The Student Loan Mess

Stupid is as stupid does.

Forrest Gump – 1994

On April 10, 2019, Rep. Maxine Waters (D-CA) chaired a session of the House Financial Service Committee for the purpose of trying to embarrass another Democrat boogey-man – large financial institutions. Among the intended victims were James Dimon (JP-Morgan Chase & Co), Michael Corbat (Citicorp), James Gorman (Morgan Stanley) and David Solomon (Goldman Sachs Group). Dead drunk and passed out on the committee’s carpet, James Dimon knows more about banking than Ms. Waters does on her most lucid day – and there are darn few of those. In fact, Mr. Dimon dead drunk and passed out on the committee’s carpet knows more about banking than the collective intelligence of the entire committee – Democrats and Republicans alike.

But no one can turn a congressional hearing into a Saturday Night Live segment like Ms. Waters. Pointing with her gavel, and summoning up her best outrage, Ms. Waters demanded to know how the banks and financial institutions were dealing with the massive student loan debt that is hanging over college graduates and ultimately America’s taxpayers. Each of the bank chiefs responded by noting that they have not had anything to do with student loans since 2010. Ms. Waters was clueless. Ms. Waters has been the ranking member of the House Financial Services Committee since 2012 when she succeeded Rep. Barney Frank (D-MA) as the ranking Democrat on the committee. She more than any one in Congress should have known that the federal government had taken over student loans.

You might think that Ms. Waters is dumb – you would be wrong. You might think that Ms. Waters is stupid – you would be right. (The difference between dumb and stupid is the difference between being unable to learn and refusing to learn.) But if Ms. Waters is stupid – and she is – what does that make the architect of the government takeover of the student loan business that created this mess?

Let me take you back.

Some time in the early 2000’s a movement began in Congress to force banks and financial institutions to revamp their lending policies so that a broader spectrum of society could enjoy “the American dream” – owning their own home. Two of the architects of this misbegotten program were Sen. Chris Dodd (D-CN) and Mr. Franks – Ms. Waters’ predecessor as the leading Democrat on the House Financial Services Committee. That is a laudable goal but, as usual, the politicians mistook good social policy for sustainable economic policy. The pressure from Congress forced the banks and financial institutions to adopt “sub-prime” lending programs.

That is to begin issuing mortgages to people who did not otherwise qualify based upon equity – ten to twenty percent – or financial reviews (verifiable net worth and/or income). Failure to conform could result in “red lining” a financial institution – a public humiliation. In other words, the banks and financial institutions began issuing mortgages to a host of people who either could not or would not repay them. There was this wistful narrative that they could dispense with all of that rational financial review because real estate values were increasing so rapidly that the financial institutions would be secured by that increased value in short order. The added inducement to the banks and financial institutions was that two federal programs – Federal National Mortgage Association (Fannie Mae) and the Government National Mortgage Association (Ginny Mae) would buy all of these sub-prime mortgages and back them with government funds. FREE MONEY.

The net effect was that the real estate market was flooded with new participants with fists full of “free money.” Prices on existing houses began to skyrocket and new housing construction went into overdrive. Both fueled by these new participants and their “free money.” But even under sub-prime lending policies, the borrowers had to make monthly payments and, lo and behold, many could not or would not. Defaults and repossessions mounted. The housing market was over supplied and thus slumped. New construction virtually ceased with its ancillary effect on workers, suppliers, and vendors. And the great recession followed. (The banks and financial institutions recognized the bad loans early and compounded the effect on the economy by bundling and selling them with more marketable loans, thus disguising how bad the situation was becoming.)

It was fortunate that President George W. Bush was still president when the collapse began. He had been negligent in the extreme by not raising the warning earlier. At the very least he had knowledgeable people who mitigated the depth of the collapse. His successor, President Barack Obama sole contribution to weathering the storm was to implement a $1 Trillion economic stimulus package that, in the end, amounted only to increasing the number of public employees and their wage bases, thus ensuring that the cost of recovery would be that much higher in perpetuity.

Having learned nothing from the Bush/Obama recession, the federal government took over the student loan program on March 20, 2010. The government liberalized the lending program and increased the number of study programs that would qualify for the loans – everything from quantum physics to cosmetology programs. They extended the time for beginning repayment and deferred action on those loans that were in default. IT WAS FREE MONEY AGAIN.

Waves of students with fistfuls of FREE MONEY inundated the post-secondary school market from universities to community colleges to trade schools and even online schools. And the education community was among the first to recognize that FREE MONEY gave them free rein. They increased tuition and room and board costs because the students had access to FREE MONEY. They raised the salaries of the faculty – none of whom worked any harder, provided better teaching skills, or taught more hours. The result was a significant inflation of the cost of higher education. (They didn’t have to worry about raising prices because the students had FREE MONEY.) The result was that student debt increased on an annual basis from $21,000 per student in 2007 to $30,000 in 2017 and total student debt, according to Bloomberg, doubled to $1.465 Trillion from 2009 to 2018

In both the building trades collapse and the student debt crises, the culprit was the same – government interference in a financial market resulting in a flood of money being made available to people who either cannot or will not repay it. Prudence was removed from the equation of lending with no regard for the purpose, the amount, or the ability to repay.

But back to Ms. Waters. As I noted previously:

“But if Ms. Waters is stupid – and she is – what does that make the architect of the government takeover of the student loan business?”

More importantly who was the architect of the government take over of the student loan business. That would be the same person that participated in urging the “sub-prime” lending while a member of the United States Senate. That would be the same person who had a ringside seat in the collapse of the home building fiasco and its aftermath. And that would be the same person who did not learn any lessons from either disastrous federal government program.

That architect would be former President Barack Obama.

And if Ms. Waters is stupid for being ignorant of the fact that it was the federal government not the banks that managed the student loans crises, what does that make Mr. Obama? Really stupid?

You might want to think about the lessons of “free money” when you listen to the current crop of Democrat presidential contenders as they vie to see how many free things they can come up with – free tuition, free medical care, guaranteed individual income, free child care, paid family leave. . . and we haven’t even made it to the first Democrat debate.

In life, nothing is free – someone always pays and that someone usually YOU.