The Next Debt Crisis

We saw the light at the end of the tunnel, but it turns out that light is an oncoming freight train of trouble. Outstanding U.S. student loan debt passed $1 trillion and is being hyped as “the next financial crisis.” College costs continue to rise at a rate double inflation, and students keep borrowing as the job market recovers at a glacial pace. These frightening numbers indicate that the education financing appears to be as dysfunctional as the American health care system.

The middle class is poised to take the biggest hit and the problem promises to impair US productivity well into the future. The recession played a major role in creating the crisis, but there is something inherently wrong with the system. College financing is ripe with perverse economic incentives for lenders and borrowers alike that distort the employment market and will continue to cause problems if left unchanged.

Lenders

In no other industry do lenders know so little about the investment their dollars are purchasing. A student could be studying underwater basket-weaving, aerospace engineering, or simply searching for that elusive Mrs. degree, but the lender doesn’t know. Imagine a mortgage lender loaning money without any regard to the house purchased. Or consider an even better example: envision a business loan being approved without a business plan. It would simply never happen.

Thanks to a law passed by Congress in the 1970’s, students can’t bankrupt (or die) themselves out of trouble and in many cases parents are also on the hook for outstanding debt. No escape or reprieve means a riskless investment to lenders, ranking student loans up there with United States T-Bills.  A “riskless” ten-year treasury earns a rate of 2%, while current student loan rates are 7%+. An investor would be stupid not to lend to any warm body headed for college. Why don’t these loans more closely follow the risk/reward model? Students are getting a raw deal while lenders make money hand over fist.

Borrowers

Students, what are you thinking? College is meant to be a stepping stone to a career; an investment in order to have a well-paying job after graduation. Take a look at these majors:

Children & family studies

Elementary education / Special education

Social work

Culinary arts

Leisure studies

Religious studies / Theology

Art /Art history / Studio arts / Drama arts / Theatre arts (pretty much any major with “art” in the name)

These are ranked as some of the worst college majors, yet students are taking out massive loans to enter these fields with no earning potential. If you do land a job in your field, you’re likely to be earning as much as a fry-flipping dropout. There is a reason the term “starving artist” was coined.

 

The desire to “do what you love” and follow your dream is noble but understand that these fields aren’t careers, they’re hobbies. You can play with children, go to church, cook, help people, and paint without a high-priced education.

Lenders are throwing money at you because it’s impossible to escape the debt and you offer a great return. To lenders, you’re a living, breathing annuity and you will be repaying those loans the rest of your life.

Solution

Although it won’t help borrowers currently drowning in a sea of debt, there is a way to ensure this crisis doesn’t repeat itself. Education financing isn’t an efficient market and the risk/reward ratio heavily favors the lenders. Students need competition to fight the evil, predatory, and price-fixing lenders. A lender is needed who uses information to make informed investments at efficient market rates.

Reform is necessary and economic incentives must be in place to promote the right behaviors on the part of lenders and borrowers. Here is my suggestion:

Student loan interest rates should vary based on the likelihood of a student’s ability to repay the loan. It’s simple – the higher the risk of default, the more the student pays in interest. In today’s society information is everywhere. This deluge of data can be crunched to determine an appropriate interest rate of a loan based on a number of factors:

College major: Not all college majors are created equal. Engineers and computer science majors will be paid well. Art majors and social workers will not.

School rankings: Not all schools are created equal. Harvard, for example, ranks near the top of the charts, while University of Bridgeport has been ranked America’s worst college. Ouch.

GPA: Students ranked near the top of their class are much more likely to be gainfully employed than students who’ve spent more time staring at the bottom of a beer mug than at a textbook.

 

Test Scores: An actuary can use standardized tests like the SAT, ACT, IQ and other exams to statistically predict earning potential.

Credit Rating: Your (or your parents) previous record of credit repayment is a good indicator of future performance.

Medical history: Do you binge drink every weekend? Add 1%. What is the likelihood that you’ll croak during the life of the loan? These risk factors can be mathematically included in the price of your student loan.

Loan forgiveness upon death should be standard. Like other business models, losses from borrower casualties should be priced into the operating costs of the business. A loan company can estimate the likelihood of death, similar to a life insurance company. The premium can be included in the loan rate or the borrower can forego the increase and take out an inexpensive declining-balance term life insurance policy, listing the lending institution as the beneficiary.

Like mortgages or any other type of debt/investment, the rate of interest should reflect the risk of the borrower repaying. The algorithm will determine which students are the most likely to secure well-paying jobs and which will be living on mom and dad’s couch. Different weights can be assigned to each category and can be reassessed each year based on the progress of each student.

Students who are pursuing money-making degrees, receiving good grades, and attending quality institutions will pay low interest rates. These low rates should increase competition amongst students and will entice more students to strive for success in areas where job growth and future potential is highest.

Students in the less than stellar majors (cough, art) will be faced with higher interest rates due to the risk they pose to investors. If you can’t make money, it isn’t a career and you shouldn’t be borrowing other people’s money to screw around for four years. University isn’t meant to churn out Starbucks baristas and Verizon sales reps.

Impact

The United States is concerned, and rightfully so, with its students’ performance in math and the sciences. Countries like China and India repeatedly outscore us and many of our best jobs are being outsourced. Our economically inefficient system – the system that loans money to art majors and engineers at the same rate – produces a distorted labor market.

Presently, there is a gap between labor demand and the supply of students who pursue a specific career path. The majority of students choose a career based solely on what they want to do (since their education costs the same regardless of degree) with no thought to the ultimate goal: employment. An intelligent lender with access to more information than a single student can close the gap using interest rates to incentivize students into fields promising employment. This will create an equilibrium between students graduating with specific degrees (supply) and finding meaningful employment (demand).

 

What if too many students shy away from the now “high-priced” art degree? Or education? At first, that should be the goal. There are too many art graduates for the number of jobs, which potentially lowers salaries. But in the future, a simple adjustment of the interest rate can change incentives. Simply put, offer a sale.

Sale! Sale! 0% financing on art loans!

Students will again fill the seats of art classes and equilibrium will be reached. At this point, art becomes expensive and student numbers drop. And the cycle repeats. This method of financing college expenses will create a more efficient market for financing university costs and will positively affect the job market by funneling people to where they are needed (i.e., financially rewarded). An economic “nudge” can be an effective way at changing behaviors and producing desired results.

The days of the one-size-fits-all, high-priced student loans are over. Maybe one day we will see the light at the end of tunnel. 

Manterest

I’ve been impressed with the meteoric rise of the website Pinterest. Recently its traffic ranked it as the third most visited social networking site behind only Facebook and Twitter. Impressive for the new kid on the block.

If you’re living under a rock and haven’t yet heard of it, you should visit -www.pinterest.com. It is a website where people (read women) can upload, save, organize, and manage photos, called “pins.” These pins are mostly pictures are of wedding dresses, rings, shoes, desserts, jewelry, clothes, princesses, and butterflies … you know, things women like. 

Visitors and members can browse the enormous online catalogue of photos, and like, comment, or share them by “re-pinning” to Facebook or other sites.

The idea of Pinterest itself is brilliant. It gives women the opportunity to look at pictures of jewelry they can’t afford, desserts they can’t eat, celebrities they could never date (or look like) – basically the lives they will never have. The timing, perhaps not coincidentally, was impeccable. Once the economy crashed, households around the U.S. were forced to cut back on spending and resort to window shopping. Enter Pinterest.

As I alluded to earlier, an extreme percentage – almost 85% - of members and traffic are women.  Given the sex bias in traffic, the popularity of the website is even more remarkable. I’m sure it’s obvious to those crafty entrepreneurs who started Pinterest , but I see a “glass ceiling” in the growth of the website.

Enter Mantrest, the manly boyfriend of Pinterest. As it stands, Pinterest needs to attract men to continue its growth. What would Mantrest look like? Here it is:

 
In reality, a male-dominated Pinterest would quickly degenerate into a hybrid of ESPN and Playboy. But that could be pretty popular.

Mantrest. Pinterest for men. The next big thing.

Revenge of the Noids

When opportunity knocks, will you answer?

It was a lazy Sunday afternoon and I was returning to the Quad Cities while talking on the phone to my brother. I passed the neighborhood strip club, and ended the conversation as I pulled into the parking lot outside my apartment. Nothing seemed out of the ordinary - just the crappy cars and trashy neighbors to which I’d become accustomed. I unhooked the iPod and gathered my bags, preparing to exit the vehicle. I walked over to the dumpster to deposit my empty can of Mt. Dew, but something tugged at my nostrils. I followed the odor, and lying in the middle of the parking lot was a Domino’s Heat Wave ® bag.

I stared with disbelief, sizing up the situation. Even from a distance it was obvious that the bag contained pizza. I had just driven over this spot a moment ago, and I was certain there was no bag. Was I about to be Punk’d, laughed at by millions of American? No Ashton to be seen, so I decided this didn’t seem likely. Perhaps was this a terrorist attack. Was it really a dirty bomb, set by Al-Qaeda to get back at capitalist America? Doubtful, since Bin Laden’s cave was nicer than my apartment complex. I couldn’t stand it any longer. Like the Siren’s song, the intoxicating aroma of hot pizza drew me near.

 

Logic kicked in and I pieced together the series of events that must have transpired. As I entered the lot, distracted, a delivery guy placed the pizzas on the top of his car and drove away. Given the placement of the hot bag, and my extensive knowledge of physics, I deduced that given the sharpness of the curve and Newton’s First Law of Motion, that pizza bag in my parking lot was a pure accident, and I was the fortunate bystander.

I was faced with an ethical dilemma. Should I keep found pizza? Better yet, should I eat found pizza? I quickly scanned the parking lot and grabbed the Dominos bag.  I called my brother back to tell him what fate had delivered to my doorstep.  As I walked into my apartment, the scent of fresh, hot pizza filled the room. Had I been hungrier, or not already had dinner plans, this story would end right here with me stuffing my pie hole with pizza. However, I wasn’t hungry so the tale continues.

I opened the box to reveal three medium pizzas, a retail value of $17.12 according to the label. My brother was still on the phone, and we discussed my options while reveling in the find.

I could call Dominos and tell them of my discovery. They could come pick it up and deliver it. I checked the time stamp on the box – almost an hour ago - that idea wouldn’t work, it would take too long and they would end up arriving late at the destination and giving the pizzas away for free. In that scenario, I received no benefit of finding the pizzas and Dominos would lose too. Scratch that.

I could eat the pizza, but I wasn’t hungry. I could freeze the pizza and eat it later, but I had no freezer space. What should I do!?

The pizza is worth $17.12 to the order-ers… now, was there a way to turn it into cash? All of a sudden I was struck with the greatest idea I may ever have: I could deliver the pizzas. Not only would I receive $17.12, but there should be a tip too!

I googled the address and it appeared the pizzas were to be delivered to a video arcade. At first, I struggled with the idea, but quickly realized that if I didn’t act quickly, all would be for naught. I would be the late delivery guy, and I would be giving them away for free. Or worse, I may arrive at the same time as the real delivery guy… and that would be awkward. Just the thought of the hilarious tale I could tell was worth it. Even if I didn’t get the money, the story-telling potential of this caper was too good to pass up.

I grabbed the keys to my older car with rust racing stripes – no one delivers pizza in a new car. As I opened the apartment door, the Dominos car was exiting the lot, apparently looking for the misplaced pizzas. But I was too late. This self-proclaimed hero had to deliver those pizzas.

I sped to the address on the box and sat for a few minutes, making sure I had all the bases covered. The rusted out jalopy I was driving was the perfect disguise; I looked like every other delivery guy in America. I parked far enough away so that they wouldn’t notice that I didn’t have a Domino’s sign suction-cupped to my car. I looked into the rearview mirror and practiced my “delivery guy demeanor” – my blank, lifeless expression conveyed an IQ of 80 and the travails of a rough life supporting two illegitimate children. The real delivery guy was nowhere to be seen, so I stepped out of the car and made my way to the door, pizza bag in hand.

As I entered, I wasn’t sure quite what to expect. Was it the owners who had ordered dinner? I was ready to react to whatever life through at me. If Dominos learned of the mistake and called or miraculously delivered new pizza, my backup story was that I had found the pizzas and just come by to ‘drop them off’ since I was on my by anyway. There was no one at the customer service booth so I scanned the room. The place was filled with prepubescent hooligans. Two of them caught my eye and stood up. One of them made a beeline for me, and I could see greenbacks poking out from his fist.

“Perfect,” I thought to myself. Dominos had obviously not made any contact yet, and from the looks of these teenagers, they had the collective brainpower of a mentally handicapped baboon. They’d never see through my scam. I confidently said,

“Total’s $17.12,” like I had been doing it for years.

The hooligan handed me a $20. Sweet! I started packing up the hot bag and wanted to quickly escape with my $20 – even better than the $17.12 that I had found.

“Um, can I get change?” the hoodlum muttered.

“Yeah, sorry,” I replied.

What a cheap-ass. This kid is worse than my brother! I dug out my wallet, hoping that I had one dollar bills and hoping that they wouldn’t notice that I was giving them change from my personal wallet and not a Dominos-issued change purse. Luckily, I had the change, handed him $2 and walked, out toting the Domino hot bag.

Victory! I had successfully completed a real-life Grand Theft Auto pizza delivery mission. So the moral of the story is, when life hands you pizzas, do the right thing. Deliver them and make some money!

Postscript

When I recounted my harrowing tale to co-workers the next day, I was met with quizzical stares.

“I thought you were a good person,” was my favorite reaction. I was shocked! After the story ended, we debated my ethical decisions and actions. In order to defend myself and prove that my actions were fair and just, I created an Excel analysis of my options and potential outcomes (Figure 1.1).

I attempted to show the universal impact of my decisions given the parameters of the situation and the potential consequences. Assumptions in this model are:

1)      All outcomes are weighted equally 2)      Domino's corporate owns the Heat Wave Bag and will not charge delivery person for the lost bag (an anonymous call to Domino’s confirmed this assumption)

3)      Teens do not have preference between on-time pizza which is paid for versus free, late pizza

4)      Teens will not give delivery person a tip if he arrives late (I barely got tipped for being on time)

5)      Domino's will not deliver pizzas that have been recovered after being left unattended (let’s hope they have some standards)

Figure 1.1

Across the top of the figure are four possible scenarios that follow finding pizza: eat pizza, deliver pizza, leave pizza in parking lot, and return pizza to Domino's.

The right column illustrates the impacted parties: the teens, the Domino’s franchise, the delivery guy, and me. I color coded the resulting consequences to help decipher the figure for even the most uneducated reader. Green = good. Red = bad.

As shown by the figure, my actions are justified. I prescribe to utilitarianism as a working ethical model.  Utilitarianism is an ethical theory which posits that the proper course of action is the one that maximizes overall "happiness." This means that the moral worth of an action is determined only by the resulting outcome, and that we can only weigh the morality of an action after knowing all its consequences.

  

Noid

So suck it, co-workers and naysayers. My decision to deliver the pizzas left the world with a net impact of (-1). A much “happier” scenario than leaving it in the parking lot (-3), or eating it myself (-3). Sure, this was a bad situation. But thanks to a fast-thinking, ethical hero, negative impacts were minimized. The world would be a better place if there were more people like me.