If you were to read only one thing…
The US college debt bubble is becoming dangerous. Rana Foroohar. Financial Times. 9 Apr. 2017.
“Rapid run-ups in debt are the single biggest predictor of market trouble. So it is worth noting that over the past 10 years the amount of student loan debt in the US has grown by 170%, to a whopping $1.4tn — more than car loans, or credit card debt. Indeed, as an expert at the Consumer Financial Protection Bureau recently pointed out to me, since 2008 we have basically swapped a housing debt bubble for a student loan bubble. No wonder NY Federal Reserve president Bill Dudley fretted last week that high levels of student debt and default are a ‘headwind to economic activity.'”
“In America, 44m people have student debt. Eight million of those borrowers are in default. That’s a default rate which is still higher than pre-crisis levels — unlike the default rate for mortgages, credit cards or even car loans.”
“Rising college education costs will not help shrink those numbers. While the headline consumer price index is 2.7%, between 2016 and 2017 published tuition and fee prices rose by 9% at four-year state institutions, and 13% at posher private colleges.”
“The average debt load individual graduates carry is up 70% over the past decade, to about $34,000.”
“Growing student debt has been linked to everything from decreased rates of first time home ownership, to higher rental prices, to lower purchases of white goods and all the things that people buy to fill homes. Indeed, given their debt loads, I wonder how much of the ‘rent not buy’ spending habits of Millennials are a matter of choice.”
“But there are even more worrisome links between high student debt loads and health issues like depression, and marital failures. The whole thing is compounded by the fact that a large chunk of those holding massive debt do not end up with degrees, having had to drop out from the stress of trying to study, work, and pay back massive loans at the same time. That means they will never even get the income boost that a college degree still provides — creating a snowball cycle of downward mobility in the country’s most vulnerable populations.”
“How did we get here?”
Essentially, “beleaguered governments are pushing more and more of the responsibility for the things that make a person middle class — education, healthcare and pension — on to individuals.”
“What are the fixes? For starters, we should look closely at the for-profit sector, where default rates are more than double those at average private colleges. These institutions receive federal subsidies but typically spend a minuscule part of their budgets on instruction; in the US, nearly 50% goes on marketing to new students. It looks all too much like an educational Ponzi scheme.”
“Transparency is also key — the student loan market as a whole is hopelessly opaque. In one recent US study, only a quarter of first year college students could predict their own debt load to within 10% of the correct amount. Truth in lending documents would help, as would loan counselling paid for by colleges. Sadly, the agency that is leading the fight on both — the CFPB — is under attack from Trump himself.”
“But the administration will not be able to hide from the student debt bubble. In an eerie echo of the housing crisis, debt is already flowing out of the private sector, and into the public. Before 2007, most student loans were underwritten by banks or other private sector financial institutions. Today, 90% of new loans originate with the Department of Education. Socialization of risk continues to be the way America deals with its debt bubbles. “
“Would that we considered making college free, as Bernie Sanders suggested. Even Mr. Dudley called this ‘a reasonable conversation.’ That way we could socialize the benefits of education too.”
Worthy Insights / Opinion Pieces / Advice
- “In reality, there is no utopia at companies like Uber, Lyft, Instacart and Handy, whose workers are often manipulated into working long hours for low wages while continually chasing the next ride or task. These companies have discovered they can harness advances in software and behavioral sciences to old-fashioned worker exploitation, according to a growing body of evidence, because employees lack the basic protections of American Law.”
- In the argument for and against, “what the two sides generally do agree on is that the Social Security trust fund needs shoring up: According to a trustees’ report from last year, the fund is on track to run dry around the mid-2030s, at which point the program would be able to pay out only about 75% of promised benefits.”
- “Finally, a brief prediction. One of the mistakes people make when thinking about the future is to think that they are watching the final act of the play. Mobile shopping might be the most transformative force in retail—today. But self-driving cars could change retail as much as smartphones.”
- “Once autonomous vehicles are cheap, safe, and plentiful, retail and logistics companies could buy up millions, seeing that cars can be stores and streets are the ultimate real estate. In fact, self-driving cars could make shopping space nearly obsolete in some areas. CVS could have hundreds of self-driving minivans stocked with merchandise roving the suburbs all day and night, ready to be summoned to somebody’s home by smartphone. A new luxury-watch brand in 2025 might not spring for an Upper East Side storefront, but maybe its autonomous showroom vehicle could circle the neighborhood, waiting to be summoned to the doorstep of a tony apartment building. Autonomous retail will create new conveniences and traffic headaches, require new regulations, and inspire new business strategies that could take even more businesses out of commercial real estate. The future of retail could be even weirder yet.”
Markets / Economy
- “Jeff Gundlach (chief executive of DoubleLine Capital – which manages $105bn on behalf of its clients), the influential bond investor, has warned that appetite for the so-called relation trade will evaporate further in coming months as expectations for an acceleration in US economic growth and inflation are tempered.”
- Not all that surprising really, and if you’re in the market for a mortgage there should be some relief in pricing (there already has been so far this year). Then the article goes on to say: “the yield on the 10-year Treasury bond will not be back up to 3% this year, a level he had previously said would spell the end of the bull market. DoubleLine’s founder told investors he believed it would head higher over a longer period and could reach 6% in four or five years.”
- Come again… please elaborate. No really, the article doesn’t elaborate or link to any reports by Gundlach. Talk about burying the lead.
- Consider the implications on home pricing if 10-year rates are at 6%. They’re currently at around 4.10% on a 30-year fixed, so about 260bp (basis points) or 2.6% points higher than 10-year rates which are around 2.4%. To translate, if you have a $400,000 mortgage (arbitrary number) you’d be looking at a monthly payment of $1,932.79 at today’s rate. That same mortgage amount if 30-year fixed rate mortgages hold a similar spread when the 10-year treasury is at 6% would be $3,104.05. A 60.60% increase in the monthly mortgage amount or $14,055.12 additional after tax dollars each year. Or if you could only afford the $1,932.79 monthly payment, then you would only be able to take on a $249,067 mortgage. Presumably that would hurt your purchasing power.
- Alternatively, consider commercial real estate. If the 10-year moved to 6% in four or five years, what should you be putting in your models for an exit cap rate? Currently the commercial property loans average about 150bp over the 10-year for the primary categories-office, retail, multifamily, and industrial-according to interest rate surveys from Trepp. Hence, you can buy a going-in cap rate of 5% and have a little spread of 1.10% (110bp) over the cost of your debt. Fortunately for the last 30 or so years you could model a lower exit cap rate – really accounting for a large part of many investors returns. Consider if you had to add 350bp to your exit cap rate…
- Again to translate. Today the idea of purchasing a property that generates $100,000 in triple net (NNN) income-net of all expenses, property taxes, etc.-at a 5% cap rate would imply that you’d be willing to pay $2,000,000 for the property. Okay. What happens if cap rates adjust to maintain a similar spread over the 10-year treasury if it moves to 6%? Then for the same income you’d want a 8.6% cap or would be willing to pay $1,162,791. A 41.86% drop in value.
- Well, the counter argument would be that the economy would have to be cranking along pretty well for the 10-year Treasury rate to move to 6%. Then some of the effects of the above would be neutralized by increasing incomes, increases in spending, and so on. However, note that rent from tenants are contracted and increase in defined amounts – so in this case, they’d probably get the better of the landlords – unless there are generous percentage rent terms…
- Don’t expect this to be a smooth transition, and real estate is not the only industry that relies on a lot of debt capital – think energy…
- On the other hand: NYT – The Economy May Be Stuck in a Near-Zero World – Justin Wolfers 4/7
- “A new study suggests that near-zero interest rates – accompanied by a lackluster recovery – may become a common occurrence.”
- In which case, buy real estate and other similar risk assets!
- “Markets have a tendency to swing from side to side. There are times when suppliers can name their prices and times when the advantage is against them. We are the cusp of a major change after half a century of producer control. For the companies involved and their investors this is a hard moment. Some will see it as a cyclical move that will be reversed as demand increases. That is a very risky investment strategy. The better approach for both companies and investors is to assume that we are experiencing a structural shift and that to thrive those involved in the sector must adapt their business model and their investment strategy to a new reality.”
- “China’s HNA Group, the small domestic airline operator turned ultra-acquisitive conglomerate, has now struck more than $40bn of deals in little more than two years after announcing plans to buy Singapore logistics provider CWT.”
- “However, the activity has confounded veteran bankers and China watchers alike, who have raised concerns over its rapid expansion and also questioned its sources of capital for the deals, many of which are done through affiliates. Moreover, the pace of HNA’s foreign dealmaking has quickened in spite of a Chinese clampdown on the flow of capital out of the country since November.”