NY Fed’s Bogus Estimate of Return on College and Brookings Institute Misses the Student Loan Crisis

Yves at Naked Capitalism writes “NY Fed’s Bogus Estimate of Return on College and the Neglect of the Intellectual Commons”

Yesterday, the New York Fed released a new report by Jaison R. Abel and Richard Dietz, Do the Benefits of College Still Outweigh the Costs? which is getting good coverage in the mainstream media. Its major finding is that despite the fall in wages to college graduates due to the crappy economy, a college degree is still worth the expense because wages of high-school graduates have fallen too, keeping the wage premium of a college education high while reducing the opportunity cost of staying in school.

The assumption is college educated students with student debt are still coming out ahead over the long term. In an earlier post on Angry Bear using graphs as taken from Student Debt is Challenging the Reason for Getting that Long Sought After College Degree I was able to show those without student loan debt appear to come out financially better over the years.

“Based on its projections, the indebted household will suffer a lifetime wealth loss of nearly $208,000, compared to “baseline” of the debt-free household. Nearly two-thirds of this loss ($134,000) comes from the lower retirement savings of the indebted household, while more than one-third ($70,000) comes from lower accumulated home equity; because of the two withdrawals from savings later in their lives, the liquid savings gap is just $4,000. The gap in retirement savings is particularly large because the household with student debt was forced to save significantly less for retirement early in their working lives while paying back their student loans, a gap which was exacerbated because of the significant compound interest that would have been earned had they been able to save the same amount as the household without student loan debt.”

Simply stated, Abels and Dietz assumptions do not appear to be true.

Yves takes on their analysis and the use of IRR as opposed to NPV. “Instead of performing a proper NPV analysis, the authors used internal rate of return. We’ve debunked that at length in a previous post, and even McKinsey hectored CFOs for relying on it precisely because it tends to overstate investment returns. Emphasis ours:

Maybe finance managers just enjoy living on the edge. What else would explain their weakness for using the internal rate of return (IRR) to assess capital projects? For decades, finance textbooks and academics have warned that typical IRR calculations build in reinvestment assumptions that make bad projects look better and good ones look great…the most dangerous problems with IRR are neither isolated nor immaterial, and they can have serious implications for capital budget managers. When managers decide to finance only the projects with the highest IRRs, they may be looking at the most distorted calculations — and thereby destroying shareholder value by selecting the wrong projects altogether.

But let me turn briefly to a much more important issue, which is the perverse nature of thinking about education as an investment. This is yet another manifestation of the degree to which citizens are inculcated to view the social order through the lens of markets.” There are reasons not to use Fair Market Valuation of student loans which I will get into later.

Coincidentally, the NYT ran an article by David Leonhardt featuring a Beth Akers and Matthew Chingos Paper, Is a Student Loan Crisis on the Horizon?. Suprisingly, the dynamic conservative dual used 2010 Fed data as opposed to the more current 2012 data as caught by News Busters Tom Blumer

“the study’s authors, directly contradicts the sunshine they’re trying blow up our keisters. What’s even worse is that you don’t even need to dig into the detail once you learn which year’s data they used — 2010. For heaven’s sake, guys, total student loan debt has grown by between 50 percent and 60 percent since then. and to $1.2 trillion rather than the ~$770 billion used by Akers and Chingos. It gets more interesting as you read Yves Smith article, the Fed study, Akers and Chingos authored study, and my comment on Yves article. TheFed, Akers and Chingos grossly underestimate the impact of student loans on the economy and on students.

In my reply on Yves thread, I attempt to bring to light some of the concerns I have:

I just finished reading both Beths and Matt’s paper “Is a Student Loan Crisis on the Horizon?” and as before they make light of the issue with student loans. Toss in with them Jason Delisle of The New America Foundation and we have the three amigos of conservative origin telling main stream America there is no problem with student loans. I have problems with their origins and we are not just talking attending a conservative university. Their backgrounds reads like an up and coming who is who of conservatism who are getting their experience at more liberal orgs only to join AEI or Heritage down the road.

– Ms. Akers spent 2007/8 as “Staff Economist, White House Council of Economic Advisers (2007-2008).” How does she fit into this other than being a closet conservative?

– Mr. Chingos has been the recipient of support from the “Smith Richardson Foundation, the American Enterprise Institute, and the Lumina Foundation, where three former Sallie Mae directors are board members.”

– Mr. Delisile was “a senior analyst on the Republican staff of the U.S. Senate Budget Committee, where he played a key role in developing education legislation. From 2000 to 2006 he was a legislative aide in the office of Rep. Thomas Petri (R-WI).”

Yet the three of them write for organizations which I would term as centrist (am I wrong on this?) organizations. What am I missing here???

This is nonsense:

“The basis for this theory is that, unlike physical capital, human capital—or the skills that one obtains through education—cannot effectively serve as collateral for a loan. This makes student lending inherently risky, because a lender cannot foreclose on a student’s education the same way it can foreclose on a borrower’s home if he goes into default. More generally, the federal loan program ensures that all students have access to higher education, regardless of their ability to pay.

as well as this too:

“Unlike the loans offered in the federal lending programs, private lenders offer loans with interest rates that reflect a borrower’s likelihood of default. This means that borrowers from low-income households or borrowers attending colleges with lower completion rates are likely to face the highest rates. In addition, private student loans carry less generous repayment terms than federal loans, an important distinction given that both federal and private student loans are more difficult to discharge in bankruptcy than other types of consumer debt.”

What Beth and Matt leave out is the inability of students to discharge student loans in bankruptcy. Students with a simple signature on a piece of paper, check into a proverbial ‘roach motel” to which there is no escape except by death or disability, portions can be done away with through public service, or wait 20-25 years on an Income Based Plan to escape the balance of the loan only to have it appear as income from the IRS. There is no default and neither can it be discharged through bankruptcy. The government with either Federal Direct Loans or with the equivalent Sallie Mae, etc. will garnish your payroll wages, your Social Security, your disability income to secure the money loaned to you. These outcomes are conveniently left out by the three of them.

When you look at Student Loans in this manner, what risk whether determined by NPV or IRR are we talking about here? The Department of Education has decades of history on student loan returns. Student loans make more money when the students quit paying on them and as Alan Collinge pointed out for every $1 loaned an unpaid loan through default makes $1.20, far greater than what Geithner let banks and investment firms off the hook. Why do student loans have to be measured according to risk when there is no escape from them and they make a return when paid back or in a technical default status. CBO Director Elmendorf would change to Fair Market Valuation in the blink of an eye except he is tied to other methodology by law. In the past, he has done the calculation both ways and has reported on it. Nothing new there and again the CBO Director has shown his partisanship.

Yes, people with college degrees make more money when compared to high school graduates who have increasing household income due to the over abundance of them and a lack of jobs requiring just a high school degree. At the same time, entry level jobs for first time college grads have experienced similar declines just not to the same extent as high school grads. Over the life time of those who did not have student loan debt compared to those who did have student loans, the ones without loans accumulated more wealth and income.

“Based on its projections, the indebted household will suffer a lifetime wealth loss of nearly $208,000, compared to “baseline” of the debt-free household. Nearly two-thirds of this loss ($134,000) comes from the lower retirement savings of the indebted household, while more than one-third ($70,000) comes from lower accumulated home equity; because of the two withdrawals from savings later in their lives, the liquid savings gap is just $4,000. The gap in retirement savings is particularly large because the household with student debt was forced to save significantly less for retirement early in their working lives while paying back their student loans, a gap which was exacerbated because of the significant compound interest that would have been earned had they been able to save the same amount as the household without student loan debt. Some of this gap in net assets also comes from the higher lifetime income of the household without student loan debt; though the indebted household begins their careers earning more, their income falls behind that of the debt-free household by its early 40s, and earns significantly less during the peak earning years of the mid-50s.“How Student Debt Reduces Lifetime Wealth”

And you might wonder why I have concerns about students and student loans?

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