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Tuesday, October 22, 2013

The Rise of an American Debtcropper System for the Young

Tuesday, October 22, 2013

Readers have often been using the term “neofeudalism” to describe the outlines of the new economic order, in which the uber wealthy and a thin cadre of their advisors, managers, and other elite professionals do well, with a network of less lofty managers helping oversee and orchestrate the provision of services to the broad base of the public, and they struggle to eke out a meager existence.

Debt appears to be the “one ring that rules them all” of this emerging order. 

And if that is the case, it’s likely to be much more like the old sharecropper system of the post Civil War era, where poor whites and blacks were kept on a debt treadmill that turned them into slaves in all but name. As Matt Stoller wrote in 2010:

Debt is not just a credit instrument, it is an instrument of political and economic control.

It’s actually baked into our culture. The phrase ‘the man’, as in ‘fight the man’, referred originally to creditors. ‘The man’ in the 19th century stood for ‘furnishing man’, the merchant that sold 19th century sharecroppers and Southern farmers their supplies for the year, usually on credit. Farmers, often illiterate and certainly unable to understand the arrangements into which they were entering, were charged interest rates of 80-100 percent a year, with a lien places on their crops. When approaching a furnishing agent, who could grant them credit for seeds, equipment, even food itself, a farmer would meekly look down nervously as his debts were marked down in a notebook. At the end of a year, due to deflation and usury, farmers usually owed more than they started the year owing. Their land was often forfeit, and eventually most of them became tenant farmers.

They were in hock to the man, and eventually became slaves to him. This structure, of sharecropping and usury, held together by political violence, continued into the 1960s in some areas of the South. As late as the 1960s, Kennedy would see rural poverty in Arkansas and pronounce it ’shocking’. 

These were the fruits of usury, a society built on unsustainable debt peonage.

Even though readers of this blog recognize the individual pieces of the hardships facing young people, I’m not certain older people can readily grasp the totality. For instance, going to college is seen as being for people who grew up with college educated parents as a basic requirement; it’s a marker of accomplishment, a necessary but no longer sufficient condition for entry into the middle class, and at least in some circles, still seen as desirable in and of itself (as in an opportunity to gain knowledge and culture, as quaint as those ideas may be). High school kids face a decision they are not well equipped to make. Most people suffer from optimism bias, and teenagers may feel not going to college is an admission of failure. And it’s not as if they have great prospects if they go into the job market with only a high school degree.

So the short form is the system is increasingly set up to load young people up with debt. And it’s not just student loans. This comes from a post by EshaC, a college student who traveled to seven cities across the country at the behest of her credit union employer to talk to students about student loans, credit cards, credit scores, and budgeting. The article is written cautiously, but the author casts doubt on claims like “nearly 50% of students know how to use a credit card effectively”. What is “effectively”? They can swipe and sign?

Lesson #1: Students take out a lot of money they don’t know a lot about.

If you were a college freshman and received a letter from your school, regarding your financial aid award that equated to half of your school’s cost of attendance, why wouldn’t you take this? It’s called an award, so it’s like a gift, right? Well, even though 63% of the millennials I talked to have student loans, 65% of them had little to no familiarity with the repayment of their loans and almost 70% of them don’t know their interest rates. I asked students why they didn’t have “interest” in their interest rates and discovered that students are just more focused on the “here and now” with school and less interested in what lies ahead in 4 years.

There were a few exceptions. I spoke with a student of Creighton University in Omaha, Nebraska that stood out among the rest. He was working two jobs on campus and paying off his student loan bill while pursuing his Master’s in sociology. His family had faced financial struggles all of his life and so he empowered himself to take charge of his own finances while in school to make it less of a burden when he finished school.

I also made a point to visit the banks and credit unions on the various campuses to see what they had to say about this issue. I was surprised to hear that these financial institutions do not offer a lot of assistance in helping students become more financially literate. They will help students if they come in with questions about their private loans, but they seldom will go out of their way to reach out to students. There are some banks that offer budgeting seminars but have had little attendance with, so they opt out of holding these types of services to students.

Lesson #2: We love our credit cards and how much we can max them out to.

67% of the individuals I talked to said that they have a credit card. This conflicted with my preconceived notion that millennials don’t typically have credit cards because they know very little about them. There were quite a few students who had credit cards tied to their parent’s credit card account, which might suggest why students don’t know a lot about them.

We have been engrained by teachers and parents throughout our adolescence that they are nothing but a trap. As students we always hear about the disaster stories – the guy who puts $25,000 on his credit cards and is unable to pay off his debt. We never hear of success stories of the people who pay off their bill every month and are responsible with their credit card debt.

One thing that shocked me the most was that only 31% of these students know their interest rate. In their defense, as I found out in Omaha, if you are paying your credit card bill off in full then there is no need to know your interest rate. The most surprising find was that almost 80% of these individuals know exactly what their credit limit was on their card. From this, it is easy to interpret that students really only care about how much money they can put on their credit card before it gets denied.

I find the discussion of ignorance about student loans particularly distressing. The media has reported regularly about how reassuring college officials are when signing up kids for loans. This is pure and simple predatory behavior (and where are their parents????). And while the college staffers who are directly responsible for the lending are most culpable, it’s not as if the rest of the people in the university deserve a free pass. How many tenured faculty members are decrying what is going on? I can guarantee in five to ten years, they will be targets of resentment the same way teachers in public schools are if they don’t get on the right side of this issue.

So colleges and financial firms are targeting ignorant, uninformed borrowers, and for at least the student loan part, they perceive it to be for an important, if not essential service. And you can see the clear signs of lender recklessness in the default rates. From the Department of Education (hat tip Bill H):

For-profit institutions continue to have the highest average two- and three-year cohort default rates at 13.6 percent and 21.8 percent, respectively. Public institutions followed at 9.6 percent for the two-year rate and 13 percent for the three-year rate. Private non-profit institutions had the lowest rates at 5.2 percent for the two-year rate and 8.2 percent for the three-year rate.

Remember, these are default rates, not delinquency rates. Ugly.

Consider what happens as they graduate and their debt payments kick in. The difficulty most young people have and will continue to have in buying a house puts them at the mercy of landlords. If they can afford to live in one of the few cities where tenants have decent property rights, like New York or San Francisco, that might not be terrible. But in most places in the country, it really does put you in a vulnerable position, although buying with a mortgage with a predatory servicing industry still unreformed isn’t so hot either.

And that’s before you factor in a third issue: that those who have the hardest time landing a decent job in this downturn have the longest lag in catching up. From NBER:

Graduating in a recession leads to large initial earnings losses. These losses, which amount to about 9 percent of annual earnings in the initial stage, eventually recede, but slowly — halving within five years but not disappearing until about ten years after graduation…

Oreopoulos, von Wachter, and Heisz further find that college graduates at the bottom of the wage-and-ability distribution experience larger and more persistent losses, while for those at the top the effects are small and short-lived. 

The researchers believe that the (present discounted value of) losses in annual earnings could be three to four times larger for the least relative to the most advantaged workers. This suggests an even larger degree of dispersion in the costs of recession, even within the group of college graduates. The patterns discerned in the data support the importance of job mobility and changes in firm quality, the authors conclude, with the exception of those least advantaged, who suffer permanent earnings losses and are permanently relegated to lower wages

So bad economic times increase income disparity even among the young, and that will also make it even harder for them to contend with debt.

I’ll return to this topic, because I think this recitation isn’t adequate to convey how the pieces are being put in place to put bigger and bigger swathes of the public under the debt yoke. And officials act as if this sort of thing is desirable as long as they can pretend it’s “affordable”. This cheery statement comes from that Department of Education release:

“The growing number of students who have defaulted on their federal student loans is troubling,” U.S. Secretary of Education Arne Duncan said. “The Department will continue to work with institutions and borrowers to ensure that student debt is affordable. We remain committed to building a shared partnership with states, local governments, institutions, and students—as well as the business, labor, and philanthropic leaders—to improve college affordability for millions of students and families.”

This is completely nonsense unless the Department is working to lower tuition costs on a widespread basis, and I see no evidence of that. All we have is yet another “transparency” initiative, to treat college, like Obamacare, as a shopping experience. While one part of the push is to provide “bigger grants” and “more affordably loans” to “better” colleges, this means they get more tuition dollars. This does nothing to address the underlying cause of price inflation and gold plated administrators.

This is a slow road to penury for young adults, save for those who manage to get on the really big ticket career paths or have parents who can pay for college and buy them a house. We can’t pretend to address the problems of the economy unless we include the increasing debt enslavement of the young along with the pauperization of the old. Otherwise, the Petersons and the Druckenmillers of the world will play them off against each other and keep them both under their boot.