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Good Debt?

posted by Debb Thorne

I grew up believing that some types of debt were good and necessary: namely, mortgage and student loan debt. (I'm in my mid-40s, just to provide some historical context.) The assumption, I expect, was that these debts would, in the long-run, pay off. (The house would eventually evolve into wealth to be passed to one's kids and the education would make it possible to pay off that mortgage.) However, with recent reports of corruption in certain segments of the student loan industry, the stories of educated Americans owing more student loan debt than they can ever hope to repay, the historically high rates of home foreclosures, and the meltdown of the mortgage lending industry, I'm not so convinced that either one of these types of debts is at all good. In fact, I think that Americans should be encouraged to rethink (even reject?) these taken-for-granted pillars of the American dream.

But what's changed? Why have these good debts gone bad? I would argue that the primary culprit exists at the social institutional level. Namely, when regulations on the credit industry were loosened in the late-1970s, it marked the beginning of the end of these two types of good debt. What had at one time been appreciated and understood as necessarily-affordable social goods (homeownership and an educated populace are positive things, right?) devolved into breeding grounds for get-rich-quick schemes and gluttenous profitability--and the big losers were, and continue to be, average American families.

As a result, we are living in a time when, I would argue, it is financially unwise for many American families to buy homes or send their kids to college. Indeed, if the only way some families can own rather than rent is to finance 100% of the value of the home and pay higher interest rates, then maybe they should relinquish this part of the American dream. And if their kids cannot attend college without accruing massive student loans, then maybe college is not the route for them. These aren't pleasant thoughts, but then neither are foreclosure and decades of making payments on student loans that may never be paid off.

My guess is that a portion of the readers of this blog will be angry at what I've written and label me as an elitist. But that's not the case. I would love it if every American could be a college-educated homeowner. (Trust me, I'm as tired of living in an apartment as the next woman.) Instead, my goal is to point out that we've experienced macro changes in our society that make it quite easy to exploit hard-working folks who want their slice of the American Dream. And until we institutionalize regulations and policies such that people can buy homes without fear of getting royally ripped off and young people can graduate without owing crippling amounts of student loan debt, we, as a society, must have this uncomfortable conversation.

Comments

Well said! It's extremely unfortunate, but you have correctly summed up the situation. Trust in corporations and markets to do what's right for our economy and our country is a luxury we can no longer afford.

It may be that what you advise will happen anyway. I suspect that those with incomes below the median who lose their homes to foreclosure will find it difficult if not impossible to qualify for a new loan again for quite some time, now that the subprime mortgage market is pulling in its horns. That alone will begin to cut into the home ownership dream for some percentage of Americans (though I have no idea how much). Too, as home mortgages become more expensive once again, it will become harder for that below-median group to obtain mortgages (and so to buy a home). If I were in real estate investment right now, I'd be investing in rental properties.

The student loan issue is harder. Here, Congressional intervention could make a difference. One reason such loans are now "for life" is that the bankruptcy law now makes most such loans virtually nondischargeable. Were Congress to revisit that part of the Code, there would be a safety valve. Congress could also tighten the rules on what loans it will guaranty. And there is already new discussion of direct lending from the government again, as an alternative to the current privately sponsored system (which has much in common with the marketing, packaging, pooling, and investing model that has been coming unwound in the mortgage industry). These changes could make a difference in the consequences of borrowing to go to college.

Still, if the current student loan system is not changed, it might tend to chill future borrowing -- and that would have a direct impact not only on students, but on higher education institutions that rely on those loans for their own revenue.

There is a key underlying phenomenon here. One long or two short generations ago, most consumer credit was drastically more difficult to obtain than it is now. That meant that people could and did rely with some justification on the credit granters as their financial advisers: "These cautious experts wouldn't be approving this loan if they hadn't determined that it is well within my ability to pay back, so I guess it must be." That was never the ideal approach, of course, but to a large extent it worked and I think to some extent it became embedded in the consumer psyche. The reality of free credit has changed faster than the psyche over the decades. Now they throw credit at you; avoiding it is more of a challenge than qualifying for it. The reality now is that consumers need to make their own evaluations. Many don't understand that and/or aren't equipped for it. Saving up a down payment for a house and taking out a prudent fixed rate mortgage may no longer be mandatory -- but neither is it forbidden. Likewise for limited student loans that are likely to be paid back easily with the increased income. But it is a brave new world, and adjustments need to be made.

I understand your conclusions to some extent. I'm not yet convinced a college degree isn't worth it, but the idea a person as educated as yourself can theorize that tells me how far we've gone.

As for home ownership, I agree. For years during the market craze my parents and parents-in-law pushed me and my wife to get a home. However after running the numbers and checking the markets where I used to live, it simply didn't seem worth it, and there were lots of hidden costs and limits. Needless to say I'm feeling rather justified as I point out the market collapse and the financial issues.

And now that I live in California, I don't think I'm getting one for sure . . .

Notice how aggressively private student loans are being marketed since BAPCPA's enactment? The late night pitches about how "easy" it is to borrow "up to $40,000" when you can "defer payment 'til graduation"? You can have your check in several weeks! Ahh, but you may have the loan(s) for the better part of your working life.

In some cases that might be true but the reality of the situation is that you will require some kind of post secondary education to get a decent job. I have a friend who is a construction worker, some college is require even for him.

Even the more advanced food service jobs require at least a vocational school. Without some kind of advanced education only the most menial jobs are available to a person.

The real problem is the costs of homes and colleges in relation to income. The price of both has risen past the ability of a middle class family to afford. I graduated 10 years ago with 20k+ in debt. I was able to work off most of my costs. However now that same degree costs twice as much. Even if I could make twice as much I'd still have had 40k in debt. The thing to consider is that salary has not risen 100% in the past 10 years. Credit has fueled an unreasonable increase in pricing for both education and housing. It certainly hasn't been fueled by in increase in worker pay.

I want to interject that there is no such thing as "good debt" the proper term is "leverage" or "leverage your balance sheet".

This way you don't have to deal with the stigma of the term "debt". Airlines are in "debt", but Microsoft is "under leveraged". Both imply that Wall Street wants companies to be in some debt to multiple the returns on capital of their core business. Any business not willing to go into debt must not believe in its own superior ROI, the saying goes.

On a serious note, the proponents of "good debt" in the consumer market always operate under the assumption that it isn't impossible to overpay for anything. You can overpay for a house through debt, you will be underwater and it will not pay off. See Japan. You can overpay for an education and be competing with graduates of lesser-priced schools which could lower salaries and you have lost money (or lost through opportunity cost of your debt services)

I agree with your conclusions about home ownership, although I think I would finesse your statement about college. First, one problem is that parents aren't sending their kids to college. Their kids are sending themselves. If parents were truly saving money and paying for their kids to go to college, then a completely different situation exists. Second, kids shouldn't send themselves to subprime colleges and pick subprime majors. There is a big difference between borrowing $100k to go to an elite institution and major in a field with job opportunities than borrowing the same to go to a school no one has heard of and major in "general studies" or a field with a starting salary of 1/4 of the debt load. This may also be a symptom of 18-year-olds sending themselves to college.

One problem with saving is that leveraging debt drives prices up much faster than savings can be accumulated.

Lets say that there are no student loans. Everyone is on an equal footing in saving. But say there are now student loans and that you have a choice of saving $1 for college or with the same $1 borrowing $5. The result is that everyone borrows pushing up the cost of college (more demand) and anyone that saves is unable to compete.

IMHO our leadership has substituted debt for government support of colleges. The result is an debt encumbered worker class unable to be flexible because if your job that you went to college for and have $40,000 to pay off goes offshore, you cannot go back to college and accumulate another $40,000 in debt you have to be working at less than your ability to pay off the first $40,000.

The same is true to some extent of home ownership as our leadership promoted asset appreciation over income appreciation.

Wow, Jim. That is a really insightful point! Leveraging itself pushes up the cost of education, but also makes the worker a very vulnerable wage slave.

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