Monday, November 21, 2016

Growing Asset Bubble

     In a change of pace from my past little articles, I want to go over this possibility of a future asset bubble: Student Loans.

     Let me set the scene. I was sitting in lecture for one of my economics classes at school. We have been talking about the history of the united states regarding recessions and depressions. As of late, we have been diving into the recessions since the early 1980's. In this particular instance we were talking about the asset bubbles that have popped and sent the economy down the tube. The oil price shock in 1990, the dot com/tech bubble in 2001, and then the housing bubble in 2007-08. [For those of you that don't know what an asset bubble's the irrational increase in the price of an asset] Back in 2001 with the dot com bubble, the internet was finally becoming much more accessible to the public and companies were able to create websites. 

     I remember hearing one story where a grocery store made a website, literally all they did was build a website for their grocery store, and their value went up by 50%. In class, we talked about the companies that were created only through a website. They just popped up and were immediately funded because everyone was speculating that the prices would keep going up and up and up. Two such companies were and Webvan. The one I just mentioned above was Webvan. It started in 1996 and went bankrupt and shut down in 2001. was a website that offered pet supplies and food online for consumers. They got 300 million dollars of investment capital in 1998 and it was all gone at the end of 2000. Many people refer to this company as the biggest flop during the popping of the bubble. They got a lot of advertisement with the super bowl and morning talk shows, but they lost money on almost every sale they made and had no sustainable plan. That's the definition of an asset bubble. The value of the company rose drastically and irrationally over a very short period and was incapable of sustaining it. Once people started to realize this, the dot com bubble popped and lead to a recession that lasted 8 months. 

     You're probably wondering what the point of all that was. The point is that conversation brought up the question, are student loans an asset bubble? My professors face lit up when the kid asked him that question. So in the next paragraph or two I'm going to try and paraphrase what he was saying and try and add a little about what I think. So here we go. 

     Basically there are a couple different thoughts when it comes to a student loan asset bubble. The first is if the payment is not made what can the lender seize as collateral. In most other situations the loan is made for a house or a car where if the consequence of not paying the loan back is losing the thing you bought. Getting a loan to go to school is much different. The money is being paid to the school for education and learning and there is no way for the bank to take that. So in general, there is nothing the bank or lender can take from the person if the loan isn't paid back. Then what's stopping people from just saying, 'screw it' and eating the bill? Their credit score.

     Usually to receive a loan the lender needs to see that you have had good credit history. The credit score is an arbitrary number given to people to show their past history at paying back loans and credit. A person doesn't have one until they get a credit card and start buying and then paying back on the credit. A good score is in the mid to high 700's and a bad one is below 650. When a loan isn't paid back or you're late on the credit card bill the number will drop to show that you aren't as reliable and more of a risk. The thing is, your credit score isn't based on a rigid system. You are scored compared to everyone else with a credit card. So if EVERYONE'S credit score goes down, then your number will mean the same thing. If the average is something like 700 (made up average) and then people start saying screw this, it doesn't matter to me and the average drops to 600, but your score will stay close to where it is because so many people dropped. I don't think I explained that very well. But I'll leave it at, your credit score is compared to everyone else's score and if you all drop then you essentially stay in the same ranking. 

     But what's the point of a credit score? You need a good one to be able to buy a house, buy a car, get loan, etc. The thing is that a lot of the young people aren't doing that anymore. They are living closer to the city and living in apartments where a credit score isn't needed. They are using the public transportation, walking, or riding a bike to work. So what's to stop those young adult fresh out of college with $37,000 of debt to pay from not paying it? If the only consequence is a bad credit score then whats the point? If people start to realize this and just stop paying on their debt then it could wreak havoc. 

     There is something like $1,300,000,000,000 dollars of outstanding student loans. Yes, $1.3 trillion dollars. If people just don't pay, who gets hurt? The people who issued the loans in the first place. Even if a quarter of that is defaulted on, that's $325,000,000,000 (billion) that banks and other lenders have to just write off. That's crazy. Student debt continues to rise every year for college students because university's continue to raise their tuition. It is becoming irrational to pay any of these back, and soon people may start to realize that. And then the bubble will pop. Some things really need to change because it's only getting worse. Otherwise we could be headed toward disaster. 


  1. Something needs to be done about this on the private institution side. This isn't as much of a public institution issue because of FAFSA. Essentially, the bank will find ways (garnishing wages) to get their piece of the pie back. Some thoughts on this also include the bank taking an interest in apartment developments and requiring renters to use credit (They might already? Not sure.) Any thoughts.

  2. Oh no doubt. It's all about the private institutions. I mentioned colleges raising their tuition as a side note. They aren't causing it, they're just trying to do what is best for them. I'm sure banks are looking into using credit for apartments. Especially recently with a lot of younger people doing that and staying there for a long time. I wouldn't be surprised if some were already trying. I'm not sure either, though. However I still think it would be tough for the banks to get their piece of the pie back if they cant physically seize anything as collateral for default.