Student Loans

While we already presented the explanation for the dramatic drop in today's unemployment report (almost entirely driven by the surge in part-time jobs for economic reasons, hardly a thing to be proud of as more and more full time jobs, especially those on Wall Street, are a thing of the past, while the transition to a part-time worker society has been documented extensively in the past here), there is another number that is by far the most perplexing in today's NFP dataset: that showing the employment of workers in the 20-24 year age category (both seasonally adjusted and unadjusted). See if you can spot the outlier in the chart below.

The policy of the Status Quo since 2008 boils down to this assumption: if we prop up an artificial economy long enough, it will magically become real. This is an extraordinary assumption: that the process of artifice will result in artifice becoming real. This is the equivalent of a dysfunctional family presenting an artificial facade of happiness to the external world and expecting that fraud to conjure up real happiness. We all know it doesn't work that way; rather, the dysfunctional family that expends its resources supporting a phony facade is living a lie that only increases its instability. The U.S. economy is riddled with artifice: millions of people who recently generated income from their labor have gamed the system and are now "disabled for life." Millions more are living in a bank-enabled fantasy of free housing. Millions more are living off borrowed money: student loans, money the government has borrowed and dispensed as transfer payments, etc. Assets are artificially propped up lest a banking sector with insufficient collateral be revealed as structurally insolvent. It's not difficult to predict an eventual spike of instability in such a system; the only difficulty is predicting the date of the instability. Hiding a broken, dysfunctional economy behind a facade of artifice and illusion can't fix what's broken, it only adds to the system's systemic instability as resources that could have gone to actually fix things are squandered on propping up phony facades of "growth" and "health."

If we look at what's skyrocketed in price (healthcare, college tuition), we find they are government funded and supported. This is not a coincidence. Inflation is generally viewed as a monetary phenomenon (print money excessively and you get inflation), but let's use a very simple definition: any loss of purchasing power. If your income buys fewer goods and services, for whatever mix of reasons (geopolitical, weather, monetary, fiscal, etc.), that's inflation "on the ground." Government spending and intervention fuel inflation, and the Federal Reserve enables that spending and inflation by monetizing Federal deficits. Eventually, declining wages lead to demand destruction, as households consume fewer goods and services. But inflation that is being driven by government spending will not decrease, as the demand is being supported by a borrow-and-spend Central State supported by a monetize-Federal-debt-til-Doomsday Federal Reserve.

Whereas earlier today we presented one of the most exhaustive presentations on the state of the student debt bubble, one question that has always evaded greater scrutiny has been the very critical default rate for student borrowers: a number which few if any lenders and colleges openly disclose for fears the general public would comprehend not only the true extent of the student loan bubble, but that it has now burst. This is a question that we specifically posed a month ago when we asked "As HELOC delinquency rates hit a record, are student loans next?" Ironically in that same earlier post we showed a chart of default rates for federal loan borrowers that while rising was still not too troubling: as it turns out the reason why its was low is it was made using fudged data that drastically misrepresented the seriousness of the situation, dramatically undercutting the amount of bad debt in the system.  Luckily, this is a question that has now been answered, courtesy of the Department of Education, which today for the first time ever released official three-year, or much more thorough than the heretofore standard two-year benchmark, federal student loan cohort default rates. The number, for all colleges, stood at a stunning 13.4% for the 2009 cohort. And while it is impossible using historical data to extrapolate with precision what the current consolidated federal student loan default rate is, we do know that there is now $914 billion in federal student loans (which also was mysteriously revised over 50% higher by the Fed just a month ago). Using simple inference, all else equal (and all else has certainly deteriorated), there is now at least $122 billion in federal student loan defaults. And surging every day.

Ladies and gentlemen: meet the new subprime.

There was a time when student loans, now almost entirely funded by the US government, and thus a general obligation of all US taxpayers who however have no recourse to ever collect on any collateral, were spent on such trivial things as, well, higher education. Sadly, it appears that that is increasingly no longer the case. To wit: "feds accuse Newport man of using school loans on drugs, motorcyles, games and tattoos." At least no iPhone 3, 3S, 4, 4S or 5 was purchased using private and taxpayer cash.... in this case.

When it comes to diving trends in the Fed's take over of the Treasury market, there are those who haven't got the faintest clue about what is going on, such as Paul Krugman, who naively looks (as Bernanke expects all economists to) at the simple total notional of securities held by the Fed and concludes that the Fed is not doing anything to adjust fixed income risk-preference, and then there are those who grasp that when it comes to defining risk exposure in the bond market, and therefore in equities, all that matters is duration, expressed in terms of ten-year equivalents. Sadly, this is a data set that not every CTRL-V major or Nobel prize winner (in order of insight) can grab from the St. Louis Fed - it is however available to those who know where to look. And as the chart below shows, even as the Fed's balance sheet has remained flat in notional terms, its Ten Year equivalent exposure has soared, rising by 50% during Operation Twist alone, from $900 billion to $1.313 trillion. What this means in practical terms, as Stone McCarthy summarizes, is that the Fed now owns 27.05% of the entire inventory in outstanding ten-year equivalents. This leaves less than 75% of the market in private hands.

We have long discussed the rapid rotation of credit growth from housing and credit card to auto loans and now student debt as the US is not deleveraging in reality at all. A recent report from the Kanasas City Fed notes that in the last 7 years, student loan debt has grown at a staggering 13.9% annual rate. This rise in debt has been accompanied by a notable rise in the percentage of delinquencies (over 10.5% and 8.8% over 120 days past due) as the complex web of the student loan market structure strangles hope for many willing learners. The clear message is that student loans present problems for some borrowers, though, at the same time, the analysis suggests that student loans do not yet impose a significant burden on society from their fiscal impact - even though rather stunningly the Federal government is now 93% of the market. We would add that high student loan debt and its associated payment burdens have left many wondering if the value of a college education outweighs the costs - especially as we note that less than 40% of borrowers are under 30 and more than a third still owe in their 40s.

On the surface, today's G.19 update, aka the monthly Consumer Credit Data, was a big disappointment due to a major miss in consumer credit, which in July dropped by $3.3 billion from $2.708 trillion to $2.705 trillion. The drop was, as always, on a slide in revolving credit, which dropped for a second consecutive month, this time by just under $5 billion, while non-revolving credit, aka student loans and GM subprime debt, rose by just $1.5 billion: the lowest monthly increase in this series since August 2011, when it declined by $9 billion. Expectations were for an increase of over $9 billion. There was a far bigger problem, however. The problem is the spike on the chart below which represents the November to December 2010 transition (source: Fed). What happened there is that 3 months after the Fed revised the consumer credit data last, it decided to re-revise it again. Frankly, at this point nothing the Fed releases has any credibility, as the central planners are literally making up data every three months as it suits them.

Until 1976, all student loans could be discharged in bankruptcy. Until 1998, student loans could be discharged after a waiting period of five years.  In 1998, Congress made federal student loans nondischargeable in bankruptcy, and, in 2005, it similarly extended nodischargeability to private student loans.  Since 2000, student loan debt has exploded, and private student loans have grown even faster. This presents a bigger problem than simply sending people to college who end up unemployed or underemployed. It means that capital is being misallocated. If debt for education cannot simply be discharged through bankruptcy, as other debt can be, private lenders will tend toward offering much more of the nondischargeable debt, and less of dischargeable debt. This means that there is less capital available for other uses — like starting or expanding a business. If the government’s regulatory framework leans toward sending more people to college, more people will go (the number of Americans under the age of 25 with at least a bachelor’s degree has grown 38 percent since 2000) — but the money and resources that they are loaned to do so is money and resources made unavailable for other purposes.

Listen up, debt-serfs, you have it good here on the manor estate. You get three squares of greasy fast-food or heavily processed faux-food a day, and if Reverse Robin Hood and his Merry Band of Thieves is ripping you off it's for a good reason: the predatory Neofeudalist Financial Lords need the money more than you do, as they have a lot of political bribes to pay: it's an election year, and the bribes are getting increasingly costly. Poor things, we're sure you understand. Now go back to work or watching entertainment (or "news," heh) and leave the Lords alone - but answer these 11 questions first, before hailing the new hero.

The punchline from today's Fed household debt and credit report is comparing student debt to one other favorite product of the housing bubble generation: HELOCs. We note home equity lines of equity because as of June 30, 2012, long after HELOCs were widely available to Americans locked in a rabid pursuit to extract as much equity as they could out of their homes, is when the 90+ day delinquent rate on this product hit an all time high of 4.92%, and is finally rising at a breakneck speed. What is fascinating is when one re-indexes the delinquency rate on HELOCs and student loans. While we admit that the "discharge" option on real estate-backed debt does have a material impact, the reality is that once the prevailing mode of thinking is one of just not paying one's student loans, it will be not the student loan chart which is already parabolic, but that which tracks delinquent student loans that will take its place in the exponential hall of fame.

Just what does all this easily accessible and now pervasive student debt fund? The chart below, courtesy of Bloomberg, provides the answer: in the past 3 decades there has been no other cost that comes even remotely close to matching the near hyperinflationary surge in college tuition and costs.

Debt offers a compelling fantasy: there is no need for difficult trade-offs or sacrifices, everything can be bought and enjoyed now. If income is flat and interest rates already near zero, then where is the leverage for additional debt going to come from? The answer is the game of relying on ever-expanding debt is over. You can claim phantom assets and income streams as collateral for a while, but eventually the market sniffs out reality, and the phantom assets settle at their real value near zero. Once the collateral is gone, the debt is also revalued at zero, and the debtor is unable to borrow more. This is the position Greece finds itself in; the collateral and income steams have been discounted, the credit lines have been pulled, and so the reality of living within one's means is reasserting itself. Living within one's income (household or national income) requires making difficult trade-offs and sacrfices: either current consumption is sacrificed for future benefits, or the future benefits are sacrificed for current consumption. You can't have it both ways once the collateral and credit both vanish.

Bernanke has all but admitted this recently, saying "I assume there is a theoretical limit on QE as the Fed can only buy TSYs and Agencies… If the Fed owned too much TSYs and Agencies it would hurt the market."

When financialization fails, the consumerist economy dies. This is what is happening in Greece, and is starting to happen in Spain and Italy. The central banks and Central States are attempting resuscitation by issuing credit that is freed from the constraints of collateral. The basic idea here is that if credit based on collateral has failed, then let's replace it with credit backed by phantom assets, i.e. illusory collateral. In essence, the financialization system has shifted to the realm of fantasy, where we (taxpayers, people who took out student loans, homeowners continuing to make payments on underwater mortgages, etc.) are paying very real interest on illusory debt backed by nothing. Once this flimsy con unravels, the credibility of all institutions that participated in the con will be irrevocably destroyed. This includes the European Central Bank (ECB), the Federal Reserve, the E.U., "too big to fail" banks, and so on down the financialization line of dominoes. Once credit ceases to expand, asset bubbles pop and consumerism grinds to a halt