Everyone is worried about debt. Government debt, household debt, personal debt, corporate debt. We are in it up to our eyeballs and often beyond.
Debt is not always bad, though. The financial system can’t survive without it; banks and traders need debt to finance growth.
As usual, the key is moderation. Debt can be good if it helps a person grow their business... or invest in a good education. Well, at least that’s the theory.
Photo: Getty Images
Student debt should be productive—after all, it buys education that enhances your income. Yet for millions of Americans, that’s not what has happened, and the reason may surprise you.
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The New York Federal Reserve Bank publishes an always-interesting Quarterly Report on Household Debt and Credit. The Q4 2017 version came out last week.
Collectively, Americans carried $13.15 trillion in debt as of year-end 2017.
As you can see, most of it is mortgage debt—about 71% of the total if you include home equity loans (“HE Revolving” in the chart).
Surprisingly, the next-largest category isn’t auto loans or credit cards. It’s student loans, which are now 10% of total debt. Their share has been growing steadily.
This might be okay if the debt enhanced the student’s financial security, but often that’s not the case. Millions of borrowers don’t achieve the desired results but remain stuck with the debt anyway.
Wall Street Journal‘s higher-education reporter Josh Mitchell had an interesting story on this last week. Using the same New York Fed data, WSJ showed this info on loan delinquencies:
While delinquency rates for other forms of debt fell after the recession, student loans didn’t. As of year-end 2017, about 11% of nearly $1.4 trillion in student debt was at least 90 days delinquent.
It’s actually worse than that. Roughly half of student debt is held by borrowers who aren’t required to make payments yet because they are still in school, unemployed, or otherwise excused. Much of that debt would likely be delinquent too.
Also important: the delinquent loans tend to be small (less than $10,000) and held by borrowers who never earned degrees.
These borrowers probably thought they were doing the right thing. They wanted decent jobs and saw that having a college degree was necessary to get one.
So why is college the key to gainful employment? It hasn’t always been so.
It’s because employers require a degree as job qualification... and that’s partly the fault of IQ tests.
Photo: Getty Images
In 1971, the US Supreme Court decided a case called Griggs vs. Duke Power Co. The subject was employment requirements.
Duke’s practice—and many other companies at the time—was to give job applicants an IQ test. Supposedly, this let them hire qualified people, but some companies also used tests to discriminate by race. The 1964 Civil Rights Act banned pre-employment tests that were not “a reasonable measure of job performance.”
The court ruled that Duke’s tests were too broad and not directly related to the jobs performed, which made them illegal.
Furthermore, the court said employers had the burden of proving employment tests were necessary for business purposes and not racially discriminatory. That’s hard to prove, so many US companies stopped using pre-employment tests at all.
That left a problem, though. How were employers supposed to evaluate job applicants without illegally discriminating?
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Employers really want to know two different things about prospective workers:
- First, can this person perform the specific tasks that go with this job? That means operating a machine correctly, carrying boxes of a certain size and weight, writing computer code, etc. You might call these the “hard skills.”
- Second, there are soft skills. Is this person willing to stick with unpleasant assignments to the end? Will he show up on time? Can she work with others?
Those soft skills are harder to judge but critically important. They’re also what the Supreme Court made hard to test.
College sort of requires those same soft skills. A degree may not give you much useful knowledge, but it shows you have some basic intelligence and literacy. It also shows you will jump through hoops if your organization tells you to. Employers value those qualities.
The Griggs case said nothing about educational requirements. Employers remained free to require high school diplomas or college degrees… and the ruling gave them a big incentive to.
College degrees are convenient, legal substitutes for the kind of testing employers haven’t been able to use since the 1970s. So apart from whatever you learn in college, merely having the credential became necessary to career success.
As a result, everyone in the equation made certain choices.
- Employers: demand a college degree even for jobs that don’t require college-level skills.
- Workers: get a college degree even if you must take on debt.
- Colleges: Raise prices since so many students were begging for degrees.
This made college more expensive, forcing students to borrow more and more money. Politicians jumped in to promote and guarantee those loans. And here we are.
In the Griggs case, the US Supreme Court effectively granted colleges a monopoly. They can discriminate based on testing—or really a long series of tests that lead to a degree. Employers can’t.
Like most monopolies, this one is inefficient. It creates unpayable debt that burdens students. Some of it eventually falls on taxpayers. Not ideal.
Methods exist to evaluate prospective workers without requiring college degrees, and without racial or other illegal discrimination. But there’s no incentive to try them when you can just screen out the non-college graduates and accomplish the same thing.
Resolving this impasse would help our debt problem and probably our employment problem as well. But the losers would be colleges and educational lenders, so don’t expect them to cooperate, unless someone forces them to.
See you at the top,
Senior Economic Analyst Patrick Watson is a master in connecting the dots and finding out where budding trends are leading. Patrick is the editor of Mauldin Economics’ high-yield income letter, Yield Shark, and co-editor of the premium alert service, Macro Growth & Income Alert. You can also follow him on Twitter (@PatrickW) to see his commentary on current events.