Opinion

Felix Salmon

Dealing with student loans

Felix Salmon
Sep 3, 2009 17:12 UTC

Anne Marie Chaker’s story is a little bit too alarmist, I think, but there’s still a serious problem here:

Students are borrowing dramatically more to pay for college, accelerating a trend that has wide-ranging implications for a generation of young people.

New numbers from the U.S. Education Department show that federal student-loan disbursements—the total amount borrowed by students and received by schools—in the 2008-09 academic year grew about 25% over the previous year, to $75.1 billion.

What Chaker never even hints at until much further down in the piece is that a lot of this is good news: students are moving from expensive private loans to cheaper federal loans. But the fact is that young students are not very good at judging what’s a reasonable amount of debt for them to carry. The dean of Hofstra University has it right:

“I don’t know if we can take it for granted that a 22-year-old knows what it means to borrow $100,000,” said Nora V. Demleitner, the dean of Hofstra Law School, where enrollment is up a relatively modest 5 percent. “They look at the $100,000 in loans, and then they look at the $160,000 salary. And they think, ‘Well, that’s not so bad.’”

At least with mortgages, people have a reasonably good idea of how much they can afford to pay back. With student loans they don’t — especially not with something like a law degree, where either you get that coveted $160,000 job as a first-year associate, or you don’t. And if you don’t, you’re very unlikely to make anything like that kind of money, and your student loans are likely to dangle over your head for decades hence.

There’s a strong case to be made that the government should not be in the business of making it easy for students to go massively into debt even when their chances of repaying that debt are slim. It’s not hard to come up with anecdotes such as this:

Lillian Russell graduated from law school at the University of Pittsburgh last year with $181,000 in debt from her seven years in school. She has spent much of the past year looking for work. In recent weeks, she found a job clerking at a small law office. While she settles into her job, she has deferred payments on most of her federal loans, though interest continues to accrue.

“I wish I had considered the long-term impacts of what I was getting into,” Ms. Russell says. When she entered school, “the idea was I’d take out the loans, get a job, and pay it back,” she says.

Realistically, most graduates from the University of Pittsburgh law school are not going to waltz into $160,000-a-year jobs: Russell’s experience, where she’s clerking for something close to a normal living wage, is surely quite normal. It’s ridiculous that colleges can charge pretty much whatever they want, and the federal government will always be there to provide loans. One good way of decelerating the inflation in tuition fees — and the concomitant rise in student debt — will be for the federal government to start getting much stricter about the kinds of sums it’s willing to countenance.

COMMENT

Oh, most graduates finish their degree with a huge debt. This debt, unless they have fortunate parents will takes years to pay when and if they begin their chosen career. The issue is often these young people cannot find employment and therefore the debt remains unpaid. This further adds to the cycle within the economic school systems.

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Money market funds, risk, and cash

Felix Salmon
Sep 3, 2009 15:12 UTC

Eleanor Laise has the encouraging news this morning that Deutsche Bank is planning to launch a money-market fund whose shares fluctuate in value, rather than being artificially pegged at $1.

On the face of it, this is a very good idea. Money-market funds are low-risk instruments, but that one phrase hides many different possible meanings, which get unhelpfully elided in the minds of investors. Moving to what’s known as a “floating NAV” (the net asset value goes up and down over the course of each trading day) helps to make some of those distinctions explicit.

Most people intuitively think that “low-risk” means “you can’t lose much money”. In finance, however, “low risk” can also mean “there’s a very low probability that you’ll lose any money at all”. And the problem with $1 money-market funds is that if they “break the buck”, then all hell breaks loose, and investors can end up waiting months to get their money back. It’s classic tail risk.

Wall Street is good at massaging risk in this way: taking risk and shoving it off into the tails. Most triple-A-rated structured products were like that: part of the reason that they offered a big yield pickup was by effectively maximizing the loss given default in the (perceived unlikely) event that a default did occur. Of course, another huge problem with tail risk is that measuring it, ex ante, is pretty much impossible.

So I’m all in favor of a product which has small fluctuations in value every day, thereby helping to reduce the tail risk associated with putting a floor on the fund value.

There are good reasons not to go down this road, however, and if you look at section 8.1 of this report, you’ll find a lot of them. What’s more, there are bad reasons to go down this road, specifically the idea that it’s just nimble-footed regulatory arbitrage:

In a letter to the SEC this week, Deutsche Bank suggested that floating NAV funds have a starting price of $10 a share and that they don’t need to be subject to tighter money-fund rules recently proposed by the SEC.

Rolfe Winkler adds another wrinkle to all this, which is the whole idea of money-market funds being “cash equivalents”. I’m with FASB on this front, in believing that the whole concept of a “cash equivalent” is dangerous and unhelpful. There’s really no such thing as “cash”, beyond folding banknotes — and those literally come with a cost of carry. All other forms of cash carry some kind of counterparty, credit, or interest-rate risk. We should move to a world where those kind of small risks are embraced and understood, rather than being ignored by being lumped into the category of “cash equivalents”.

COMMENT

I don’t see why money funds were ever permitted to pretend to be something they are not. If they are an investment product such that investors can lose money, then it should be illegal for them to pretend that they have a NAV of $1. The value of an investment fund is what it is — it’s simply illogical to try to bound an investment fund below by some fixed value.

On the other hand, if money funds want to have a NAV of $1, then they are clearly not investment funds. They are making an implicit promise to account holders to return their funds. It is only possible for a money fund to support this promise if it has reserves/capital set aside in case losses exceed the NAV (as was demonstrated by the fund bailouts of 2008).

The ICI wants to continue to have it’s cake and eat it too. Regulators need to recognize that they have allowed the development of a financial product with investments that are inconsistent with the marketing of the product. This situation would be okay if there were money fund failures every one or two years — so the reality of the investment fund attribute of money funds was brought home to investors on a regular basis. In the absence of such market feedback, regulators need to rationalize the money fund market by demanding truth in advertising: If you want to have a fixed NAV, you have to maintain reserves to support your target NAV.

Late links, September 2

Felix Salmon
Sep 3, 2009 02:54 UTC

The behavioral economics of playing hard to get

OK, so being good at Task X is a good predictor of academic success. But that doesn’t mean that we should teach Task X.

Raising tuition rates increases the demand to attend liberal arts schools

Using satellite data on lights at night to improve GDP figures

“Redemption rates for coupons on receipts can run as high as 3%, about triple the rate of coupons mailed to customers

Finance should not be 8% of GDP. “JP Morgan, at his peak, employed less than 100 people.

Video of politician’s SUV running a red light and hitting a cyclist

COMMENT

Should look before crossing the road, roads are for motor vehicles not bicycles.

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Ben Stein and the plight of the upper-middle-class parent

Felix Salmon
Sep 2, 2009 16:46 UTC

Now that he’s been fired from the New York Times, Ben Stein has popped up as a “contributor” to Fortune, of all places. (I’m not sure that “thank” is the right word, but I found out about this from Dan Gross.)

Stein’s first column there is a doozy:

Thanks to a variety of factors, often parents have to struggle like galley slaves to get their offspring into private schools and pay for them…

Then there is college and a real course in horrors getting the darling in somewhere that won’t embarrass you in front of your pals at the club. That’s before paying for the school, which is a stunning slap in the face. Total college costs at a “prestige” school can easily touch $70,000 a year, real money for most people.

Words fail me when it comes to Stein’s description of $70,000 a year as “real money for most people”. But apart from that, he has a point. The plight of today’s upper-middle-class parent is exactly analogous to that of a 16th-Century prisoner in France, condemned to a decade or more of working in the nation’s war galleys.

Hell, the galley salves of old had it easy: they didn’t need to worry about “ballet, horse, and music lessons, math tutoring, and chess club”, let alone “the ‘play dates’ that lurk like unanesthetized colonoscopies in modern life”. (Note the utter horror embedded in the term “play dates” — Stein can only bring himself to use it when it’s encased safely in a prophylactic set of scare-quotes.)

This is an old theme of Stein’s: back in his NYT days, he spoke of himself as a latter-day Willy Loman (apparently they have “heavy bags” in common):

“ `Attention must be paid,’ as Arthur Miller said. So start now, and make it a habit to be grateful to your parents. Say you’re grateful and mean it. Do it now, however young or old you are. Do it on Father’s Day, Mother’s Day, every day.”

Stein is clearly not a happy parent, the evidence of his book on fatherhood notwithstanding. But even a man as narcissistic as Stein must surely realize that kids never beg their parents to work harder so that they can go to private school or ballet lessons; and they surely don’t fret about whether their choice of university might embarrass their father in front of his “pals at the club”. (Some pals Stein has.)

Any parent who so chooses — especially any upper-middle-class parent — can at any time opt out of private-school rat race, spend a fraction of those tuition fees on books and travel and fun, and work less hard, if they want, now that their annual expenses have dropped sharply from private-school territory. (Working less hard, of course, means spending more time with your kids, which is also a good thing.) No child will ever object to any parent making such a decision.

Yet somehow Stein has convinced himself that all parents who choose otherwise somehow deserve their children’s unending gratitude for making that choice. Indeed, he doesn’t seem to think that it’s much of a choice at all, and that the costs of private school are so high that would-be parents of a certain class are actually choosing to get German shorthaired pointers instead. (Of course, it says everything about Stein and nothing about today’s parents that he thinks that dogs can and do replace children.)

Stein even ends up declaring that this whole working-hard-to-pay-school-fees phenomenon is so dreadfully pervasive that it bodes ill for the entire future of the country:

It’s happening right now. The native-born upper middle class barely replace themselves in America, if they do at all. In a way we are committing suicide as a class, possibly in part because of the burdens of child rearing in modern life.

I love that idea of “committing suicide as a class”, as though there’s any evidence at all that the “native-born upper middle class” is shrinking. (It isn’t, and why does it matter anyway if a member of the upper-middle classes is native-born or not?) It used to be that the American Dream involved being born poor and making it rich: clearly for Stein that doesn’t really count: all he cares about is the people who are born rich and succeed in breeding rich offspring.

Maybe, if those offspring are spectacularly successful, they too can be described in Fortune magazine in tones like this:

Ben Stein is an actor, lawyer, writer, and economist who also appears in commercials as a spokesman for various companies.

You go, Fortune. Now that you’ve disclosed something so vague as to be utterly meaningless, there can’t be any conflict of interest over the fact that Stein is a paid shill for an evil and predatory company. Maybe you should sign up the Cash4Gold guys next.

COMMENT

l’ Upper Middle class c’est moi

London? London… lived there. Weather sucks, pretty much most of the time. Been several years though, might be improving with global warming. I hear chicken tikka masala is now the national dish. That would be an improvement as well.

Anyway, I sent my upper middle class kids to the local far suburb public schools, they got admitted to very good public universities, got degrees in law and science, and jobs, even in a bad economy. My wife and I were very tired of soccer by the time they graduated tho..

Anyway, we put the money we didn’t spend on ed into retirement accounts and eventually retired early, so public education works fine for me.

@felix should try some of that because Ben S IS TRYING TO GET A REACTION BY BEING PROVOCATIVE BECAUSE IT INCREASES HIS READERSHIP. Seems to be working too, sort of like Obama and Rush Limbaugh.

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The Opel saga

Felix Salmon
Sep 2, 2009 13:01 UTC

A team of seven Spiegel staffers has produced a spectacular account of the big M&A story you’re probably vaguely aware of and find far too complicated to understand — the attempted sale of GM’s European car division, Opel. There’s lots of great stuff here, such as the games of phone tag being played out at the highest levels of the German and US governments (including Angela Merkel, Tim Geithner, and even Hillary Clinton and Dmitry Medvedev); and the spectacular own-goals being scored by the German government (like appointing board members to the German-American trust overseeing the sale of Opel who disagreed fundamentally with the government’s own plans for the carmaker).

Then there’s the even more spectacular own-goal made by at least one bidder, RHJI:

The plan offered by private equity investor RHJI would have been less expensive. It only requires government assistance to the tune of €3.8 billion.

However the fact that Magna was chosen in the end was a consequence of more than just political lobbying. It was also a result of a lack of tact on the part of RHJI representatives at a meeting in the Chancellery.

When Merkel asked Magna CEO Siegfried Wolf why he wanted to take over Opel, he said he believed in the company, in the future of the automobile market, and the value of the Opel brand. Merkel liked that.

Then she asked RHJI CEO Leonard Fischer why he was interested in Opel. The former investment banker answered very matter-of-factly that it was because the German government was assuming the risk. Merkel liked that less.

At this point, the chances of a deal being done before the German elections on September 27 seem to be negligible. After that, the political will behind bailing out Opel might well dissipate, to no particular sadness in Detroit, where important GM board members are asking why Opel need be sold at all. The most likely scenario could well be, now, that no deal will be done at all, and all the high-level politicking will be ultimately for naught.

(Via Hasselback)

COMMENT

Zu Guttenberg is about the only person in Germany to have admitted, though only briefly (he has been forced to change his music since then), that the Magna plan makes no sense and insolvency may be the only viable option. WSJ has reported that GM, besides putting in a billion euros of its own, has apparently been offered loans for another billion from UK, Span and Poland. If, as Spiegel reported, it is true that the German factories cost twice as much as those in Spain, and over four times as much as the factory in Poland, the only way to return to profitability is to close all the factories in Germany. Even if GM were to accept over 100 billion euros from Germany for Opel (as in Hypo Re), this money would simply go down the drain since the German factories are the cause of the problem in the first place. To this one should add the hostility faced by the German government and especially the trade unions.

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Is Wells Fargo regretting its Wachovia acquisition?

Felix Salmon
Sep 2, 2009 11:31 UTC

Putting aside the all-but-irredeemable basket-cases BofA and Citigroup, there’s only one major bank which has yet to repay its TARP money: Wells Fargo. How come? I Wells has a reputation as being the best and most solid bank in America, a favorite of Warren Buffett, and a bank which managed to sidestep most of the worst excesses of the credit boom.

The answer, I think, is that Wells was ultimately undone by exactly the same thing which doomed BofA: a panicked and unwise acquisition. In this case, of Wachovia. Because the demise of Wachovia was structured with a different acquirer (Citigroup) already in place, Wells had to essentially outbid Citi for Wachovia, and is now suffering from the winner’s curse.

The other problem with the Wachovia acquisition is that Wells Fargo is now far too big — it has an astonishing $711 billion in US deposits, 11% of the total US deposit base — and as a result it will be under intense regulatory scrutiny for the foreseeable future.

Only one of America’s four megabanks seems particularly healthy: JP Morgan. Wells Fargo, which should by rights be the big boring safe one, is instead struggling with all the extra leverage it brought upon itself with the Wachovia acquisition; its sheer enormity also leaves it vulnerable to calls from people like myself who think that all banks of its size should be broken up into less systemically-dangerous chunks. One can’t help but think that with hindsight, Wells might rather have simply left Wachovia to Vikram Pandit’s tender mercies.

COMMENT

See also: Lloyds TSB.

Deconstructing nature-vs-nurture charts

Felix Salmon
Sep 2, 2009 09:39 UTC

After Greg Mankiw sparked a blogospheric resurgence of the nature vs nurture debate, Brad DeLong and Tyler Cowen Alex Tabarrok weighed in with very different views of the empirical data. Tyler Alex featured an extremely provocative graph, and I waited for someone, maybe Yglesias, to respond.

tyler.png

In the end, the expected take-down came from finance whiz Mike Konczal, solidifying even further his status as the Italian Vogue of the econoblogosphere: the best that there is, read by everybody who matters, if nobody else. Mike drilled down deep in to the dataset used to generate this chart, and found:

  • The adoptees are four years younger than the non-adoptees: 28 years old, on average, compared to 32 years old. These are years in which most people’s income rises substantially.
  • 70% of the adoptees are female, compared to only 39% of the non-adoptees. Females earn less than males, and male heirs might well be better at inheriting their father’s income than female heirs.
  • The family income of the non-adoptees was $61,000 per year; the family income of the adoptees was only $42,000 per year.
  • The income of both adoptees and non-adoptees was measured by asking their mother how much she thought they were earning. Which obviously affects reliability.

On top of all that, there are racial issues which may or may not be relevant: the adoptees, in this group, were generally of a different race than their adopted parents. Put it all together, and the most we can learn from Tyler’s chart is, as Mike puts it, that there are “a lot of interesting questions for follow-up”. We certainly shouldn’t treat the study as showing anything solidly empirical.

Update: Karl Smith weighs in.

COMMENT

Taller people earn more. so do attractive people. Also physics professors make less than sucessful builders or salesmen, though not higher in IQ.

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Late links, September 1

Felix Salmon
Sep 1, 2009 23:31 UTC

Ex-girlfriend ignoring you? There’s an app for that

Taibbi on TARP math: “like calculating fund returns by only counting the stocks that have gone up”

Stanford receiver Ralph Janvey has paid his PR firm $165k. Which doesn’t seem to have done his image any good.

I saw this and thought “someone’s ripping off Charles Kenny”. Thankfully, it was Charles Kenny.

The placebo effect is getting stronger. So let’s encapsulate it in pill form!

Citi sells undisclosed assets to an undisclosed buyer for an undisclosed price, resulting in an undisclosed P&L

Gary Wolf on Craigslist: Extremely good.

“Google has taken the world’s greatest research collections and returned them in the form of a suburban mall bookstore.”

COMMENT

the market go down like hell.. nobody save this world cheats $charts… only jacobian fantasies happen here..

jobs for ….ing? well p value or z value, you’re damn sure to loose money in these days… dude..

u say about p-value based indicator… ha.ha.is it worst than Elliot Wave? then i buy!

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Why there can only be one basket of regulatory eggs

Felix Salmon
Sep 1, 2009 23:27 UTC

The prize for the weakest argument ever against a single strong bank regulator goes to Sheila Bair, with her tired and utterly inappropriate metaphor that “we can’t put all our eggs in one basket”. To the contrary, we have to put all our regulatory eggs in one basket, because otherwise the phenomenon of regulatory arbitrage will simply result in a race to the least-safe basket, as well as competition between regulators to see who can be most accommodating to banks.

The most corrosive aspect of the US regulatory infrastructure to date has been the ability of financial institutions to go regulator-shopping: that must be stopped. And the only way to stop it, in a world where AIG can end up being regulated by the Office of Thrift Supervision, is to have just the one regulator.

I was on KCRW this afternoon with economy.com’s Mark Zandi, who said that the financial crisis was a “scarring event, imprinted on our DNA” and that “for at least two generations”, regulators are going to “do the right thing enough times so that we don’t get into another crisis like this”. I don’t buy it. If there’s a choice of regulators, there’s inevitably going to be at least one which lets things fall through the cracks. And that one is going to be the one which ends up in charge of AIG. The only way to prevent that is to have just one regulator.

COMMENT

I don’t think your argument here — “there’s inevitably going to be at least one which lets things fall through the cracks” — is much stronger than Bair’s. If there is only one, what is to stop it from being the one that fails?

A single point of failure is a risk in itself. While I do think there should be an agency with the primary responsibility of overseeing systemic risk across the full scope of financial institutions — banks, brokers, mortgage originators, ratings agencies, insurancers, hedge funds, etc. — I do not think it should be the one and only regulator of all those institutions.

Better to trap the institutions in a web of regulators according to function. Do you accept retail deposits? You’re subject to the FDIC. Do you also sell insurance? That’s another regulator looking over your books. Engage in proprietary trading on your own account? Someone else will keep an eye on what you do there. Just bought a savings and loan, a la AIG? That doesn’t mean your whole business is now under the purview of the OTS, it just means that part of your business is: the other regulators to which you were previously subject are still on your back.

“Defense in depth”: no single points of failure.

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