Taking on debt can be a terrible idea or a wonderful idea. More often than not, whether it’s a student, a home buyer or even a country, it’s the latter: Taking on debt is an absolute necessity if we want to invest in the future.
More precisely, taking on debt is how we borrow against future resources to pay for current investment or consumption. And therein lies the rub: There have to be future resources against which to borrow. Whether it’s a college student, a homeowner (see “The Big Short”), a country (see Greece), a city (Detroit) or a “territory” (Puerto Rico), the reason debt becomes unsustainable is because earnings or growth fail to materialize.
That’s the recipe for a debt spiral, when paying what you owe to your creditors is not just tough, it’s increasingly impossible because your debt burden is growing faster than your income. You figuratively drown in debt because you lack the growth to push back its tide.
I was reminded about these dynamics by this Wall Street Journal piece from Sunday, from which the following figure is drawn. There’s a lot in there, so let’s start unpacking.
First, student loan delinquencies are now higher than those of the other types of debt shown in the figure. You may be aware of that, as student debt burdens have become a campaign issue, at least for Hillary Clinton and Bernie Sanders (Donald Trump’s response to debt issues tends to be some variation of: Just default … that’s what I do!). But the key point in the article is that many of these borrowers “never learned new skills because they dropped out.” They can’t finance their loans because they’re paying off “an asset they never received,” i.e., a college diploma.
For-profit colleges have generated particularly serious problems in this space. Researchers “tracked the earnings of some 1.4 million students who left a for-profit college in the two years through September 2008. Seventy percent of them dropped out. Those who enrolled in associate’s and bachelor’s programs earned an average of $600 to $700 a year less in the six years after leaving school compared with the six years before they entered.”
The right part of the figure, showing real median weekly earnings by education level, tells the other important part of the story. The magnitude of the college earnings premium comes across clearly in the figure, underscoring the point that many borrowers who do “receive that asset” will have the means to service their loans and come out way ahead. Conversely, many of those who do not will be stuck trying to pay their debts without the salary premium.
[Important data note: The Journal kind of pumps up the college premium by combining those with four-year degrees along with those with advanced degrees. The four-year college premium over those with terminal high school degrees is about 67 percent in these data; for those with advanced degrees that premium is about 100 percent — i.e., they earn twice what high school workers earn. Also, if we’re thinking about young graduates, they earn considerably less than those in the WSJ figure. See Elise Gould’s careful analysis of young college grads.]
The other thing you see in the wage figure is that, contrary to popular mythology about how all you need is a college education to be forever insulated from any of those negative wage trends that befall the “less skilled,” even college wages appear to have stagnated since 2010. I carried the analysis through to 2015 (data here) and found that while earnings generally rose last year, no education level had surpassed its 2000 value. As I recently argued on this page, that’s surely one reason people are pissed off about the economy.
My point here is not to deliver a “stay-in-school” public service announcement, though that’s definitely part of the message. It’s a broader message about debt.
Taking on debt to pay for college is usually a smart move, but you need the degree/asset if you hope to earn the premium. Dropouts who over-leveraged but fail to benefit from the earnings premium must be able to restructure or charge off their loans. These issues are fulsomely discussed by education economist Sandy Baum (here with Martha Johnson), who has been writing about student debt from a smart, nuanced perspective for years.
This understanding of debt dynamics applies across the board. Puerto Rico, which over-borrowed without regard to its growth, now must be allowed to restructure its debt so that it can begin to grow again (with its fiscal affairs overseen by an oversight board). Though knee-jerk debt hawks (do hawks have knees?) squawked when the deficit grew sharply in the Great Recession, that was exactly what needed to happen to offset the private sector demand contraction. As growth returned, the deficit receded.
Remember all of this, not just in your own life as you consider taking on student (or housing, etc.) debt, but when you hear politicians blithely rant about any public borrowing. With interest costs as low as they are, significant deterioration in our public goods, and the need for both more jobs and higher productivity growth, borrowing to invest in infrastructure right now would be a smart play. But chins would be stroked and fingers wagged by those who fail to grasp these dynamics.
In other words, there’s smart borrowing and foolish borrowing. As they say in the economic serenity prayer: Keynes grant us the wisdom to know the difference.