The Next Unexploded Financial Time Bomb And How to Defuse It

My good friend Bob McBarton had lunch with one of his friends a couple weeks ago when the conversation about college costs turned into student loan debt. When Bob left UC-Davis with a freshly minted BA in 1985, he left with a grand total of only $6,000 in student debt, a figure he quickly retired soon after he entered into the workforce. Bob benefited from a stellar education at a "Public Ivy" and paid in-state rates. He started a career, met Felicia in Los Angeles before moving to San Francisco, where they have a lovely daughter.

However, his friend, who graduated a decade later with a MBA and law degree from an Ivy League school, is still facing a mountain of student debt. When combined with the debt from his undergraduate years, Bob's friend still had a remaining balance of $200,000 at an 8 percent rate. His friend is smart, well-connected, and has had senior positions in two presidential elections. He is the type of guy you would want in any senior management position, either in a start-up or in a political campaign.

The current debt load carried by Bob's friend has an APR twice the going rate of a 30-year fixed home mortgage. However, his friend is not alone. Today there is roughly $1 trillion in outstanding student loan debt. Those who will receive their undergraduate diploma as members of Class of 2013 will have an average debt load of over $35,000. Out of the 37.1 million Americans who are paying their student loans, their current average balance is roughly $25,000. What's telling is that there are 6.8 million Americans who are over 50 that are still paying down their student debt. It means we have a generation of college students whose parents are still paying off their loans.

We live in a world where the sum total of student debt exceeds our nation's revolving credit card debt. Today, total student debt also equates to roughly 10 percent of the nation's entire outstanding mortgage balances, an all-time high.

Bob's generation is the last to graduate college without the crushing weight of student loan debt. However, as he and his wife ponder how to pay for his daughter's education when she graduates from high school in three short years, both shudder at the cost of college.

Moreover, we live in a time where a basic bachelor's degree has become the equivalent of a high school diploma. Those in Bob's daughter's generation will probably spend more time in grad school in order to keep from falling behind. Add to that, the basic costs of an undergraduate degree have outpaced the rate of inflation four times since the mid-1960s. In the end, parents are looking at longer years in college for their children, higher costs, and larger student debt. The average business school grad enters the workforce with an MBA and an $80,000 hole in his pocket. The average lawyer leaving law school also leaves with a $200,000 hole in his pocket. If you plan to become a doctor, it only gets worse. Get ready for an average bill of $240,000.

Even Fed Chief Ben Bernanke's son cannot escape the student loan dilemma. According to his father in congressional testimony, he is on track for a student debt load of $400,000 once he emerges from medical school.

When Bob's student loan forms were signed more than three decades ago when he attended SUNY-Oswego, retiring the debt would be handled by some decent job off into the future. And it was. When Bob graduated a couple of years later from UC-Davis, the monthly payment could easily fit into his budget, even when he was eating more than his share of spaghetti in an entry level job.

By 2020, when Bob's daughter graduates from college with her undergraduate degree, she will leave with a debt load of $60,000 if present trends continue or $45,000 if she attends a public institution. Grad school will only increase the tab.

More students have gotten into trouble when it comes to repayment. Sometimes the times conspire against you. Most people who entered as college freshman back in 2005 never imagined they would graduate in the middle of an economic nuclear meltdown. If people ran into problems paying their monthly student loan bill, it harmed their credit rating. Even if they were current, people quickly realized that their monthly payments were mostly interest and little principal. However, if their life completely derails and they need to file for bankruptcy, student debt will remain with even as other debts disappear. I understand the arguments surrounding moral hazard and student loan bills, but there has got to be a better way to manage this program.

Education has become the new health care. The facts are clear; better educated people tend to succeed while those who lack one will fall behind. Higher education is a national imperative and as without it, we would be in great trouble. However, higher education also arrives with an accelerative cost factor that outstrips basic the rate of inflation. Worse, it shows no signs of slowing down. What becomes worrisome is that the sheer costs of paying for college may sink many working and middle class families, even when student loans are taken into account. Higher education has always been the silver bullet of the American Experience; it has been the one tried and true route to move up socio-economically. Tomorrow we run the risk of backsliding over the long haul.

However there are politicians like Mitt Romney who said, while out on the campaign trail, that college is not for everybody. It's an arrogant comment and I've always wanted to ask him how many of the Romney sons followed their father's advice. We all know the GI Bill ignited the post-war recovery and boom of the 1950s and 1960s. Returning soldiers graduated from great colleges that would have been pipedreams but for their national sacrifice in war time.

In the 21st century, we are competing in a world that thirsts for knowledge because everybody knows that education is the only pathway upwards. Cal may play Stanford on the football field, but we compete in an increasingly competitive landscape where nations, once considered backwater or agrarian, are now hard chargers.

We need to rethink how Student Loans are organized, issued, and repaid or else it will become the next great unexploded financial crisis that could crater the economy as it struggles to emerge from the Housing Collapse of 2008. Here are some of the storm clouds:
•Nearly 40 percent of borrowers experience some form of payment delinquency during their first five years out of college.
•14 percent of the current population — 5.4 million — are past due on their student loans.
 •The Department of Education reported that the three year default rate is roughly 13 percent.

The great worry is that people might walk away from their outstanding student debt in droves, not unlike the strategic defaults within housing, when people left behind their keys on the counter and walked away after housing crashed. If that happens, the lender confidence will erode to the point where these programs will falter without a huge federal infusion.

But what can be done for the rest of us? How can we honor our obligations for repayment but not make the process onerous?
•Support the current bill offered by Senator Elizabeth Warren (D-MA) that will tie student loans along the same rate structure that big banks get from the Federal Reserve's short-term cash window. Her comment: "If the Federal Reserve can float trillions of dollars to large financial institutions, surely they can float the Department of Education the money to fund our students to keep us competitive and grow our middle class." It's a statement that resonates with me and many parents I know who have college bound children. On July 1, the rates of some student loans are set to double, which may make college unaffordable for many lower and middle class students.

•Take an imaginative approach that maximizes your return but minimizes your debt. The sheepskin on diploma might have the name of a great college but if you spend your first two years at a cheaper state school, it will cut down your potential college debt by roughly 50 percent. Get your General Ed classes out of the way early and work with your guidance counselors at the schools that you wish to attend so that you can position yourself for easy acceptance in your junior year. A good example of this is my good friend Bob McBarton. He spent his freshman year at SUNY-Oswego, his sophomore year at Cal State San Bernardino, and the rest of his undergraduate time at UC-Davis. There is no asterisk on his diploma that says that he was a transfer student and he is a classic example of somebody who bootstrapped his way into a Public Ivy.

•Finally, parents and students need better information to make the hard choices when it comes to getting a good college education. Aside knowing the basic SAT averages of the incoming student population, I would want to know about what happens after the diplomas are hung on the wall, long after people have graduated. Did the costs of your college education provide commensurate mid- and long-term value? Here is the data that I want to know about a college.

— The percentage of those who have graduated within four and five years.
 — The number of who has gone on to grad school and graduated.
 — The average salary five years after graduation.
 — The average salary ten years after graduation.
 — The percentage of unemployment five years out.
 — The average level of debt at graduation.
 — The average level of debt five years after graduation.
 — The average level of debt ten years after graduation.
 — The number of graduates who have purchased homes (proxy for economic advancement)
 — The number of graduates who have filed for bankruptcy.
 — What would an aggressive debt repayment plan look like so that you can pay everything back within five years?

By looking at unemotional data points on a grid, parents may be able to conclude the value from an education at Sacramento State may offer up to 90 percent of what comes with a Stanford undergraduate degree, but at half the cost. Getting stocks that are underpriced made Warren Buffett a wealthy man. Getting a college education that shows demonstrable value, especially when you compare it against the lure of an expensive well-branded university, may be the best education that any of us will ever receive.


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