Risky Financial Behavior Increases When Someone Else Will Be Left Holding The Bag

The ongoing economic crisis, beginning in 2008 and still bedeviling us, has churned up an important concept, “moral hazard.” The basic notion of moral hazard is easy enough to grasp. If certain institutions or individuals believe that they are insulated from the possible bad effects of their actions (e.g., if big banking firms know that the federal government will bail them out no matter what, or investment firms know that the same federal genie will pump up the stock market artificially), they will tend to act in careless or risky ways (e.g., trading in subprime mortgage bonds, while having insufficient funds to cover these perilous but high-yielding “investments”).

The “hazard” in moral hazard is that there’s no penalty for taking big risks. No matter how risky one’s actions are on the “high wire,” there’s always a safety net provided by someone else.

Even more morally hazardous, vice is rewarded, and virtue is punished. The CEOs and other executives still get their bonuses. The guys on Wall Street gambling with other people’s money, don’t take a hit themselves when it all goes sour. Somebody else takes the soaking (in this case, not the government itself, but honest taxpayers, innocent investors, and solvent homeowners).

Sadly enough, the situation of moral hazard is not confined to the big banks on Wall Street, but has come to define every aspect of Main Street, and both streets came to such disrepair in part because they were paved with good intentions.

And nowhere is this more clear than with our current college debt crisis—also known as the higher education bubble because of its affinity with the housing bubble.

You remember the housing crash of 2008? It all began when nice guys in government wanted low-income folks (denoted as “sub-prime”) to have a house even though they couldn’t afford to pay a mortgage. Interest rates and borrowing standards were lowered accordingly.

Soon, nearly everyone on the income spectrum was trying to buy a house he couldn’t afford. You didn’t even have to have a job—that’s how big the gap became between the old-fashioned virtues entailed in hard work and the reward of one’s labor. On the money-lending end of things, since the sub-prime mortgage bond market ended up being fantastically lucrative, why should banks and investment firms worry about taking a drunken walk on the risky financial edge when the government was there to catch them if they fell?

And caught them it did—and then handed the taxpayers the bailout bill.

Now we are facing a higher education bubble, one part of which is constituted by the student loan debt crisis.

The government college loan program had its origins in FDR’s well-intentioned G.I. Bill (or more properly and aptly called, the Serviceman’s Readjustment Act of 1944). The goal was to help returning veterans make up for lost time and give them a boost up in repayment for their sacrifices. So, the government gave them low-cost mortgages and business loans, and tuition payments if they wished to attend a college.

In his signature desire to extend government largesse to everyone, so he could create the Great Society, LBJ hoped to eradicate durn near everything unpleasant, from poverty to the bane of sub-collegic ignorance. To serve the latter task, LBJ pushed through the Higher Education Act (1965) which was designed both to fund colleges and universities directly and to make college possible through low-interest loans for those who couldn’t afford it.

I quote the original HEA words in regard to the aim of student loans. “It is the purpose of this part [Title IV—Student Assistance] to provide, through institutions of higher education, educational opportunity grants to assist in making available the benefits of higher education to qualified high school graduates of exceptional financial need, who for lack of financial means of their own or of their families would be unable to obtain such benefits without such aid.” Beyond outright grants to students, the HEA also made provision for insured, subsidized student loans.

The unintended effects on college education have been, to say the least, interesting. As is always the case, the immediate effect of an enormous influx of government money is always the same: a drastic inflating of the price. The next effect, in regard to the price of higher education, was an equally drastic inflating of the amount of loan money offered by the government to pay for it.

Let’s illustrate. Here’s an interesting snippet from an article in the Harvard Crimson written in 1963, about the tuition hikes about to take place for the fall of 1964—a year before the HEA was passed.

Harvard will follow the lead of other Ivy League schools when it raises its tuition in the fall of 1964. This fall three Ivy League schools are hiking tuition rates and rates may go up at the other schools by the fall of 1964.

This September Cornell and Columbia will both raise tuition to $1700, which will be the highest in the League next year. Dartmouth is planning an increase in tuition to $1675 for next fall, with an additional hike of $125 scheduled for September, 1964.

Pennsylvania and Brown both announced that they plan no immediate rise in tuition. Penn now charges $1630 for tuition and fees, but Henry R. Pemberton, vice-president in charge of business and finance, said earlier this year that future rises are inevitable.

Zenas R. Bliss, provost of Brown University, said last February that tuition at Brown will remain at $1600 next year, but did not guarantee that tuition would not increase in the fall of 1964.

Yale and Princeton have not announced any impending tuition rises. However, there are rumors of an increase at Yale, where the last tuition rise went into effect two years ago. Tuition at Yale is $1550. Princeton charges $1600 for tuition and health services.

Harvard’s present tuition of $1520 is the lowest in the League. It also compares favorably with rates at many of the smaller liberal arts schools. For example. Colgate University recently raised their tuition $200 to $1700. But room and board at Colgate cost only $800, compared to an average of $1100 at Harvard.

And now, after fifty years of government subsidizing of higher education? The average tuition of a private university last academic year (2014-2015) was over $31,000, and the average room and board price tag was over $11,000. The total average cost: over $43,000.

And that’s the average. Harvard costs well over $60,000 this academic year, 2015-2016.

The cause of this astounding ballooning of prices over a fifty year span can’t be set down to the over-all inflation rate during the period, otherwise a loaf of bread today would cost $9.73. The single most important cause is that educational institutions realized (like doctors and hospitals getting insurance payments) that they could charge whatever they wanted because students were using ever larger federally subsidized loans to pay for whatever the universities dared to charge.

Making the situation far, far worse, is that the loans were not just indiscriminate in size (loan sizes rose with the hyper-inflated increase in tuition), but also in scope. Every major, every possible study—no matter how arcane or tenuously connected to getting a job that could possibly pay back the loan amount—was subsided by the loan system. One of my children attended a college where students were blithely sinking in debt with such majors as Aroma Therapy.

Google the phrase “student loan horror stories” and feast your eyes. Alan borrowed over $100,000 to get a degree in jazz guitar, Steve is over $100,000 in debt for his degree in Game Art and Design, Mary has over $90,000 to pay back for her degree in Social Work, Eric has a Master’s in Graphic design with a price tag of $170,000. Joseph owes $172,000 for his undergrad degree, and is going on to law school, thereby adding another $100,000 at least—and on and on and on.

All bought degrees they couldn’t afford because—like the housing boondoggle—federal loans were available to do it. Nor was there any real connection to the “exceptional financial need” of students, as the original HEA demanded. In parallel with the housing crisis, the presence of fast and loose loan money was used both by the very poor, and everyone else up to the rather well off—in part because HEA was reconceived as making sure anyone and everyone get a college degree who wanted it, in part because the price of higher education rose so precipitously that nearly everyone needed a loan to pay for it.

Today the average student loan debt is $30,000, and there are almost 40,000,000 student loan borrowers in the US, with over a trillion in total debt—and 85 billion of it is overdue.

Hence the wages of Moral Hazard.

Note the parallel to the 2008 Banking/Housing crash. To focus on the education side of things, institutions of higher education recklessly expanded their offerings, lowered their standards, and ran more and more students through more and more majors with no moral regard for the actual economic (or even intellectual) worth of the degrees granted. They had nothing to lose, and millions upon millions of federal dollars to gain. There was no penalty for inflating their prices, inflating their offerings, inflating their grades to accommodate more and more unqualified students to get more federal funds, and inflating prospective students’ perspectives on what would actually happen to them when they graduated. Unsurprisingly, the number of colleges and universities expanded recklessly as well, absorbing the endless supply of federal loan dollars, even while successively lowering the quality of the education (ending with the notoriously bogus degree mill, the University of Phoenix).

On their part, Students recklessly took on loans, without any moral regard for their future ability to pay them back, because the money—at least in their short-term eyes—appeared to be free and abundant. They assumed, like homeowners just before 2008, that no matter how large their loans, that no matter how bizarre or practical their degrees, no matter how entirely abstracted their majors were from the actual economic needs of the society into which they would graduate, they would be able to “flip” their degrees on the other side of graduation for a handsome profit.

What will happen when the education bubble bursts? Surprise, it is bursting. Google “Student Debt Crisis.” What you find—sounding again, like 2008—is that students are unable to pay their loans, and colleges and universities are unwilling to take any responsibility for boondoggling all-too-willing students, so the federal government is left as the magic money genie fixing to bail everyone out.

That’s the government that’s already over $18 trillion in debt. That’s your debt, taxpayers.