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Student loans another example of good intentions gone wrong

Government owns more nonrevolving debt than banks
Government owns more nonrevolving debt than banks
Federal Reserve Bank of St. Louis

A consistent theme in the E$caping Oz: Protecting your wealth during the financial crisis is how good economic government intentions tend to go wrong. Rather than trace the broad history of these intentions, I will mention the most obvious one, housing, and the other one that will gather more attention in the future, and that is the student loan program.

But first, let's take a slight detour. Four years ago, I was coaching my son's baseball team and inquired about someone with whom he played basketball, to see if there was an interest in joining the baseball team. I was met with stiff resistance from the parents of that boy who were very adamant that their son was only going to play basketball from that point. A couple of years later, during a rain delay, a parent of one of my son's teammates took some offense when I asked if his son played any other sport besides baseball. I also noticed that a large percentage of the kids playing on my son's baseball team did not play any other sports. In fact, my son was the only one who played baseball and basketball. Conversely, on my son's basketball team, there were no baseball players. My son's football team tended to have baseball players but few basketball players.

Why do I bring up these anecdotes? It became apparent a few years ago that there was an earlier onset of sports specialization for what I considered young athletes. Some of this I attribute to the Tiger Woods effect. This syndrome directed parents to specialize their kids in one sport much like Earl Woods did for his son Eldrick "Tiger". The parental hope was to grow one of their own to be a talented and wealthy performer. There is, however, another underlying reason for the specialization and this I believe relates to funding college attendance. Since the cost of higher education has risen incomprehensibly, parents are reacting by trying to make college more affordable. One obvious way is through scholarship achievement, both academic and athletic.

Student debt is estimated at over $1 trillion. This debt surpassed revolving consumer credit (credit cards). In fact, revolving consumer credit peaked around $1 trillion during the last official recession and has fallen to just above $800 billion. If you look at the attached chart, note how non-revolving consumer debt owned by the Federal Government exploded after 2008. The Federal Government now holds more non-revolving debt than the commercial banking system.

This reaffirms points made in E$caping Oz that the Federal Government and/or the Federal Reserve have stepped in to mask the enormous credit contraction that would have otherwise occurred in the economy. Part of masking that credit contraction is the massive increase in student debt. Credit finds its way into the economy regardless of its origination. This credit is funneling towards higher education, which translates into higher tuition. This translates into higher debt loads upon graduation. From 2003 to 2012, average graduating debt loads doubled from $10k to $20k. Since this type of debt cannot be discharged through bankruptcy, it will have a dampening effect on future credit creation since the younger generation will be burdened with educational debt payments.

The economy never had a chance to experience a true catharsis after 2008. Government intentions are creating a credit bubble, that unlike housing, has no collateral to support it.

Jim Mosquera is a Principal at Sentinel Consulting, a business restructuring firm and the author of E$caping Oz: Protecting your wealth during the financial crisis.

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