Household Formation

Council of Economic Advisors: College Pays. Grad School? Sh!

Or, “The Reality Behind AEI’s Reality Behind the Student Debt ‘Crisis'”

Speaking of student loans, I am directed to the American Enterprise Institute’s response to the Council of Economic Advisor’s (CEA’s), “Investing in Higher Education: Benefits, Challenges, and the State of Student Debt” (pdf).

Because I try to deliver early on my post titles rather than bury them, here’s the report’s chart on the crucial but under-emphasized dispersion of earnings by educational attainment for 35-44 year-olds with payroll incomes. (This cohort doesn’t seem so representative to me of recent student borrowers—and not in a good way, but that’s a different issue.)

CEA--State of Student Loans--Figure 5

Eyeballing the chart, more than a quarter of graduate-degree holders earn less than the median 4-year-degree holder in the same age bracket, and the bottom 25 percent of grads earn about $45,000 or less. The B.A.s earn between about $20,000 and $130,000 while the grads make roughly between $30,000 and $170,000. Graduates in between the 75th and 90th percentiles haul in nearly half the total difference. This wide dispersion cries for more analysis because graduate borrowing amplifies student debt loads. High debts and low incomes, even for this small group of debtors, tend to discredit the human capital hypothesis and the purpose of student lending.

But back to the reality behind the reality behind the- etc.

Critical readers should always be on their guards whenever someone characterizes the “student debt crisis.” Frequently it’s a strawman of the crisis writers want to discuss rather than how much of the unpayable debt will be written down in the future. In the AEI’s case, the crisis is, “[T]he macroeconomic impact of high debt levels.” Here, AEI takes this to mean the stock of $1.3 trillion of debt.

The AEI post turns to its education scholars, startlingly Jason Delisle, who perhaps has moved on from the New America Foundation. Delisle focuses first on the claim that “student debt is holding back the economy.” The CEA report attempts to discredit this position in six ways. One, student debt is not as big as the mortgage bubble (which I don’t think I’ve seen anyone argue for a few years now). Two, hardship today will be offset by the future productivity unleashed by education. Three, everyone borrowed student loans when the opportunity costs were lowest, so high debt levels are in step with the economy and not undermining it. Four, student debt is only slightly reducing homeownership among young people. Five, student loans only reduce auto debt for high-balance debtors. Six, student-loan debts reduce small-business formation and their incomes somewhat, but other factors are involved.

The study concludes, “Had the same students received an education without as many loans, the recovery would likely have been stronger, but not substantially so. Most individuals, and the economy as a whole, will benefit from the education made possible by student loans” (56).

In other words, the Obama administration is asking everyone to double down on its hope that all this education will pay off someday and the government won’t have to write down hundreds of billions of dollars in unpayable education debt, whether by forgiveness promises in repayment plans or new legislation. It’s a theme that crops up elsewhere in the report, and it suffers from two problems. One, higher education doesn’t correspond to higher aggregate incomes; rather it seems to be swapping high-school grads with college grads while keeping incomes flat. If college boosts incomes like video-game power-ups, then we’d expect exponential growth in aggregate incomes, but we’re not. And anyone who thinks the payoff will come later must explain why intervening variables aren’t involved, e.g. occupational differences, which would explain the wider earnings dispersions for the credentialed. The CEA gives us no confidence in its education bet.

Problem number two is that the report tends to side against studies produced by the Federal Reserve Bank of New York (especially those by Meta Brown, et al.) in favor of research producing more satisfying results. The impacts might be trivial, but the NY Fed found that youngish student debtors weren’t getting mortgages or were more likely to live with their parents than the unindebted (links buried here). Meanwhile, the report shoos away the Bennett hypothesis by claiming a lack of consensus, with the caveat that there may be some “administrative bloat” in colleges and universities. Consensuses are tough rhetorical animals to wrestle with and should require significant evidence to prove. A few studies here and there will not do it.

So back to AEI. When Delisle writes, “[Advocacy groups] say student debt is forcing people to delay things like buying a house, starting a family, all productive things. This report is pretty clear that isn’t the case,” he’s wrong. The report clearly concedes that student debt is negatively affecting the economy, albeit to a small degree, and thanks in part to wishing away contrary NY Fed studies and insisting that all the education will pay off someday.

To clarify, student debt is a notable if not primary contributor to a generational disaster dominated by the trade deficit or slack aggregate demand—and new student borrowing is declining—but the CEA report isn’t the source to show it. So that’s a strike against Delisle.

He asks:

Why are millions of borrowers flocking to enroll in a program [IBR, PAYE, REPAYE, etc.] that allows them to cap their student loan payments at a small share of their income if the return on an educational investment are large? Something seems amiss there. I’ve done a lot of work showing that the income-based repayment program is too generous as a result of Obama administration changes, which may explain this disconnect.

I’ve answered the first question already: There is no large, aggregate return to higher education. As to Delisle’s work on the changes to IBR, it’s never demonstrated that the programs are too generous because it’s based on lopsided, self-verifying hypotheticals. In fact, according to a GAO study, in 2014 only 2 percent of debtors in IBR or PAYE plans earned more than $80,000, so Delisle’s mythical IBR deadbeat is not a serious policy concern. Amusingly, Delisle’s reaction to the GAO study at the time was to blame debtors for not making enough money, gasping that they’d use IBR plans for long-term rather than short-term debt relief.

AEI then turns to resident scholar Andrew Kelly, who writes, “Lower interest rates [proposed by Democrats] won’t help folks with small balances who aren’t repaying nearly as much as they’ll help those with average or large balances, most of whom have no trouble repaying because they have the highest educational attainment!”

I have problems with the Warrenian interest-rate proposals too, but Kelly makes the frequent mistake of flipping the income and debt variables to conclude that high-balance debtors are deadbeats, even though the CEA report shows a wide income dispersion for graduate-degree holders.

I admit I didn’t give the CEA report a thorough read, but it looks like the AEI scholars didn’t either.

CBO Misleads on Household Formation?

Last year, the Congressional Budget Office reported in its “Budget and Economic Outlook” that better job prospects and easier access to mortgages would help accelerate household formation. At the same time it raised concerns that student loans were inhibiting people from buying houses.

I thought the CBO was living in a fantasy world about household formation, and soon after the Federal Reserve Bank of New York agreed with me. However, going by this year’s “Budget and Economic Outlook,” it looks like I could be wrong: Household formation started rising as the CBO predicted.

"Household formation is the change in the average number of households from one calendar year to the next."

“Household formation is the change in the average number of households from one calendar year to the next.”

(Page 163)

At first I thought, “Well, it might be the start of a trend, but I don’t see why it’ll continue.” But then I looked at the Census Bureau’s household data (Table 13a), which the CBO was clearly relying on. It turns out, when you look at the whole calendar year, and not just the average, household formation spiked until mid-2015, and then it collapsed.

YoY Change in Household Formation by Month

Household growth in 2015 could be a blip in either direction, but I’m curious how 2.2 million households would choose to form in December 2014. Seems like an awful time of year to do it. Even the CBO concedes household formation could be slower than it expects (page 54).

I think the CBO should’ve inspected the household data a little more closely before concluding that residential real-estate construction would contribute to economic growth. It said nothing about the vacancy rate, which I’ll look into when the Census Bureau updates those data.