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The Grand Illusion 2.0

The Grand Illusion 2.0

Introductory note: this is a very long epistle. But I think my point needs to be made fully and at length. Before you go further, in fairness here is the TL:DR version:

  • Advocates of free trade and globalization were taken aback a week ago by the assumption by China’s President Xi Jinping of rule for life.
  • This was because it runs completely contrary to their theory that free trade leads to economic liberalization, which in turn leads to political liberalization.
  • This theory has been repeatedly and thoroughly repudiated throughout history, most catastrophically be World War I.
  • That’s because autocrats will use the gains of economic trade for their own ends, typically the pursuit of further political and military power.
  • Historically middle classes do not revolt against autocracy when they are prospering, but rather only after a period of rising expectations has been dashed by an economic downturn in which the autocratic elite unfairly forces all of the burden onto them.
  • But since these historical facts are nowhere to be found in the economic models, they are ignored as if they do not exist. We can only hope they do not once again lead to catastrophe.

First, let me pose a thought experiment.  Country A and Country B propose to enter into Agreement X. We have no idea at all what Agreement X is, but we know that the result will be that both Country A and Country B will each be richer by $1 Trillion each and every year thereafter.
Country A, being an egalitarian paradise, is going to share out the proceeds equally among its population of 250 million, with each person getting $4,000 per year.
The dictator of Country B is going to do the same with 1/2 of its $1 Trillion gain, making his population very happy, but — because this is his personal aim — he is going to spend the other $500 Billion each and every year in building up its military so that it can challenge and eventually vanquish Country A, and then keep all of the gains of Agreement X to itself.
Should Country A enter into Agreement X?
A week ago The Economist opined that “The West’s Bet on China has Failed,” stating that:

Last week China stepped from autonomy into dictatorship. That was when Xi Jinping … let it be known that he will change China’s constitution so that he can rule as president for as long as he chooses …. This is not just a big change for China but also strong evidence that the West’s 25 year long bet on China has failed.

After the collapse of the Soviet Union, the West welcomed [China] into the global economic order. Western leaders believed that by giving China a stake in institutions such as the World Trade Organization would bind it into the rules based system … They hoped that economic integration would encourage China to evolve into a market economy and that, as its people grew wealthier, its people would come to yearn for democratic reforms ….

CNN’s Fareed Zakaria recoiled in horror, writing in the Washington Post that

[W]hat’s happening in China … is huge and consequential. China is making the most significant change to its political system in 35 years.

For decades, China seemed to be getting more institutionalized…. But that trend has now been turned on its head. If term limits are abolished, which is now almost certain, Xi Jinping could stay China’s president, general secretary of the Communist Party and chairman of the Central Military Commission for the rest of his life. And he is just 64.

…. The real danger is that China is eliminating perhaps the central restraint in a system that provides staggering amounts of power to the country’s leaders. What will that do, over time, to the ambitions and appetites of leaders? “Power tends to corrupt,” Lord Acton famously wrote in 1887, “and absolute power corrupts absolutely.” Perhaps China will avoid this tendency, but it has been widespread throughout history.

If Zakaria felt blindsided, he should not have been. Because ten years ago, after he published “The Post-American World,” arguing that because the US had successfully spread the ideals of liberal democracy across the world, other countries were competing for economic, industrial, and  cultural — but not military — power, I confronted him at the former TPM Cafe.
For the truth is, the West’s bet on China, so ruefully mourned by The Economist and Zakaria, was always likely to fail. That free trade leads to economic and political liberalism and to peace —- championed by neoliberal economists and their political retinue — has been a fantasy for over 100 years, and for 100 years it has been a lie. They would have known if their theories and equations could account for the likes of Kaiser Wilhelm II. But since their equations and theories are blind to the pursuit of power, they dismiss it — at horrible cost to the world.

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Conner Lamb will represent PA-18

First I stress the great effort I put into avoiding all Lamb puns in the title.
Second, I think the discussion of his recent extremely narrow voctory makes the discussion of the campaign seem almost sane.

Before their humiliating loss, Republican operatives insisted that voters were coming around to support their tax cut bill. In spite of the lack of much movement in public polls, they claimed they had private polls showing increased approval. They neglected to mention the fact that they had shifted from arguing against Lamb on the (accurate) grounds that he denounced the tax cut to arguing on the grounds that the former prosecutor was allegedly soft on crkme.

Then he won. Suddenly, Republicans discover that Lamb won because he supported their tax bill, in spite of the fact that he “opposed the tax cuts as a ‘complete betrayal of the middle class.'” When faced with an inconvenient fact, they just lied claiming he campaigned supporting the tax bill.

I think this is a new form or Republican insanity. For 38 years, they have insisted that the secret to economic growth is tax cuts which will pay for themselves (give or take a trillion). This is an absolute article of faith. Even Sen Susan Collins restated the orthodox fantasy. But now they have a new insane article of faith which is that all tax cuts are popular, and their generally disliked tax bill will save them in November.

In this case too, no evidence can dent their (stated) certainty. Not even the evidence from PA-18, where there was a huge “independent expenditure” campaign telling people that a vote for Lamb was a vote against the tax bill. The total failure of this effort (demonstrated by opinion polls before election day) caused Republicans to shift to racists dog whistles. But then when the actual vote showed their effort had failed, Republicans just declared that a victorious critic of their tax bill was a supporter of their tax bill.

So after the spectacular failure of a campaign centered on the tax bill I read (quoted by Costa in the post see below)

“Everybody will … emphasize the parts of the Trump presidency that have been wins for the whole party — taxes, regulatory reform, those kind of issues …” said former Pennsylvania congressman Bob Walker (R).

This is exactly what Americans for Prosperity tried in PA-18 and it was a spectacular failure. It seems as if the GOP’s insane faith in failed policies has infected their previously healthy judgment about political strategy. I sure hope it has.

Not all reporters have covered themselves with glory either. After the jump, I get back to dumping on the MSM

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Wealth and the National Accounts: Response to Matthew Klein

by Steve Roth    (via Asymptosis)

Wealth and the National Accounts: Response to Matthew Klein

I’m both abashed and delighted that the truly stand-out econ writer Matthew Klein has offered wonderfully fulsome praise of one of my pieces, Why Economists Don’t Know How to Think about Wealth, and some very interesting discussion as well. Some responses here. Please excuse me if I repeat some of the points from the first article.

>His key point is that changes in net worth caused by asset prices fluctuations are just as important as standard measures of income and saving.

That’s important, but there are really three key points I’d really like to come through:

1. Wealth matters. Net worth and total assets. Those are absent from the Flow of Funds matrix, because it ignores: A. Nonfinancial assets — the (L)evels tables aren’t balance sheets — and B. Holding gains. Yes: changes in wealth measures also matter a lot (see below), and they’re of course also invisible and largely unexplained in the FFA matrix.

2. Accounting statements are economic models, based on deeply-embedded assumptions that are largely invisible except to accounting-theory adepts. The FFAs’ closed-loop construct depicts, promulgates, and validates the whole factors-of-production worldview (each according to its contribution…) which underpins travesties like Greg Mankiw’s “just deserts” claptrap. See in particular national-accounting-sage Robert Hall’s discussion of the accounts’ implicit “zero-rent economy.”

3. The dumpster fire (@noahpinion) of terminology that economists rely on to communicate — and really to think (together) — is (or should be) rigorously defined based on accounting identities. But that requires deeply understanding #2 above: what those measures and identities mean. To repeat: accounting classes don’t even count as electives for econ degrees at Harvard and U Chicago. (Really, the situation is more like the sub-basement of Fukushima Three. One word: “saving.” Many economists vaguely think that more individual saving results in some larger stock of monetary “savings.” Sheesh.)

>Roth’s presentation…is not new. Alan Greenspan wrote about these ideas back in the 1950s

Johnny-come-lately. Haig-Simons, who I refer to repeatedly, bruited their comprehensive accounting definition of income in the 20s and 30s. (Dead-cat bounce. I’m thinking the rich hatethis idea. The political implications of fully revealing wealth and wealth accumulation could be…revolutionary?)

Wikipedia informs me that a German legal scholar named Georg von Schanz was on it somewhat earlier. (Modern Money Network, are you listening?)

>Roth ends up downplaying the importance of the liability side of the balance sheet.

Perhaps. At least three reasons:

1.The FFA matrix does an excellent job of accounting for (inevitably “financial”) liabilities. Nothing to complain about there. That’s where the IMAs get most or all of their liability accounting from. And economists have made very good use of that data.

2. Looking at households as the “buck stops here” balance sheet, liabilities are surprisingly (to me) small percentage of assets. Yes, a long secular trend with one big spike (not much for sample size…). Click for Fred.

3. For the economic import of (change in) assets versus liabilites, I’ll just point to one economic factoid which I find darned significant:

Post-1960s (post Bretton-Woods?), every time you see year-over-year decline in real household net worth or assets, you’re just into or about to be in a recession. (There are two bare false positives, just after the ’99 and ’08-’09 market dives; they look to me like blowback, residual turbulence, if that suffices as cogent economic terminology…)


Notice: The two measures are equally predictive; including liabilities (in net worth) adds no predictive power. These two measures move closely together. This especially makes sense for declines; asset markets dive, while liabilities are much more sticky downward. (They tend to climb together over time.)

So yeah, I’m with Roger Farmer about stock-market declines “Granger-causing” recessions, though 1. I cringe at that faux-statistical usage, and 2. at least for the GFC, I’d say the real-estate crash caused the stock-market crash. In any case, overall, it sure looks to me like wealth (asset) declines (proximate?) cause recessions. I’d say high debt levels amplify the effects when that does happen.

So yeah of course, net worth is not some kind of tell-all economic measure. You gotta deconstruct it. But it’s a bloody-well-necessary measure that economists (and national accountants) have largely ignored, like forever.

>defining “saving” as the “change in net worth”, as Roth does, is that this obscures as much as it clarifies

Note that I use a particular term for that, Comprehensive Saving, while leaving what I call Primary Saving (largely) intact. (The IMAs’ measure of primary income hence saving is after “Uses of property income (interest paid)” are deducted, which seems crazy (and politically pernicious) to me. I’ve moved it from it’s sort-of-hidden position in Sources, to appear explicitly in Uses, so my Primary Income and Primary Saving measures are a bit higher than the IMAs’.)



Now it’s true that I relegate Primary Saving to an addendum, favoring Comprehensive Saving as the more important measure. This imparts how deeply rhetorical all accounting presentations are. But I think this privileging makes sense give the relative magnitudes we see. (Net Lending + Capital Formation here is traditional primary “saving”).


This is J.W. Mason’s recent graph, which I was delighted to see, showing the same measures (the IMAs’ ∆NW decomposition) that I’ve also graphed in the past.

>asset price appreciation generally leads to proportionally tiny increases in spending.

The linked study, like others of its kind, in my opinion gives too much weight to marginal propensities, based on one-time changes. So I question how good a guide they are to determining economic reaction functions. This is too much of a subject to address here, so I’ll only suggest that more straightforward, long-term propensity-to-consume measures by wealth/income classes might be more illuminating. Also velocity of wealth. (I’m a monetarist! As long as “money” means “wealth”…)


Whether or not you consider these figures illuminating, they are the kind of figures you can derive from a complete accounting construct that tallies total assets and net worth. Note that both are also dependent on data from Zucman/Saez/Pikkety’s magisterial Distributional National Accounts (DINAs). What I’d really like to see is Distributional IMAs (DIMAs). I corresponded with Gabriel Zucman on this a bit; he’s given me permission to quote him:

You are correct that there can be pure asset valuation effects in the long run (i.e., capital gains in excess of those mechanically caused by retained earnings). These pure valuation effects are not part of national income, hence not included in our measure of income and our distributional series. However, they could be included down the road by computing income as delta wealth + consumption (i.e., Haig-Simon income). We have wealth in our database so we’re not far from being able to do this.

To conclude on a decidedly accounting-dweeby note, here’s the key accounting identity for Haig-Simons (which I call Comprehensive) Income:

∆ Net Worth + Consumption = Primary (traditional) Income + Holding Gains (+ Other Changes in Volume)

Subtract taxes, and you’ve got Comprehensive Disposable Income. Subtract Consumption, and you’ve got Comprehensive Saving. Equals…change in Net Worth.

Accounting identi-tists, have fun!

(For those who prefer this kind of thing in slide-deck form, here’s a PDF of my presentation from the recent Modern Monetary Theory conference.)

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Menzie Chinn notes:

Mr. Kudlow is apparently on the short list for new National Economic Committee chair. Maybe a good time to review some of his macro predictions.

Yours truly goes back memory lane:

But let’s turn back the clock to the first term of the Bush43 Administration when Kudlow writing for the National Review was all in defending Bush’s fiscal stimulus and arguing at several points how the labor market was booming even when it was not. Kudlow was infamous for claiming the household survey was a better measure of employment when it showed that employment was rising while the payroll survey said the opposite. Of course there were months when the payroll survey showed better job growth than the household survey showed – to which Kudlow declared the payroll survey was more reliable. And during those months when the unemployment rate fell even though the employment-population ratio fell, Kudlow was all aglow that labor force participation rates were falling. After all, spinning for the Bush-Cheney 2004 campaign was more important than actual improvement in the labor market

Of course my main point was to remind us of Kudlow’s deficit dance and how Robert Novak fell for it:

OK Kudlow said this $2 trillion was a gap over 2 years so we can blame Novak by not dividing these figures by two. But Kudlow was also using annual flow information as if it were quarterly flow information. So to correct even what he wrote – we needed to further divide his figures by four. Our second graph shows the GDP gap on an annual basis using the CBO estimate of potential GDP and they were nowhere near $1 trillion per year. Could Kudlow really be this incredibly stupid or did he know he was trying to deceive stupid readers? I guess he did because Robert Novak certainly fell for this incredibly misleading and incorrect assertion.

It is sort of funny that Kudlow and Novak were making a Keynesian economics argument given both of their disdain for Keynesian economics. Of course summing 8 numbers when the right approach would be to take the average of 8 numbers is a conceptual error that one would trust a first grader could point out. It is also interesting that Kudlow wanted to assume that potential real GDP always grows at 3.5% as he is likely going to be Trump’s chief economic adviser. Trump is even bragging that Kudlow now favors tariffs. And why not – Lawrence Kudlow’s entire career has been telling any lie that his political master want him to tell as long as there is another tax cut for rich people in store.

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Labor force participation, unemployment, and wages: an update

Labor force participation, unemployment, and wages: an update

About a year ago I wrote a series of posts on the relationship between the unemployment rate, labor force participation, and wage growth. Especially in view of last Friday’s jobs report, which showed blockbuster hiring, but a continuation of tepid wage growth over 8 years into the expansion, now is a good time for an update.

To recapitulate, history shows that wage growth is lags the economy, and specifically only turns after the unemployment rate begins to decline. More specifically, since 1994, once the underemployment rate has fallen below about 9% (red, inverted in the graphs below), wage growth (blue) has begun to improve:

Meanwhile, the YoY% change in the prime age labor force participation rate turns about one year before wages (green):

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February jobs report: a blowout! Except (sigh) for wages

(Dan here…better late posted here than not…. )

 by New Deal democrat

February jobs report: a blowout! Except (sigh) for wages

  • +313,000 jobs added
  • U3 unemployment rate unchanged at 4.1%
  • U6 underemployment rate unchanged at 8.2%
Here are the headlines on wages and the chronic heightened underemployment:
Wages and participation rates
  • Not in Labor Force, but Want a Job Now: declined -40,000 from 5.171 million to 5.131 million
  • Part time for economic reasons: rose 171,000 from 4.989 million to 5.160 million
  • Employment/population ratio ages 25-54: rose 0.3% from 79.0% to 79.3%
  • Average Weekly Earnings for Production and Nonsupervisory Personnel: rose $.06 from  $22.34 to $22.40, up +2.5% YoY.  (Note: you may be reading different information about wages elsewhere. They are citing average wages for all private workers. I use wages for nonsupervisory personnel, to come closer to the situation for ordinary workers.)
Holding Trump accountable on manufacturing and mining jobs

 Trump specifically campaigned on bringing back manufacturing and mining jobs.  Is
he keeping this promise?

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“The Bank Always Gets Paid,” Mr. Potter

I met Lynn while working with Alan Collinge of the Student Loan Justice Organization. She too has been working with Alan to call attention to the plight of students who took loans out to pay for college and the mishandling by servicers of them.

The first story is of an older man who took out a Parent Plus Loan for his daughter, who has since died, and he is paying off the loan through garnished Social Security checks.

The second story is a time table and it is long. A younger person takes out a student loan for $10,000, graduates with a Bachelors degree, encounters many issues along the way, and works in the type of work which does not pay as well as many. The $10,000 debt turns into $30,000 over time. This is a well detailed story as told by Lynn a CPA. I plan to send this story to a few people I know to make a point. Monica’s story is one of most detailed accounts of student loan mischief and as close to fraud I have read. It is typical of what students face today.

Obama took the student loan lending business away from commercial interests and kept it within the government. The only problem, he left the servicing of the loans to commercial interests, who are in it for the money, and prey on unknowing teenagers trying to go to college, and eventually a living. These loans have greater profitability in default and are impossible to escape unless a person is disabled or dead.

Lynn Petrovich, CPA: In 2016, I prepared the return for an 80-year-old man who came into the tax clinic. He handed me his W-2 form which reported wages of $500 and a Social Security statement. He needed to file a tax return to obtain a refund of federal and state withholding reported on the W-2. While reviewing his Social Security statement, I noticed one-third of it was garnished. When I questioned him about this, he became very solemn, put his head down, and explained it was for an education loan taken out for his daughter “some time ago” to help her attend college. She had since died. Piecing together what he told me, I figured he took out a federal Parent Plus loan, had defaulted (before, during, or after his daughter’s illness and death), and didn’t know what to do. The default resulted in the garnishment of his Social Security, most likely without end for the rest of his life. There is not even an accounting of what is taken each year.

Monica’s Story

Between 1984 and 1987 Monica took out $10,000 in student loans. Over the next 30 years she made payments totaling over $24,000, yet she still owes more than $3,000 on her loans.

I first met Monica at a tax clinic in the early 2000s. As a CPA, I had been volunteering my time preparing tax returns pro bono on Saturdays during tax season. Monica and dozens of other taxpayers were waiting patiently to have their taxes prepared at this free clinic located at the Jersey Shore.

When it was her turn, Monica brought her completed interview/intake form to my workstation. I looked over the information she had provided and asked a few follow-up questions, including if she had any student loan debt.

She shifted in her seat and explained that she took out $10,000 in student loans when she was in college in the 1980s. She said that she has been doing her best to repay the loans since graduating but wasn’t really sure about how much she had repaid, how much of the principal she has knocked down, or how much she still owed. As a single person who rented, Monica needed all of the deductions to which she was entitled, so I encouraged her to get some specifics about her loans. She agreed to come back the following week with her student loan interest amount.

I’ve prepared Monica’s taxes many times since that first meeting in the early 2000s. Each year, she provided statements from her loan servicers which reported student loan interest received. During the 2017 tax season, while preparing her return, I discovered that she was still paying down the original student loan debt she’d taken out 30-plus years earlier.

How could that be?

My curiosity piqued, and I asked Monica if I could perform a review of her student loan debt. A week later, she handed me a large and overflowing manila folder containing 30 years’ worth of payments, loan documents, and servicer statements.

I dove into it with passion.

The following is a narrative on what I found (below narrative is summary recap of events by date, numbers are rounded):

1984 -1987: Origination of Student Loans

Monica attended a large public university outside New Jersey, graduating in the spring of 1987. In order to pay for tuition, housing, and other college costs, Monica obtained four (4) Federal Stafford FFEL loans for $2,500 each. All of the loans were fully subsidized.

What are FFEL Loans?

The Federal Family Education Loan program (FFEL) was a student loan program in which commercial bankers issued student loans directly to borrowers or colleges. FFEL loans are what the accounting industry calls “cash cows,” a type of business investment which rewards investors beyond risk (initial investment costs) with liberal guaranteed payments and profitability. FFEL loans are 100% guaranteed by the government, including subsidized interest rates, and administrative costs (special allowance payments).

FFEL loans issued for qualified educational expenses began to earn interest from the date the loan was distributed to the borrower or school (date of origination). While the borrower is in college, interest accruing on subsidized FFEL loans is paid by the government directly to the lender. Since this interest is paid by the government, the borrower is only responsible for repaying the original principal balance upon graduation.

The FFEL program was terminated by President Obama effective July 2010. Federal student loans are now issued directly by the government to borrowers (or colleges) and are a part of the Direct Loan program.

December 1987: Graduation, Repayment Begins

Monica graduated from college in the spring of 1987. Once her six-month grace period expired, her FFEL loans entered repayment.

Overview of Monica’s student loan debt in 1987:

Term of note: 10 years, 120 monthly payments
Monthly payment: $127.00
Interest Rate: 9%
Principal: $10,000 (because interest while attending college was paid to the lender by the government)
Interest over loan term: $5,238.00.
Total repayment: $15,238.00
Grace period: 6 months
Repayment to begin: December 1987

Over the next two years, Monica made consistent monthly payments of $127 directly to the commercial bank in New Jersey which originated the FFEL loans.

1989: Monica Gets a New Loan Servicer

November 1989; the commercial bank notified Monica that the servicing of her loans was being transferred to the Student Loan Servicing Center (SLSC), effective January 1990. The principal loan balance at the servicing transfer date was $8,706.

The commercial bank reported student loan interest received for 1989 was $746.33.

1990 – 1992: Negotiating New Terms in Hard Times

Despite working two jobs, full-time for a local nonprofit during the day and waitressing at the local bar at night, Monica had problems meeting her repayment obligations. She fell behind on the $127 monthly payments and approached her servicer for help.

July 1991; Monica signed a new note with SLSC (replacing her original loan note) for 90 monthly payments of her loans at 9% interest. Her new monthly payments were $136. The principal at note date was $8,148 plus accrued interest of $368 (for periods when she was unable to make payments interest was still being charged). With the interest capitalized (added to principal), her new principal balance totaled $8,516 ($8,148 plus $368).

1993 – 1995: Struggles and Forbearance

Over the next three years, Monica continued to work at least two and sometimes three jobs. Despite her hard work, she still struggled to make her loan payments. During these years, Monica’s housing and transportation costs accounted for more than 50% of her income. She had very little left for discretionary purchases and the payment of student loan debt.

November 1994; SLSC accelerated the loan due to nonpayment. The principal balance at acceleration was $7,325 plus accrued interest of $375. The interest was capitalized, bringing the principal balance to $7,700.

Monica requested forbearance. Forbearance allows student loan debtors to pause their payments for a short period of time. While payments are not due, the interest on the loan generally continues to accrue. As a result, the balance due will be greater after forbearance. SLSC agreed to grant a six-month forbearance, giving Monica a little bit of breathing room.

January 1995; Monica signed a new note with SLSC. Under the new deal, Monica would be required to pay 63 monthly payments of $154 at 9% interest. The principal of the note at signing was $7,325 plus accrued interest of $495, which came to a grand total of $7,820. Monica would begin payments in April 1995.

1996 – 1998: Increased Cost of Living Leads to Default

Over the next two years Monica did her best to make payments each and every month. Cost of living and transportation increased, continuing to swallow more than half of her monthly income. Monica skipped or delayed payments on her $154 plan.

August 1997 – ten years after graduation – Monica’s FFEL loans had been purchased by the NJ Higher Education Student Assistance Authority (NJHESAA). SLSC (the loan servicer) denied a request for economic hardship relief forbearance allowing the forbearance period to be interest free. Principal balance in August 1997 was $5,187.

[The NJ Higher Education Student Assistance Authority is a State agency which administers NJ CLASS loans (private student loan debt* originated through the sale of bonds to investors) and, as investments, maintains large quantities of purchased FFEL loans in their portfolio. As of 6/30/17, NJHESAA’s FFEL-owned loans totaled almost $2 billion].

*The Federal Reserve categorizes any loan that is not a Title IV loan as private. Title IV refers to the Higher Education Act of 1965 and amendments.

September 1997, after SLSC granted forbearance through April 1998, Monica signed another note with SLSC. The terms of the new note included 38 monthly payments of $173 at an interest rate of 9%. Principal balance was $5,187 plus accrued interest of $520 which was capitalized, bringing repayment of principal to $5,708. Payments were to begin May 1998.

1999 – 2003: Default and Rehabilitation

Over the next 2 years, Monica struggled to make the increased loan payments. Originally her monthly payment was $127 and a decade later, the monthly student loan commitment had jumped to $173. Working 60 hours a week, Monica’s yearly income rarely exceeded $25,000. In addition to struggling to keep up with the rising cost of living, Monica endured a series of medical catastrophes, fell behind on her payments, and defaulted in early 2000. NJHESSA told Monica she had to “rehabilitate” the loans.


Default of federal loans occurs when payment has not been made (or acknowledged by the lender) for more than 270 calendar days. Default causes the loan to be subject to higher interest rates, collection, and late fees. Collection costs for Monica’s loans were 18.5%.


A process where the borrower must bring the loans current by making consecutive monthly payments over no less than a 10-month period. Most often payments are determined by calculating 15% of borrower’s discretionary income, are not applied to the principal, and are used to pay for collection costs, fees, and interest.

Late 2000; Monica enters the rehabilitation program. After a year, she was notified by the guarantor, NJHESAA (who owned the FFEL loans), her rehabilitation was completed, and the loans had been referred to Sallie Mae for servicing. Principal at completion of rehabilitation was $5,282 plus accrued interest of $338 plus collection and late/collection fees of $1,076 (both of which were capitalized) brought the new loan principal balance to $6,697.

Monica signed a note with Sallie Mae for 104 monthly payments at $86.

February 2003; Monica continued struggling to make payments on the latest note. She was still working on paying off medical debt and dental work. Housing and transportation costs exceeded 60% of income. She requested and was granted a forbearance of 12 months.

2004 – 2007: Request for Consolidation

Early 2004; Monica’s forbearance ends. Housing and transportation costs still accounted for more than 60% of Monica’s income, and she was still paying off medical debt. Adding to this burden, she encountered large veterinary bills for her dog. Monica could not keep up with the new payment plan and was delinquent.

2006; Monica contacted NJHESAA and requested to have her loans consolidated. She completed the Direct Loan Consolidation application complete with loan detail, personal information, and references and submitted it to the Direct Loan Consolidation center. If the loan consolidation were approved, Monica’s loans would only be subject to 8% interest. She received a postcard informing her that her application had been received on 06/22/2006. Loan balance at June 2006 was $9,436. 18 years after graduation, her principal balance was almost as much as the original loan amount of $10,000.

There is no evidence her application for loan consolidation was ever processed and/or approved. If Monica’s loans had been consolidated, they would no longer be the cash cow FFEL-guaranteed loans were and may have been a deterrent to consolidation by the loan holders.

February 2007; Monica was notified by NJHESAA that her loans had again defaulted. They threatened garnishment of her wages. Monica agreed to a voluntary repayment arrangement of $112 a month over a 10-month period which required direct deduction of the payments from her bank account.

NJHESAA Form 1098-E for 2007 reported “defaulted FFELP loan” interest received of $972.87.

2008 – 2010: Struggling to Find a Solution

March 2008: After completing the second rehabilitation** program of her loans and 20 years after graduating from college; Monica entered into another repayment agreement with loan servicer AES, agreeing to monthly loan payments of $95.

[**According to studentaid.ed, prior to 2008, defaulted federal loans could only enter rehabilitation once. After receiving the notice from NJHESSA reporting her loans in default and threatening wage garnishment, Monica “volunteered” to make 12 monthly payments of $112].

NJHESAA Form 1098-E for 2008 reported “defaulted FFELP loan” interest received of $633.48.

2008 and 2010, Monica attempted to make monthly payments of $95. She was granted several periods of forbearance. In September 2010, AES notified Monica that her most recent forbearance had ended.

NJHESAA Form 1098-E for 2009 reported “defaulted FFELP loan” interest received of $580.77.

September 2010; Principal balance was $6,211, accrued interest of $1,000 (during forbearance) was capitalized, and resulted in new a principal balance of $7,209. Housing and transportation costs continued to hover around 55% to 65% of income. Old and new medical and dental bills exceeded $1,000.

NJHESAA form 1099-E for 2010 reported “defaulted FFELP loan” interest received of $225.86.

2011 – 2016:

Monica’s income stabilized a bit, and she was able to make monthly payments of $95.

2017 – 30 Years After College Graduation

January 2017; A statement issued by loan servicer AES reported principal balance at $3,208.



January 2017 According to servicer statements and after thirty years after college graduation, Monica still owed over $3,000 on her original student loans. Along the way, she’d made over $24,000 in payments. The loans were not consolidated, although she tried to do so to lock in a lower interest rate.

Her New Jersey refunds were levied for over a decade and seized by NJHESAA. Additionally, her tenant homestead rebates were also seized. Total amount of income tax refunds or homestead rebates taken by NJHESAA, exceeded $1,000.

Student loan payments are applied as follows:
1. First to late charges, fees, and collection costs,
2. Second to outstanding interest, and
3. Last to reduce principal.

During forbearance; interest does not stop accruing when payments were not made and if payments are less than the amount to pay accrued interest, the principal balance increases. When a borrower is seeking forbearance for FFEL subsidized loans claiming economic hardship, application must be made and approved by the loan servicer. Monica made application for economic hardship in 2007 but it was denied by the servicer.

Student loan borrowers should be aware of the daily interest cost of their loans. This is important because if payment is made for less than the daily amount, principal will never be reduced. At the beginning of Monica’s repayment journey in 1987, her daily interest cost on the 4 FFEL loans with a principal balance of $10,000 at 9% was $2.50 per day. She needed to pay at least $75 ($2.50 times 30 days) per month in order to satisfy the interest accrued and due before payment would be applied to principal. The daily interest rate decreases with each payment, assuming interest has first been fully satisfied.

Federal student loans are exempt from most consumer protections (Fair Debt Collections Act, Truth in Lending, Statute of Limitations), are excluded, for the most part, from oversight by the Consumer Financial Protection Bureau, and are dischargeable in bankruptcy only under the most dire of circumstances (you have to meet the Brunner test proving harm and undue hardship). Collection costs are punitive, enormous, and add to the principal.

Like most students entering college right after high school, Monica was a teenager when she signed her student loan contracts. It is apparent she had no idea what kind of indenture she’d “agreed to.” This can be said for the majority of student loan borrowers. Financial education at the high school level is seriously lacking, if existent at all. Student loans are originated between borrower (student) and lender without much scrutiny, oversight, awareness, or repayment considerations. Politicians in Congress made this possible.

Over the past decade, through both pro bono and paid tax preparation work; I’ve seen many student loan borrowers like Monica struggle to make ends meet and have tried to understand what is happening with their student loans. I’ve watched as refundable credits in the thousands of dollars have been seized by federal and state agencies year after year to pay for student loan debt. Many low-income taxpayers who took out debt decades ago and who have tried to pay this debt back, find – with accrued interest and collection fees – they owe much more than the original loan amount. Those who qualify for tax credits earned for dependents, education, or economic qualifications (refundable child tax credit, education, and earned income tax credits), never see the refunds which could have helped with housing, utilities, and child care. Instead the money is siphoned off into a vat of pots to pay for bloated collection costs, fees, interest, and most likely never touching principal. It is a cycle that can last decades, is rarely broken, and often without any reconciliation of seized funds.

This past tax season I prepared the return for an 80-year-old man who came into the tax clinic. He handed me his W-2 form which reported wages of $500 and a Social Security statement. He needed to file a tax return to obtain a refund of federal and state withholding reported on the W-2. While reviewing his Social Security statement, I noticed one-third of it was garnished. When I questioned him about this, he became very solemn, put his head down, and explained it was for an education loan taken out for his daughter “some time ago” to help her attend college. She had since died. Piecing together what he told me, I figured he took out a federal Parent Plus loan, had defaulted (before, during, or after his daughter’s illness and death) and didn’t know what to do. The default resulted in the garnishment of his Social Security, most likely without end for the rest of his life. There isn’t even an accounting of what is taken each year.

Without basic consumer protections, financial education, understanding, or advocacy, and absent the ability to discharge in bankruptcy, the contracts Monica and other borrowers enter to secure loans to help fund higher education are heavily lopsided in favor of lenders, investors, and loan servicers.

I question, as required by the basic principles of contract law, whether there is even a meeting of the minds between borrower and lender. Additionally, there seems to be some amount of unconscionable favor on behalf of one party over the other.

Student loan debt has topped $1.3 Trillion. By entering into these cumbersome, confusing, complicated, non-transparent contracts, the US has been devouring its citizens- young and – old in a cruel system of endless servitude.


Original principal 10,000
Interest added to principal 5,173
Collection fees added to principal 2,225
Revised principal increase over 30 years 17,398
Principal paid 14,370
Principal balance January 2017 3,028

Total paid over 30 years Dec 1987 thru Jan 2017
Paid toward principal 14,370
Paid toward interest 9,710

Lynn Petrovich, CPA
Copyright 2018

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Interest rates and jobs: a variation on the model

Interest rates and jobs: a variation on the model

Friday is nonfarm payrolls day, so in the absence more noteworthy economic news, let me follow up on Monday’s post in which I discussed “A simple model of interest rates and the jobs market.”
In it, I suggested that:
1. a YoY increase in the Fed funds rate equal to the YoY% change in job growth has in the past almost infallibly been correlated with a recession within roughly 12 months.
2. the YoY change in the Fed funds rate also does a very good job forecasting the *rate* of YoY change in payrolls 12 to 24 months out.
One shortfall of that model is that there are two “false negatives” in the low interest rate environment of the 1950s, during which the YoY increases in interest rates by the Fed were relatively modest, and did not exceed the YoY change in payrolls until after the recessions had already begun.
I suspect that in a low interest rate environment, more modest increases in interest rates might have a more pronounced effect. For example, an increase in mortgage rates from 2% to 4% doubles the monthly interest payments on a mortgage (i.e., a 100% increase), whereas an increase from 8% to 10% only increase it by 25%.
While I haven’t explicitly looked at mortgage rates as of yet, what I did do is plot the simple rise in interest rates from their low points near the beginning of each expansion since the mid-1950s, and see if, during a period of Fed tightening, they always rose to exceed the YoY% change in job growth *before* the onset of all of the recessions since.  Here’s what I got:

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