How to Profit From the Student Loan Bubble

To understand how America has, once again, found itself in another financial bubble, you first must go to the source of the problem. College tuition in this country has been increasing at a rate 2%-3% above that of inflation for many years.

At public institutions, the reason for the 8% increase we’re seeing is fiscally irresponsible behavior by state and local governments that create massive deficits, requiring fees to be raised at state schools.

As tuition rises, more people need financial aid. Couple that with the ongoing economic crisis and high unemployment, and even more assistance is required. Finally, the economic crisis slammed many endowments, decreasing the asset base at most private schools.

But that’s not all: Because most financial aid is guaranteed by the government, schools have no qualms about raising tuition. If the student defaults, they still get their coin.

Prior to the housing crash, the Stafford Loan Program tied student-loan interest rates to the Treasury-bill rate. At the time, Stafford loans were hovering at 8.25%. Then Congress cut the rate to 3.4% in 2007 and timed the legislation to expire in 2012. Of course, if it hadn’t messed with the program in the first place, students would now be paying about 1%.

Outstanding student-loan debt is now $1 trillion. With students struggling to pay off the debts but unable to discharge them in bankruptcy, the government picks up the tab. This is exactly what happened with the mortgage crisis that cratered Fannie Mae and Freddie Mac. And as long as debt is easy to come by, which it is, nothing will improve.

Once again, the ultimate reasons for this mess are 1) a bubble in the cost of the “asset,” in this case, college tuition; and 2) people taking out loans they can’t afford to repay.

Rather than fume with outrage, do what I do: profit from it.

SLM Corporation (NYSE:SLM), known as Sallie Mae, is yet another quasi-government entity. It guarantees student loans. It will implode just as its cousins did. The CEO said: “We don’t see anything of any evidence close to a bubble.” Oh, brother. Talk about a reason to short the stock!

With all that student debt, guess who won’t be getting a mortgage? So young, first-time homebuyers will not be in the market the way they used to, especially given the crappy postgraduate employment situation — 53% of graduates are jobless. So stay away from homebuilders such as NVR (NYSE:NVR) and D.R. Horton (NYSE:DHI) or short them because I think the recent optimism in those stocks is way overblown.

This brings up the interesting issue of for-profit schools. I think it’s a double standard to call these institutions “corrupt” for allegedly milking government financial-aid programs to get students into these schools that allegedly don’t give them skills to make money once they graduate.

That’s the same thing universities do! The Department of Education has attempted to crack down on these schools with onerous new regulations requiring that graduates obtain gainful employment. There have also been enrollment problems, possibly the result of bad press.

DeVry Inc. (NYSE:DV) was once one of mutual-fund genius Ron Baron’s gems — and still is, with his funds holding 10% of the stock. The shares are 50% off their high, with earnings getting whacked this year by 25%, and projected to lose 15% more next year.

This is reversing a multiyear uptrend. The company does have $450 million in cash, no debt and strong cash flow. Yet even with $7 per share in cash and an effective price of $24 per share, why aren’t insiders buying? Baron has always done well in this stock, and I’m sure he’s buying on the dips. It’s certainly the brand name in this sector and has been around a very long time. If you insist on buying a stock in this sector, I’d go with this one. If anyone survives, it’ll be DeVry.

Apollo Group (NASDAQ:APOL) is  in the same earnings conundrum. Yet, like DeVry, the company has $1.3 billion in cash — $11 per share – and no debt. It has strong cash flow, and the cash-adjusted stock price is $23. Private-equity rumors are swirling. Again, you could do worse, but keep in mind that earnings are expected to fall, just like DeVry’s.

Education Management Group (NASDAQ:EDMC) has a huge problem: It’s being sued by the federal government for $11 billion for its recruiting, enrollment and other allegedly deceptive practices. If you can find shares to short, I’d short it.

Keep your eye on the situation — more profits can be made from this kind of uncertainty.

Lawrence Meyers does not have a position in any stocks mentioned.

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