Something The President And Congress Should Pay Attention To: Student Loans

One of the very first government-created disasters that I wrote about on this blog was the student loan mess. The blog opened for business on November 6, 2012; and already on November 29, 2012 I had a post titled “Out Of Control Student Loans.” That post noted that, from a beginning in 1966, the federally-guaranteed student loan program had just reached a milestone of $1 trillion of student loan debt outstanding, with no signs of an end to the ongoing increase in outstanding balances. Also, at that time, the so-called “delinquency” rate for student loan borrowers had just suddenly soared from about 8.5% to 11% within less than a year. And, the post pointed out, the 11% delinquency rate was in fact quite deceptive, because very large numbers of borrowers — about half — are in some kind of deferral or forbearance status at any given moment, which leads them not to be counted as “delinquent,” even though they are out of school and not paying anything. That meant that if delinquencies had been measured as a percentage of borrowers expected to be paying, rather than as a percentage of all borrowers, the delinquency rate would have suddenly doubled to more like 22%. The post concluded: “Get ready to lose half or so of the trillion.”

Could things possibly have gotten even worse since then? Of course! After all, this is a pile of free federal money there for the taking. Who is going to pass it up? As long as nobody is really paying much attention, this problem will just continue to explode out of control. And really, what with the “civility” crisis, the Elizabeth Warren Cherokee scam, the Kavanaugh confirmation, the midterm elections, and whatever, who has time to pay attention to a mere trillion dollar problem?

Which is exactly why the problem continues to grow. . . .

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It's A Good Thing That Our Geopolitical Rivals Are So Incompetent

Many on the right have been getting mileage lately from bashing the incompetent foreign policy of outgoing President Obama.  The guiding theme of Obama's worldview has long seemed to be that we just need to be nice to our geopolitical rivals, and then of course they will be nice back.  Next thing you know, Russia is invading Ukraine and sending bombers to aid Assad in Syria; Iran is controlling Iraq behind the scenes and backing Hamas in its attacks on Israel; and China is building new islands to claim jurisdiction over the South China Sea.

But before you conclude that incoming President Trump needs to take drastic steps to rein in these three world bad guys, it is useful to look at their situations with a somewhat broader perspective.  The fact is that none of Russia, Iran or China is currently in a very good position to be more than a marginal player on the world stage, and the only one of the three that might become a much bigger player any time soon is China.  

Let's consider them one at a time.

Russia.  When I was a kid going to high school in the 1960s, it was the Soviet Union.  In the mid-60s the Soviet Union had around 230 million people, compared to about 190 million for the United States.   And that was before including the population of all the satellite countries in Eastern Europe, like East Germany, Poland, Hungary, Czechoslovakia, Romania and so forth -- not to mention then-comrade-in-arms Communist China.  The economy of the Soviet Union at that time was said to be about 60% the size of the economy of the United States, and they were putting out fake statistics claiming that their economy was growing at a rate about double ours.  If you believed it, that meant that their economy would overtake ours in as little as 10 years, 20 at most.  Their military was about double the size of ours, with thousands of nuclear missiles, and equal thousands of tanks lined up at the East/West barrier then known as the "Iron Curtain."  Now that was a geopolitical rival to reckon with!

Compare that to Russia today.  About half of the population went away in the breakup of the Soviet Union, and even the population of the remaining Russian state has shrunk from about 148 million in the mid-90s to about 143 million today.  That's because their birthrate is so low, and also because nobody immigrates into Russia.  (Population of the U.S. today is more than 320 million.)  

For its economy, Russia has gone the route of crony capitalism on steroids, with the head guy passing out the plum economic prizes to his friends.  The economy is completely dominated by the oil and gas sector.  The best that can be said for this form of economic management is that it is better than Stalinist totalitarianism.  Without much diversification or entrepreneurialism, Russia is at the mercy of swings in the international oil and gas market.  As of 2013, as oil prices were riding high, the economy of Russia seemed to be doing OK, with GDP about $2.2 trillion, or about $15,000 per capita.  (By comparison, U.S. GDP today is about $18.5 trillion, or about $57,000 per capita.)  Then came international sanctions in early 2014, followed by the bottom dropping out from under oil prices in the second half of that year.  The Trading Economics web site estimates that by 2015 the GDP of Russia had declined to $1.326 trillion, an astonishing decline of about 40% from the 2013 peak; and TE's estimate for 2016 is for only a small increase from that.  That's less than $10,000 per capita.

Meanwhile, Russia has lost most of its former friends.  Almost all of the former Eastern European satellites have joined NATO.  So have Estonia, Latvia, and Lithuania, which were part of the Soviet Union proper, albeit with only about 6 million people among the three of them. Then a few years ago, the very largest non-Russian member state of the former Soviet Union -- Ukraine, with about 50 million people -- was threatening to join NATO.  Russia headed that off with the invasion of Crimea and some incursions into Eastern Ukraine.  Ukraine today has not joined NATO, but it's certainly no friend of Russia.  And elsewhere among the former Soviet states, there are plenty that are also none too friendly.  Georgia comes to mind.

Russia does have an unusually large military for a country with such a small GDP, including a substantial nuclear arsenal; but the small economy really limits its abilities.  The U.S. Defense Department budget, at around $600 billion per year, is almost half the size of Russia's entire economy!

Russian President Vladimir Putin likes to get his kicks by throwing around such military weight as he has, and by tweaking Western leaders in his speeches.  But fundamentally, based on the size of his population and his economy, he is playing a very weak hand.  If Russia wanted to grow its geopolitical power and status, it would need to open up its economy to private capital and entrepreneurs.  But that doesn't seem to be Putin's way.

Iran.  Iran is a much poorer country than even Russia, with GDP per capita at around $6000.  (And fewer than 80 million people.)  And their economic policy in recent years seems to have been designed to keep the economy small.  At least in Russia the oil and gas sector is mostly in the hands of nominally private entities like Rosneft, Gazprom and Lukoil.  Iran has instead gone for full-socialist public ownership of its national company, the National Iranian Oil Company.  And here is a 2015 description of some other Iranian economic policies in recent years from a website called Al Monitor ("The Pulse of the Middle East"):

[T]he nominal exchange rate was fixed at around 10,000 rials for every dollar during 2006-2011. During this same period, Iran’s annual inflation rate was on average 16% above the global average, and as a result, Iranian goods gradually lost competitiveness with foreign goods. Thus, there was a flow of imported goods into the Iranian market. Because of the aforementioned policies, many of Iran’s industries were closed down; during  2011-2016 more than 2,500 industrial firms were shuttered and there was a reduction of more than 500,000 workers in the industrial sector. Most important, during this period, the net total of created jobs in Iran was equal to zero. The only main exports, besides crude oil, were condensate as well as oil and gas derivatives, including oil and petrochemical products.  On the other hand, the growth of the monetary base (with an annual average of more than 26%) — a major cause of which was the Central Bank’s purchase of oil revenues — led to macroeconomic instability and persistently high inflation rates of above 20%.

According to Trading Economics, Iran's GDP reached a peak of $592 billion in 2011, and began a steady decline after that, despite high oil prices into 2014.  And of course, when your only significant export product is completely government-controlled and is the government's main source of revenue, you are setting yourself up for disaster when the price of that product declines -- as the price of oil did in mid-2014.  By the time 2014 was over, Iran's GDP was down to $425 billion, where it remains today according to the TE estimate.  That's down more than 25% from the peak five years ago.  And the U.S. frackers look set to keep a lid on the price of oil at around $50 - 60 per barrel for the foreseeable future. 

As you can see, Iran was not exactly negotiating from a position of strength when it did its deal with President Obama in 2015.  Yes, they are getting back some of the assets frozen back in the 70s and 80s.  How long will that one-time bounty last?  

China.  By comparison to Russia and Iran, China's economic management looks almost competent.  After a couple of decades of rapid growth, China now has the second largest GDP in the world! -- it's around $11 trillion, if you believe their numbers.  But let's not get ahead of ourselves.  They have about 1.36 billion people, which makes their per capita GDP only about $8,000.  That's well less than Russia.  For that matter, it's behind places like Mexico, Kazakhstan, and Panama -- and, indeed, behind the world average per capita GDP of about $10,000 according to the tabulations of all of the IMF, World Bank and CIA as presented here.   

Sure China has not made the same fundamental mistake as Russia and Iran, going all in on one industry that is subject to wild cyclical swings.  But don't kid yourself by thinking that its economy represents real capitalism -- a system where everybody gets to participate on equal terms in a grand game of trial-and-error to see who can come up with the next big thing.  Instead, China's economy is directed by state-owned banks who invest in state- and crony-owned companies that have privileged status to expand endlessly and cannot fail.  Look around for reports on the state of China's economy, and the word that you see again and again is "overcapacity."  For example, this from the Cheung Kong Graduate School of Business in June 2016, "Solving the Prickly Issue of Overcapacity in China":  

Having delayed serious structural reforms, China faces eye-watering overcapacity in heavy industries.  Steel production volume is more than double that of the next four leading producers combined: Japan, India, the United States and Russia.  Aluminum production capacity reached 40 million tons last year, exceeding global consumption by 9 million tons, according to Chinese think tank Antaike.  Most remarkably, between 2011 and 2013 China produced more cement than the US did during the entire 20th century -- 6.6 gigatons, compared to the US's 4.5 -- according to data from China's National Bureau of Statistics and the US Geological Survey.       

Without doubt, China just counts all of this (and other) excess production as a full addition to GDP, as if nothing was wrong.  Its economic statistics are completely phony -- and all of that just to pretend that its per capita GDP is only a little below the world average.  In any real economy, there would have been a massive shake-out long ago, with a good half or two-thirds of the heavy-industry producers forced out of business so that the resources could be put to other uses.  What is China's real per capita GDP, honestly measured?  $5000?  $4000?  And do they think that enough free government credit can postpone the inevitable shake-out forever?  Good luck with that!

In its favor, China does have those 1.36 million people, many of whom are highly intelligent, creative and entrepreneurial.  If it just opened up its credit system and turned its people free, it could shortly have a world-beating economy.  But that would require having the current oligarchy open itself up to rivals for its power.  Also, it would require going through a severe recession, the likes of which the world has probably never seen, and then restarting from a new much lower base.  Oh, the loss of face!  

I don't foresee this any time soon.  Indeed, I think that China will do everything in its power to keep the economic charade going, potentially for decades.  Its economy will languish.

Meanwhile, the United States, even with completely incompetent foreign policy (not to mention almost equally incompetent domestic policy), continues to race further ahead of its geopolitical rivals.  Imagine what we could do with competent foreign policy!  

 

Out Of Control Student Loans

Once the Federal credit card gets behind something, how far and fast can it blow up and explode?  The student loan programs give a good example.  This is a trillion dollar or so Federal problem that you may never have thought was a problem.

I have located here something called the Federal Student Loan Programs Data Book from 2000, that gives a good summary of the financial status of the student loan programs from inception through that year.  It's a pdf - I hope the link works.  According to this book, the first Federal student loan guarantee program began in 1966.  By 1989, cumulative loan volume had reached $102 billion.  By the end of FY 2000, an additional program had been added, and the cumulative volume of the two was about $330 billion. 

Now to today.  According to this site, total outstanding student loan debt is now over $1 trillion.  Zero to one trillion in about 36 years.

Any chance of getting the trillion back?  Well, we can check in on how it's going so far.  From the web site ZeroHedge, we find the chart below just put out by the Federal Reserve.  It seems that the 90 day delinquent rate on these loans had reached about 6% by 2003, and then gradually crept up to about 9% and leveled off there in 2010 - 2011.  Early in 2012 it seemed to drop to 8.5% (election coming up?), but now suddenly when they report the Q3 2012 numbers it shoots up to 11%.

Oh, wait a minute, do you have to read the footnotes?  Here's what they say in footnote 2:

As explained in a Liberty Street Economics blog post, these delinquency rates for student loans are likely to understate actual delinquency rates because almost half of these loans are currently in deferment, in grace periods or in forbearance and therefore temporarily not in the repayment cycle.

This implies that among loans in the repayment cycle delinquency rates are roughly twice as high.

So the real delinquency rate is actually 22%, and rising like a rocket.  Get ready to lose half or so of the trillion.  Of course, that's only the equivalent of one year's Medicare spending.

Transient

Big And Small Bubbles

Anyone who follows markets knows that bubbles, and succeeding crashes, are a recurring phenomenon.  Famous historical examples include the Dutch "tulip mania" of the 1630s, the French Louisiana Company bubble and British South Sea Company, both around 1720.  More recent examples include the American stock market bubble of the 1920s (and crash of 1929) and the Japanese stock market bubble of the 1980s (and crash of 1989).

Getting to the more recent time, we have the housing bubble of the early 2000s that led to our current economic difficulties.

It's easy to spot bubbles in hindsight.  But a better question is, are we in any bubbles right now, bubbles that have blown up really big and are getting ready for a big crash?

Over at Instapundit, Glenn Reynolds has a long-running series on what he calls the "higher education bubble."  The thesis is that the cost of higher education has soared under an umbrella of Federal spending and easy student loans, and that that bubble is set for a big crash over the next few years, as students realize that the education is not worth the cost and debt, and as internet alternatives replace ridiculously costly in-person college courses.  I'm willing to bet he's right.  On the other hand, higher education is only about 3% of U.S. GDP.  If that suddenly got cut in half over the course of a few years, it would be rather hard on colleges and professors, but not nearly the scope of the bursting of the housing bubble a few years ago.

But is there any other bubble out there that is much larger, a big multiple of the size of the higher education bubble?  Here's a hint:  private economic activity, although subject to bubbles, is also subject to self-correction.  There are limits to how large bubbles can blow up without the government credit card to back them.  With the backing of the government credit card, a bubble can start taking over an entire economy.

Here's my nominee for the really big bubble, the one whose bursting will be a multiple of anything previously seen:  health care.  In 1960, before Medicare and Medicaid, according to this article U.S. spending on health care was about 5% of GDP.  Today, 18%.  Those numbers are somewhat exaggerated compared to what I've seen elsewhere, but suppose it's 7% and 17%.   At 10% of GDP, we have $1.5 trillion of annual spending in play in excess of the best evidence of what private spending alone would support.  And, the 17% is rapidly increasing.  Medicare and Medicaid have grown at about an 8% CAGR since inception, and are not really showing signs of slowing down.

Proposition One:  Something that can't continue, won't.  Proposition Two:  When this one ends, it will not be pretty.

I do think that the higher education bubble will burst first.