The Student Loan Bubble: How We Got Here and How to Profit

The student loan bubble will burst, but with limited stock downside

   

The Student Loan Bubble: How We Got Here and How to Profit

The latest internet debate is focused on how 37 evil Republicans opposed Sen. Warren’s student loan bill, which would have permitted borrowers to refinance from the 6.8% rate to the current 3.86% rate.

Just to clear the facts up — students can already refinance their loans. It’s just that no bank will take on the risk of a student loan without a federal guarantee, at an interest rate below 3.86%.

The bank generates revenue from the loans through interest payments. However, the spread between what the borrower pays and the bank’s own borrowing rate, less overhead for long-term servicing of the loans, will not make the loan profitable. Warren wants borrowers to be able to refinance student loans with — you guessed it — the federal government, even though they are already getting a great deal.

Warren is one of these politicians who think college should be free, and that there should be no such thing as student loan debt, so the bill was an attempt to make it next to free. How would this be accomplished? By making the borrowing rate next to nothing. Students get loans that are effectively free. Colleges have no fear of loss because the loans are guaranteed by the federal government, so if the borrower defaults, the taxpayer is on the hook for the loss.

Oh, and who pays for the decreased revenue intake from lower interest rates on student loan debt? Warren naturally wants a minimum income tax on the wealthy. This is more of the same from Warren — redistribution of wealth from one group of people to another.

williams college The Student Loan Bubble: How We Got Here and How to Profit

Student Loans: How Did We Get Here?

The current U.S. outstanding student loan debt balance is about $1.2 trillion. Of that, some 14% is in default, and that is expected to get worse. The economy has stalled again (-1% GDP in Q1), and the Labor Force Participation Rate is at a 30-year low. There aren’t many jobs waiting for college grads.

How did we get to $1.2 trillion in student loan debt? Think about it. If you run a college, and you know that vast amounts of tuition are paid for by federally-guaranteed student loans (meaning the college will still get its money if the borrower defaults), wouldn’t you raise prices as much as possible? Of course you would. It’s free money from the government.

That’s why tuition prices have been climbing at a rate that vastly exceeds the rate of inflation. Just in the past five years, rates are up 24% beyond the rate of inflation.

Tuition rates skyrocket due to the overabundance of federally guaranteed student loans, for which a 3.86% interest rate does not reflect the risk associated with a 14% default rate, brought about by a job market faltering under failed government economic policies.

What’s the commonality here? Government.

And by the way, the federal government is going after for-profit education providers for deceptive sales practices while leaving public universities untouched. They are all after the same pot of cash, yet the for-profit folks are the only ones receiving SEC and DOJ complaints.

So what’s an investor to do?

Student Loan Debt: How To Profit

Defaults will rise. That’s the bad news. The good news is outstanding student loans only average $29,000. Sure, if you’re a student, that seems high, but on a macro scale, we’re not looking at another mortgage crisis. A 14% default rate doesn’t torpedo the US Economy. Furthermore, the NY Fed reported that people with a college degree were twice as employable as those without, so the diploma has value.

Still, this means that non-guaranteed student loan providers shouldn’t be touched if that’s their only business. I would avoid what used to be known as Sallie Mae, or SLM Corporation (SLM). It is no longer federally chartered or guaranteed and only makes private loans. I would avoid the tempting value trap of First Marblehead Corporation (FMD) as well. You may want to consider shorting either.

Many of the big banks have student loan debt on their books — including Bank of America (BAC), Wells Fargo (WFC), Citibank (C) — and while those loans total into the billions, it’s not at the level of the mortgage crisis. I wouldn’t avoid the big banks because of their student debt load. If any of these stocks get hit because of negative news about student loans, I would consider buying, especially Bank of America, which I think is the most undervalued.

As of this writing, Lawrence Meyers was long BAC. He is president of Asymmetrical Media Strategies, a crisis PR firm, and PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at pdlcapital66@gmail.com and follow his tweets at @ichabodscranium.

 


Article printed from InvestorPlace Media, http://investorplace.com/2014/06/student-loans-bubble/.

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