Austrian economic theory tells us that asset bubbles arise when artificial credit expansion distorts capital allocation and leads to production that is out of sync with underlying demand. The standard example is how money creation by central banks lead to financial or housing bubbles. Bubbles are characterised by rising prices without a corresponding increase in underlying value. There is no strict relationship telling us where a bubble will occur, but conditions in various asset markets may attract the newly minted money to a specific sector. The existence of Freddie Mac and Fannie Mae, the government sponsored enterprises charged with facilitating mortgage lending in the US, was instrumental in the formation of the housing bubble in the early 2000s. A political ambition to expand home ownership amongst people who couldn’t afford it led to these agencies underwriting billions of sub-prime mortgages, until one day the bubble burst and the predictable bankruptcy (or conservatorship) followed.
Today, there is no better example of a bubble than US education. Year after year, the same education costs more and more, as colleges continuously increase their prices while seemingly offering the same product.
As Austrians, we can explain this phenomenon with a simple chart:
Student credit has exploded over the last few years. And what has causes the explosion is simple: government guarantees. Government subsidised student loans have made educational funding readily available, and now makes up more than 90% of outstanding student loans. As the money has flooded into the sector, prices have risen without a corresponding improvement in the underlying product. At the same time as prices have gone up, subsidies have increased demand, a seemingly perverse fact in a market with steeply rising prices. And in fact, value for money has decreased more than reflected in the rising prices. As college degrees become more common, the value of a diploma decreases. Students are paying more for increasingly worthless educations and pile on debt for the privilege. 70% of bachelor degree recipients now leave school with debt. Students graduating in 2015 left with an astounding average of more than $35,000 of debt.
Bubbles burst, but as the vast majority of student debt is federal, the money is owed to the state and the education bubble is therefore ultimately underwritten by the US Federal Government – and as such has the backing of the US tax payer and the printing presses in the basement of the Eccles Building. It is therefore a fools game to predict the bursting of the bubble. What we can say is that more and more young Americans will graduate with ever more expensive and increasingly worthless degrees. Many will not be able to repay the debt from working the minimum wage jobs they (despite their prestigious degrees) are forced to take.
The scale of the student loan bubble is not nearly large enough to be a threat to financial stability, but it is a textbook case of how artificial credit expansion and foolish government policy can interact to the detriment of not only the economy at large, but also the very people the policy was designed to support.