Landmark Links July 24th – Misaligned


Quick programming note: I’m taking off this afternoon for my annual east coast family lake trip tonight which means that I’m going to be on a news and social media diet (including writing this blog) for a couple of weeks.  I posted about why I do this last year if you’re interested.  See you in a couple of weeks!

Lead Story…  One of the most troublesome factors that allowed the housing bubble of the aughts to inflate was that the misalignment of interests in the originate-to-distribute lending model.   The near-complete lack of accountability and misalignment of interest in the process of originating mortgages, packaging them into securities, rating them, creating a bond and then selling that bond to investors allowed the bubble to grow to a size so massive that it put the entire world economy at risk was .  Treasury Secretary John W. Snow explained how this worked in testimony before the Committee on Oversight and Government Reform in the US House of Representatives in October of 2008:

“Throughout the housing finance value chain, many participants contributed
to the creation of bad mortgages and the selling of bad securities,
apparently feeling secure that they would not be held accountable for their
actions. A lender could sell exotic mortgages to home-owners, apparently
without fear of repercussions if those mortgages failed. Similarly, a trader
could sell toxic securities to investors, apparently without fear of personal
responsibility if those contracts failed. And so it was for brokers, realtors,
individuals in rating agencies, and other market participants, each
maximizing his or her own gain and passing problems on down the line
until the system itself collapsed. Because of the lack of participant accountability,
the originate-to distribute model of mortgage finance, with its once
great promise of managing risk, became itself a massive generator of risk.”

I bring this up in 2018 not to re-litigate the housing bubble but rather to point out how similar it is to another major consumer credit sector of the US economy: student debt.  In the world of student loans there are three major participants:

  1. Government backed lenders
  2. Students
  3. Colleges and Universities

Two of the three – students and the government (taxpayers) suffer losses when loans default, defer or get written off.  The third – colleges – gets paid upfront and then has no further financial responsibility despite playing an extremely important role in the development of the student who will ultimately repay the loan.  As such, colleges and universities can raise tuition and offer ever-larger benefit and pay packages to administrators with impunity since they will continue to get paid, regardless of what happens to the students in their charge post-graduation.

Today, nearly all student debt is originated through federal programs (excluding refinances of existing balances after graduation).  If there is a loss created through default, taxpayers are ultimately holding the bag.  Students in 2018 are able to borrow money to go to school with very little oversight or critical analysis as to whether or not the debt that they take on can actually be repaid based upon the amount being borrowed and the chosen course of study.  Student debtors are not able to discharge their loans through the bankruptcy process and today’s income-based repayment or deferral plans allow for substantial interest accrual and the possibility of a large 1099 if the loan is ever discharged – leading to a tax bill that will likely put the borrower back into deep debt, this time with the IRS.  Colleges, on the other hand have been given the ability to push the price of higher education into the stratosphere relying both on the largesse of the federal government and the fact that 17-year olds are not exactly paragons of thrift when making life-altering financial decisions that they are wholly unqualified to comprehend.

This is not the first time that I’ve written about college debt. It’s something that has been on my mind lately both as the father of two young children and someone who follows the housing market and sees how much this additional indebtedness is impacting young people.  In the past, I’ve mostly lamented the spiraling cost while pointing out that the ROI on a college education is still quite good, meaning that there was little that was likely to change anytime soon.  In reality, the problem can’t be fixed until colleges share accountability with government lenders and borrowers, finally aligning the interests of all parties.  This seems challenging as there is no way that colleges and universities are going to guarantee student debt repayment obligations short of federal mandate which I would consider highly unlikely.  However, there is another way that colleges could take some of the risk, align themselves with borrowers and make a solid if not spectacular return in the process.  That answer is income-share agreements.  From the Associated Press (emphasis mine):

As more students balk at the debt loads they face after graduation, some colleges are offering an alternative: We’ll pay your tuition if you offer us a percentage of your future salary.

Norwich University announced Tuesday that it will become the latest school to offer this type of contract, known as an income share agreement. Norwich’s program is starting out on a small scale, mainly for students who do not have access to other types of loans or those who are taking longer than the traditional eight semesters to finish their degree.

“Norwich University is committed to offering this new way to help pay for college in a way that aligns incentives and helps reduce financial barriers to degree completion,” said Lauren Wobby, the school’s chief financial officer and treasurer.

In contrast with traditional loans, in which students will simply pay down the principal and interest until there is nothing left, students with income share agreements pay back a percentage of their salary for a set period of time. Those touting the programs say they give colleges greater incentive to help students find high-earning jobs after graduation, because a higher salary means the school may recoup its investment in a shorter period of time.

For some students, income share agreements are seen as less risky, especially if they end up in a lower-paying job or struggle to find work after graduation. While students are unemployed or earning below a certain threshold they don’t have to pay anything back.

This idea is brilliant in its simplicity as it puts the onus on the college to prepare the student for the real world and deliver the value-add proposition that it claims to provide.  It also forces schools to assess risk with regards to repayment because overextending credit would result in real losses.  The colleges could (and should) get some degree of return for doing this which could actually help smooth out increasingly volatile endowment earnings.

Now, I’m sure that some of you will counter that this would lead to colleges to favor certain courses of study over others to which I would answer: that’s part of the point.  To wit: f I make $100,000 a year and you make $500,000 a year lenders will not extend me the same amount of credit to buy a home as they would to you, nor should they.  Why then should a student be able to borrow the same amount for an English or Art degree as they could for Computer Science or Engineering degrees that offer much better employment and earnings prospects upon graduation?  The short answer is that they shouldn’t.  That’s not how credit markets work…..unless of course there is a disincentive for a market participant to allow for this sort of behavior which is exactly what having colleges completely isolated from the consequences of default and loss is.  Please note that I’m not saying that a college shouldn’t extend credit to an Art or English major, just they shouldn’t extend as much credit as they would to a Computer Science or Engineering major.  That’s not discriminatory, it’s just common sense and is actually better for the student who will eventually be responsible for paying back the sum that has been borrowed.

The increasing college debt burden faced by young people is a headwind to the economy in general and the housing market in particular.  However, it’s something that can and should be solved and the first way to do that is through a level of shared accountability that is nearly non-existent today.


Ballooning: The federal budget deficit is on pace to push above $1 trillion in 2019, or 5.1% of GDP.  The deficit has only topped 5% of GDP twice since World War II, both of which followed massive recessions and high unemployment.

Wrong Direction: Thirty year olds are worse off today than they were in 1977 by almost every possible measure.


Staying Power: Despite its planned phase-out, LIBOR is still the most important number in finance and it doesn’t appear to be going away anytime soon.

Lucrative Niches: Student housing, manufactured homes and industrial assets were the top performing commercial real estate sectors in the past 12 months while retail assets have continued to under-perform.


Priced Out: The average renter in California now needs to make over $100k a year in order to be in a financial position where rent is not taking up over 30% of their gross income.  In other words, good luck saving up for a down payment.

Shell Game: Secret home purchase deals in Miami completely dried up once the feds started watching in 2016.


Sign of the Times: Big insurers are jumping into the market to insure against cryptocurrency hacking thefts.

Heaven: Hundreds of Golden Retrievers gathered at an estate in the Scottish Highlands to celebrate 150th anniversary of the breed at its birthplace.  The next time that I’m having a tough day, I’m going to think of this link. (h/t Steve Sims)

Chart of the Day




No Sense of Humor: Millennials were outraged on social media after a minor league baseball team promoted an event called Millennial Night which included avocados, participation ribbons and napping stations.  What’s ironic is that manufactured outrage is another prominent Millennial stereotype.  Perhaps the team should have offered safe spaces as well.

In More Ways Than One: Poop is getting to be a big problem at the Burning Man festival.  It turns out that modern plumping isn’t readily available when a bunch of weirdos converge in the middle of a desert.

Hindsight is 20/20: A 20 year old Dallas rapper was sentenced to 12 years in prison after bragging about committing crimes including drive by shootings and other acts of gang violence on Facebook.  Perhaps sharing this on social media wasn’t a great decision.

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