Opinion

Edward Hadas

The stupidity of student debt

Edward Hadas
Jul 2, 2014 14:31 UTC

By Edward Hadas

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The fast increase in loans to pay for higher education is a trend that is moving in the wrong direction. The idea that borrowing should play an important role in financing higher education, now standard thinking in the United States and the United Kingdom, is financially dangerous and economically wrongheaded.

Overall, American households are deleveraging. Most notably, U.S. mortgage debt outstanding has fallen to 51 percent from 71 percent of GDP since the end of 2008, according to survey data from the New York Federal Reserve. However, over the same period the ratio of student loans to GDP increased to 5.7 percent from 4.3 percent. The $1 trillion now outstanding is economically significant. In England, the ratio of student loans to GDP is only about half as high as in the United States, but the 80 percent increase over the last five years has been even faster.

For the financial system, the growth is simply bad news. The last thing highly leveraged economies need is an expanding category of debt. Worse, student debt makes the financial system less secure and more complicated, thanks to high default rates and complex repayment terms. Also, student debt, like all debt, distorts behaviour. Heavily burdened new graduates are likely to delay such adult activities as buying houses and having children.

Few people would argue with these negative effects. But after decades of increased borrowing to pay for almost everything – housing, cars, holidays, government spending – it seems natural to use the credit system to put off paying for just one more desirable thing until some fine day when more money is available.

When credit is too much of a good thing

Edward Hadas
Apr 9, 2014 15:00 UTC

What does credit do after it has finished the job it was designed for? The supply of credit ought to stop at funding productive activity. But the reality is different. Surplus credit fuels dangerous asset price inflation and funds profligate governments. As leverage increases, so too does the risk of crisis and recession.

Credit, otherwise known as debt or loans, is not necessarily monstrous. It can be a most helpful economic beast of burden, carrying resources to the places where they can be best used. Loans from households to businesses fund helpful investments, and loans from rich older households to poor younger ones help spread property, especially houses and cars, more equitably. Even loans to governments can be a useful alternative to taxes.

However, credit too easily goes astray and there is no natural force to rein it in. Without firm regulatory guidance, credit seems to expand indefinitely, until the financial system explodes. That has been the pattern since the end of the Second World War.

Mega sovereign writeoff could work

Edward Hadas
Feb 12, 2014 15:48 UTC

A massive sovereign debt reduction is the right way to reduce the ridiculously high indebtedness of governments. The idea might sound crazy, but it makes economic sense, and could be done, albeit after some serious preparatory work.

Many rich country governments have been borrowing excessively in recent years. In 1991, when the calculations from the International Monetary Fund started, gross government debt of advanced economies was 60 percent of GDP. This year it is expected to be 108 percent of GDP, or about $51 trillion.

The current level is much too high for the overall economic good. Heavily indebted governments spend too much of their tax revenue on interest payments and spend too much time trying to placate bond buyers, who rarely support useful long-term investments. Rumours of possible default can spark a financial crisis. And the excessive supply of sovereign obligations encourages parasitic speculation. The economically pointless trades of supposedly risk-free government debt pay much of the high salaries at investment banks.

A Christmas message for lenders

Edward Hadas
Dec 18, 2013 15:30 UTC

For many shoppers, Christmas is a time to rack up debts in the expression of seasonal goodwill. For policymakers, it should be the holiday of debt forgiveness.

The inspiration for that religious-sounding thought comes from the atheist philosopher Hannah Arendt. She argued that forgiveness has a central role in human affairs, and the secular world should be grateful to Christianity for the discovery. Arendt was of course talking about forgiveness in the common understanding of the term – a pardon for a wrong, the cancellation of “you owe me one”. But her understanding of this as enabling people to “begin something new” works just as well when thinking about the financial equivalent: a willing erasure of material obligations.

Consider a loan from parents to a son or daughter who wants to start a business. If the new venture fails, a tough demand for repayment is likely to spawn resentment. Debt forgiveness will breed gratitude and closer ties.

Imagine a world without debt

Edward Hadas
Aug 7, 2013 09:32 UTC

I have a dream: a world without debt, and with much more equity. It’s not just that summer holidays are a good time for fantasising. The fifth anniversary of Lehman Brothers’ bankruptcy is a month away, and regulators have recently forced both Deutsche Bank and Barclays to issue more shares.

Some regulators’ beach thoughts may drift to the magic numbers of bank capital ratios. My approach is less technical and more philosophical. I wonder why the financial system relies so much on debt. Loans and bonds are poorly designed for their primary economic purpose – investment.

This observation may sound shocking. Interest-bearing debt is considered totally normal. Financial theory unquestioningly treats risk-free debt as the standard instrument. Savers usually compare all investments to a similar standard: safe bank accounts which pay a steady interest rate.

What to do about debt

Edward Hadas
May 30, 2012 15:11 UTC

Debt, a little like sex, is a two-sided relationship which, when used appropriately, pleases the partners and is good for society. But both are also intoxicating and can easily become excessive and anti-social.

The financial bubble of the 2000s was the financial equivalent of the 1960s enthusiasm for “free love”. The delights of nearly free debt set pulses racing. Since the financial collapse, the dangers of uncontrolled borrowing have been recognised, but the bad habits have hardly changed.

When debt is used as it should be, lenders receive a just return on their assets and borrowers pay a just price for the use of the fruits of other people’s labour. Loans finance helpful investments and assist governments and individuals to manage periods of adverse fortune. But debt can also be used for promiscuous pleasure-seeking, unaffordable consumption, unjustified corporate investments and excessive government spending.

Bad ideas spawn Lesser Depression

Edward Hadas
May 16, 2012 14:18 UTC

On September 15, 2008 Lehman Brothers collapsed in a heap, a bankruptcy that was followed by a recession in most rich countries. As time goes on, the severity of the disruption becomes both more apparent and more puzzling.

When Lehman failed, it was reasonable to expect the pain to be brief and concentrated. While too many houses had been built in the United States, most of the world’s real economy (comprising factories, offices, retail outlets, construction projects) was doing well. The global financial sector was more distorted, even before investors took fright at the decision to let Lehman go under. But by the middle of 2009, governments and central bankers had agreed to provide bankers and brokers with anything needed to keep them healthy.

Optimism was not justified. Although the countermeasures stopped the deterioration, the rich world now seems stuck in a Lesser Depression – many years of poor economic results and a series of financial crises. In the United States, the euro zone, Japan and the UK, real GDP per person is still lower now than it was four years ago. In all of them, GDP growth is currently either slow or non-existent.

What is the morality of debt?

Edward Hadas
Oct 26, 2011 14:18 UTC

Debt is a moral matter. While most economic activity is concerned with the “is” of how things are (investment, consumption and so forth), debts are always entwined with an “ought” – to repay. In discussing controversial debts–for example government borrowing in the euro zone and the U.S.–the moral question should be addressed directly: should these debts be paid off in full, or is some forgiveness justified?

Aristotle can help frame the argument. The philosopher condemned all lending at interest because money cannot create wealth by itself; a loan is just a way for the lender to take advantage of the borrower. Some proponents of Islamic finance make a similar argument, but it is not quite right. Capitalism has shown that loans can indeed produce wealth. If the lent funds are invested well, enabling the borrower to improve his lot and the world’s, then interest payments are the lender’s just reward for providing the fruitful funds.

But Aristotle’s moral logic remains relevant; his condemnation is appropriate for loans which do not share wealth justly between borrower and lender. Unfair loans should not be made, and where they have been, full repayment only compounds the original injustice.

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