse Journey. But I don’t need to do that any more: we’ve collectively lived it and are now caught in the debt-deflationary pathologies of “the paradox of deleveraging.” Not everybody in the private sector can delever at the same time without creating a depression. Accordingly, the sovereign must go the other way, levering up the public balance sheet. And Washington has finally started to do so with appropriate vigor and enthusiasm.

It’s not a pretty picture. In fact, it’s repugnant, giving proof to the proposition that breaking the paradox of deleveraging does involve socializing the downside of previously profitable private sector activities. In a recent speech, I called it “creeping socialism” and was interrupted by an irate, older man in the back of the room bellowing, “It ain’t creeping socialism, it’s galloping socialism!” I really didn’t have a soothing come back, noting that many things are what they are only in the eye of the beholder. But his point wasn’t lost on me or anybody else in the room.

Fortunately, the sovereign is currently able to borrow money for thirty years at about 3.7%.

The Next Bubble to Burst in the Deleveraging Process: Higher Education?

Like housing, spending on higher education has been fueled by cheap credit facilitated by a government sponsored enterprise (Sallie Mae, in the case of higher ed). As with housing (up until the burst of that bubble), all this cheap credit has led to higher prices (interestingly, politicians who call for increased spending on higher ed every election year never seem to consider that this increased spending may have helped drive up tuition costs). Now, the common sense observation that, for many, college is a waste of money and time has started to seep into the mainstream. A few recent examples come to mind: Charles Murray's op/ed in the Wall Street Journal in August ("For Most People, College Is a Waste of Time"), "Professor X"'s essay in the June Atlantic ("In the Basement of the Ivory Tower"), and James Altucher's February column in the Financial Times, ("College a waste of time and money for kids").

How long until a clear-eyed consideration of the return on investment (of time and money) of college educations becomes part of the conventional wisdom? Given the increase in household debt over the last few decades (see the top left chart in the graphic above¹), and the current, inevitable process of deleveraging, it would make sense for the federal government to throttle back on its policy of throwing money at student loans and grants. The best American universities -- public and private -- probably have enough money to provide scholarships for the most talented high school grads whose families don't have the resources to pay for college. If they don't, a leaner education policy more narrowly focused on providing merit scholarships to worthy applicants would make more sense from an economic perspective. From a political perspective though, the higher education industry is a reliable Democratic constituency, so I would be surprised if a Democratic-majority Congress decided to cut back on education funding.

¹Graphic borrowed from Martin Wolf's September 23^rd Financial Times column