Debt forgiveness as economic stimulus

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This entry was originally posted at The HLPR Blog: Notice & Comment.

Following up on an earlier piece about the student loan bubble, I wanted to share two graphics that depict the over $550 billion in student loan debt carried by U.S. households. The first shows 2011 student loan debt relative to 2000 debt.

The second reveals how much faster student loan debt has grown relative to all other household debt. If you look closely, it’s possible to notice that since 2008 Americans have reduced their dependence on credit with the exception of student loans.

With default rates rising, the student loan bubble has gotten a lot of attention in the past few months. The Chronicle recently reported that students are bearing an increasing percentage of university costs. A piece at the Washington Monthly demonstrated that many of the added costs have come from increased administrative hiring. And a number of other articles have explored how the debt has impacted people in their 20s and 30s. While it’s tempting to debate how the student loan bubble is or is not like the subprime mortgage crisis, I simply want to note that it has the same potential to create political rifts when the debt proves unpayable.

During the debt ceiling debates back in July, Rep. Hansen Clarke (D-MI) proposed a resolution in the House entitled “H.Res. 365 — Expressing the sense of the House of Representatives that Congress should cut the United States’ true debt burden by reducing home mortgage balances, forgiving student loans, and bringing down overall personal debt.” While this bill is just sitting in committee, it seems noteworthy for being one of the only post-crisis bills that acknowledges what’s actually straining the global economic recovery: high levels of private debt.

The political turmoil in Europe, the subprime/foreclosure crisis, and the student loan/unemployment disaster facing the United States all boil down to the same issue. Creditors made a lot of bad, risky loans leading up to the financial crisis in 2008. But rather than take losses for those loans, what we’ve seen across Europe and the U.S. has been an attempt to use the legal system and political pressure to make sure these creditors get 100 cents on the dollar. Borrowers and, in many cases, taxpayers (in the form of austerity programs) have been tapped to make sure that debt does not get written down. In the U.S., politicians have proven more willing to see homeowners foreclosed on than ask banks to start refinancing mortgages, and student loans were made virtually unforgivable in 2005 when the bankruptcy code was amended.

These outcomes are not mandated by economic principles. Rather, they are political choices that reflect a systematic preferencing of creditors over borrowers. They also happen to be economically bad policies. After a bailout and two rounds of quantitative easing, banks have still not resumed the lending necessary to achieve sustained job growth, and politicians need to realize that policies that protect creditor interests at the expense of an over-leveraged population are postponing economic recovery.

With private debt at record high levels, debt relief (whether in mortgage writedowns, loan forgiveness, or some other form) has enormous potential as an economic stimulus. It would free a portion of people’s paychecks to start purchasing again, stimulating demand and creating jobs. And it would keep many others in their homes. As Kenneth Rogoff, a professor of economics at Harvard and former chief economist of the IMF, recently wrote, “the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation.”

This deleveraging process can happen through austerity and defaults or it can happen through sensible policies that write down debt in ways that can stimulate the economy. David Graeber has written a fantastic book, Debt: The First 5000 Years, that shows how debt has been at the middle of political disputes for all of recorded history. And Bob Kuttner noted quite early in an excellent piece for the American Prospect that debtor-creditor tensions are likely to become far more pronounced and more central to our political debates.  Debt resolution is already threatening the stability of the European Union. The sooner American policymakers realize what the current phase of the financial crisis is really about, the sooner we can devise a coherent response and begin the recovery.

Now that the debt ceiling has been raised, can we get around to abolishing the debt ceiling?

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Originally posted at The HLPR Blog: Notice & Comment.

On August 2 of this week, the United States successfully—if you can call it that—raised its debt ceiling for the 10th time since 2000. Regardless of the merits or un-merits of the deal that was eventually reached, the negotiation process was overwhelmingly bad for the country’s fledgling economic recovery. America’s reputation globally has suffered as a result. China’s state run paper called the negotiations “dangerously irresponsible,” and many commentators thought the US was coming perilously close to a constitutional crisis.

The country may be suffering from a bit of debt ceiling fatigue at the moment, but given the harm that the past few weeks have done, the United States needs to get around to abolishing the debt ceiling before this situation repeats. It would be a good signal to markets and remove political uncertainty that’s likely to keep US interests rates up, and it’s important for the continued stability and civility of our political system.

In case you need persuading that the debt ceiling should be abolished, I recommend this article by James Surowiecki at the New Yorker or Annie Lowrey’s piece in Slate from back in May, where she referred to the debt ceiling a “historic relic” with a “horrific downside and negligible upside.” And on August 1, Bruce Bartlett, a former policy advisor to Presidents George H.W. Bush and Ronald Reagan, laid out a persuasive argument for the debt ceiling’s abolition, explaining that:

“Even if the Treasury avoids default on government debt this week, we will inevitably have to go through the same political drama the next time the debt limit runs out and every time thereafter. And sooner or later the shoe will be on the other foot, as Democrats hold the debt limit hostage against a Republican president.”

“Unfortunately, the option of just letting the debt limit expire is not available. It is permanent law and can be abolished only by repeal or by a ruling by the Supreme Court that it is unconstitutional.”

Given the fight that was just waged over raising the debt ceiling, I am rather skeptical that the Republican-controlled House is prepared to repeal the debt ceiling at the moment. Neither party, it seems to me, has the proper incentives to give up this political bludgeon willingly. As Michael Shear stated, “it may be impossible for Washington to put the debt ceiling genie back in the bottle.” Whether the debt ceiling statute is unconstitutional is another matter.

Bruce Bartlett has also written an excellent summary of the constitutional issue and has compiled some of the best arguments for and against the executive branch’s invoking the 14th Amendment to avoid hitting the ceiling. While most of these arguments focus on whether the President was empowered by the 14th Amendment to authorize the Treasury Secretary to continue issuing debt, the relevant question is whether the legislation establishing the debt ceiling is itself constitutional. Niel Buchanan at Dorf on Law has addressed exactly this issue and argued that the debt-limit statute is unconstitutional because it separates Congressional spending from the authorization to raise money to pay for those obligations.

Alternatively, it might be possible to argue that Congressional action that calls into question the United States’ debt might itself be unconstitutional. As Jack Balkin has written:

“Secretary Geithner does not believe that the President is allowed to violate the Constitution himself to stop congressional Republicans, but it does not follow that what the Republicans are doing is constitutional.

The press so far has been asking whether the debt ceiling is constitutional. The correct question they should ask is whether the Republican strategy of hostage taking violates the Constitution.” (emphasis in original).

As most legal commentators have recognized, standing and the political question doctrine pose hurdles to the Supreme Court ever ruling on the issue. Given the enormous damage this game of political chicken caused and how perilously close the nation came to an unprecedented constitutional conflict, however, these questions are worth exploring in more depth—and soon.


Short-termism is a kind of contagion

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An emphasis on short-term performance does not always produce a long-term viable strategy. That looks obvious enough when typed out. But short-termism has become the prevailing logic of many American institutions, none more radically than those institutions that make up its financial sector. As Sheila Bair noted in an op-ed on her last day as chairman of the FDIC, our media, political institutions, and businesses fall victim to this tendency, and it has begun to undermine our long-term stability.

To persist in acting this way would require a kind of insane faith that what’s good for now is good for tomorrow. It’s the story of how every tragedy of the commons ends badly. These attitudes, however, persist less because of any rational deliberation than because institutions can easily devolve toward incentives that reward short-term results.

One principal reason for this is that short-term strategies have a tendency to spread. In a way, this might even be a more general feature of unrestrained competition. I want to make a slightly tenuous comparison to evolution before returning to the more general point.

Assume there is a small plot of land with two unrelated breeds of plant. If plant A can absorb soil nutrients faster and outbreed plant B, it will proliferate and might eventually displace plant A entirely. This is known as exploitation competition. The evolutionary pressures on A become: 1) either depend on fewer nutrients, 2) develop a some alternate replication strategy, or 3) simply beat B at its own game, by reproducing faster and extracting nutrients more quickly. The last of these is the one I want to emphasize: Short-termism is self-reinforcing and it is contagious. When B’s reproductive strategy is on short-term success, it redefines the game for A. Eventually it becomes the only game left. This is what kudzu did when introduced in the southeastern United States. Taken to an extreme, quite literally, this is the logic of cancer.

In other words, if B chooses to play a shorter-term game than A, that redefines the game A must play to survive. Market competition is also susceptible to this dynamic, and in many ways it may account for some of markets’ successes. The process can weed out under-performers and produce more efficient manufacturing processes. But it also weeds out other business models that under other conditions would be perfectly viable and sustaining.

This fact alone should also provide a compelling reason for market regulations—something I’ll write about another time—but this dynamic also means the following: If a business starts engaging in rent-seeking activities (i.e. attempting to influence government into creating a legislative or regulatory playing-field more favorable to its interests), then quickly other competitors, other businesses, and even entire sectors may be forced to follow suit.

To make the link now to the financial sector: Incentives in the financial community have become tied closer than ever to short-term performance. Such incentives have the potential to reward speculation, and the 2008 crisis revealed that these incentives have the potential to reinforce bubble-generation. Extreme short-termism redefined the terms of competition. It drove firms that emphasized longer-term performance and responsible practices to obscurity and irrelevance, and it drove many organizations into riskier positions to remain competitive (e.g. the decision at Fannie Mae to get into subprime mortgages in 2007). It should not be surprising that given the ways that incentives were linked to performance that the terms of competition became what they did.

Nor is it surprising, as Bair notes, that short-termism has come to characterize many of Wall Street’s interactions with Congress and other regulators. Rent-seeking through lobbying and other activities directed toward obtaining a favorable regulatory playing-field have now become part of the ways that businesses in America compete. To take one easy example, provisions of Dodd-Frank that were seen as restraints on business were cut, watered down, and those that were left in have been implemented half-heartedly. And that happened despite a general consensus that Dodd-Frank was not aggressive enough in providing the US the framework it would need to respond to another financial crisis.

[Legislators are now plagued by a similar dynamic of having to fund-raise to keep up with each other, with a short-term focus on reelection rather than on governance. This further exacerbates the influence Wall Street spending can have].

Given the various ways in which Wall Street successfully defeated attempts to impose new regulations after the 2008 crisis, we would expect that the financial sector would be well-positioned for the coming decade or to handle another crisis. But this hardly seems to be the case. The shadow banking system, probably the single largest accelerator of the crisis’ spread remains largely unregulated. Banks are fighting tooth and nail against hightened capital requirements. And the fact that large financial institutions pushing for austerity measures is so shorted-sighted as to ignore any possible interdependence between growth and a healthy middle class. Etc. etc.

Perhaps the most insane thing about all of this is that large financial institutions and proponents of deregulation are so short-sighted that they believe this kind of game is actually serving their interests. [Or maybe the game is just to be the last one standing?]

To quote a post at Digby’s blog about Murduch’s ability to rapidly corrupt the WSJ, one of the world’s “most important sources of financial news”:

I think this may be the best sign yet of just how crippled our institutions have become. If there is one group in the world who should demand unadulterated facts and data it is the financial community. Sure, they’ll play it to their advantage, and care not a whit about how it affects our democracy. That’s not their job (although it is their duty as citizens.) But they simply cannot function properly if their information is tainted.

The ‘invisible hand’ produces races to the bottom just as often as it produces self-regulating systems. We have failed utterly to keep the terms of this game from keeping this short-term contagion in check. When that happens, even the winners are at risk.

Photo credit: Galen Parks Smith.

Debt: The First 5000 Years

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This is just a short follow up on my last post, to observe that there’s absolutely nothing new about the dynamic underlying the economic policy of the United States or the resistance to the austerity packages we’re seeing across Europe. I just ordered David Graeber’s excellent-sounding book, Debt: The First 5000 Years. If this summary is any guide, Graeber is suggesting that debtor-creditor relationships predate currency-based markets and are one of the fundamental organizing devices in human history:

Every economics textbook says the same thing: Money was invented to replace onerous and complicated barter system—to relieve ancient people from having to haul their goods to market. The problem with this version of history? There’s not a shred of evidence to support it.

Here anthropologist David Graeber presents a stunning reversal of conventional wisdom. He shows that for more than 5,000 years, since the beginning of the agrarian empires, humans have used elaborate credit systems. It is in this era, Graeber shows, that we also first encounter a society divided into debtors and creditors.

With the passage of time, however, virtual credit money was replaced by gold and silver coins–and the system as a whole began to decline. Interest rates spiked and the indebted became slaves. And the system perpetuated itself with tremendously violent consequences, with only the rare intervention of kings and churches keeping the system from spiraling out of control. Debt: The First 5,000 Years is a fascinating chronicle of this little known history—as well as how it has defined human history, and what it means for the credit crisis of the present day and the future of our economy.

UPDATE (11/7/11): I wrote a review that was published in Guernica a few weeks back.

The Debtor-Creditor Divide

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Several weeks ago, Bob Kuttner published an excellent 1-page piece called “Debtor’s Prison” in the American Prospect. The distinction he offers now seems quite clearly to be one of the emerging battle grounds in global politics—between rentier creditors and debtors. This is a line that’s deeply obscured in our political discourse but one that underlies virtually every economic debate. Reading this article and Paul Krugman’s follow-up offered one of those rare, paradigm-shifting moments where a number of seemingly disparate and complicated elements all fell together into one coherent picture.

The basic idea is that decades of U.S. financial deregulation and the government’s response to the financial crisis have systematically favored the claims of creditors and transferred the losses and downside of their risk to taxpayers, homeowners, and less sophisticated borrowers. To quote Krugman, “everything we’re seeing makes sense if you think of the right as representing the interests of rentiers, of creditors who have claims from the past — bonds, loans, cash — as opposed to people actually trying to make a living through producing stuff.” I also recommend Yves Smith’s post on the costs of rentier rule.

Geithner, Summers, and most of Obama’s financial team have done little to alter this development. Charles Fergesun, the director of Inside Job, has drawn attention to regulators’ unwillingness to see creditors take even minor haircuts. This has proven true even in egregious cases such as AIG’s toxic credit default swaps in which creditors cashed in at 100 cents on the dollar during the bailout. As Shelia Bair, the Bush-appointee who recently stepped down as Chairman of the FDIC, noted in her wonderful farewell op-ed in the Washington Post, there were few prominent regulators advocating that banks write down losses for the bad mortgages and other bad borrowing. Quantitative easing and the Fed’s decision to keep interest rates near zero have likewise served as a second stimulus for large creditors but have not translated into economic growth or more jobs.

As Tim Harford argues in his book, Adapt: Why Success Always Starts With Failure, we need individuals and businesses to take risks because success is an iterative, evolutionary process of failing and building off of what works. But when we punish borrowing so harshly and reward rentiers uncritically, we destroy incentives to innovate and instead encourage speculation and bubble formation. Getting people above water in their homes and allowing businesses to take loans on favorable terms is precisely what we need to stimulate demand and begin an economic recovery. Even Goldman Sachs acknowledged that this job crisis is a problem caused by too little aggregate demand.

But instead the response has been more of the same. In order to stay in creditors’ good favor, Europe is facing what feels like an endless series of sovereign debt crises and austerity measures forced on its population, and the U.S. is quickly throwing itself down the same rabbit hole. By imposing austerity measures and penalizing borrowers, policy-makers risk creating an entire class or an entire generation that’s too indebted to innovate, move, or seek additional training — creditors need to wake up and realize they’re not getting paid this way either.

Perhaps the most frustrating aspect of this entire situation is that because our political system is so closely tied to its own creditor class, this conversation is completely absent from the current fiscal debates. As Peter Dorman rather tragically observed:

“There are lots of interesting, complex issues in political economy. None of that matters now: the world is in the hands of politicians governed by expediency calculations whose time horizon can be measured in weeks. As far as I can tell, the gross illogic of their policies is simply beside the point.”

FDR 1936 Re-Election Speech

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“For twelve years this Nation was afflicted with hear-nothing, see-nothing, do-nothing Government. The Nation looked to Government but the Government looked away. Nine mocking years with the golden calf and three long years of the scourge! Nine crazy years at the ticker and three long years in the breadlines! Nine mad years of mirage and three long years of despair! Powerful influences strive today to restore that kind of government with its doctrine that that Government is best which is most indifferent.

For nearly four years you have had an Administration which instead of twirling its thumbs has rolled up its sleeves. We will keep our sleeves rolled up.

We had to struggle with the old enemies of peace—business and financial monopoly, speculation, reckless banking, class antagonism, sectionalism, war profiteering.

They had begun to consider the Government of the United States as a mere appendage to their own affairs. We know now that Government by organized money is just as dangerous as Government by organized mob.

Never before in all our history have these forces been so united against one candidate as they stand today. They are unanimous in their hate for me—and I welcome their hatred.

I should like to have it said of my first Administration that in it the forces of selfishness and of lust for power met their match. I should like to have it said of my second Administration that in it these forces met their master.”

  — Franklin D. Roosevelt, 1936. Full text and recording here.

It’s extremely easy to get caught up in the news cycle and lose any historical perspective on what’s happening. This FDR speech, however, makes me wonder that there’s something deeply wrong with our constitutional design and the rules we apply to business entities if corporate power poses such a recurrent threat to stable and independent democratic institutions.

This quote alone makes it quite clear that the US government has been captured by the rentiers in its financial class before, and it’s somewhat heartening to know that the democracy managed to survive it. (At least for the few decades before we began dismantling banking regulation and campaign finance laws). But I wonder how much of that came down to FDR personally. It is troubling that the party and election-financing systems now in place have more completely blocked out any possibility that anyone as adverse to “organized money” could ever win a nomination, let alone the Presidency.

Anyway, this speech is incredible, in part because it’s so unthinkable today. It’s hard to believe now that people ever took FDR-Obama comparisons seriously.

Crowdfunding a Beer Company Buyout

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I came across an interesting post in the Blog of the Legal Times yesterday about two advertising executives who attempted to raise $300 million from online investors in order to purchase Pabst Blue Ribbon. Rather than approaching large investors, they came up with a rather brilliant method for crowdsourcing the buyout. The two men, Michael Migliozzi II and Brian William Flatow, actually managed to raise $200 million before the SEC stepped in to block the purchase.

Since late 2009, the two friends operated buyabeercompany.com (now defunct) and created a facebook page and a twitter account that helped them coordinate investors. The idea was to attract investors who would pledge money, as little as $5 or as much as $250,000, and they would only be asked to pay this money if they reached the threshold $300 million. Like Kickstarter andPledgeMusic, there was no money out of pocket until the project’s target had been reached.

The SEC canned the planned takeover because the two organizers had failed to properly register what amounted to a security issuance. In effect, the website was a stock issuance that required registration and disclosures under Sec. 5(c) of the Securities and Exchange Act. Given that there were no sanctions accompanying the SEC’s “cease and desist” order, there is some chance that after properly registering and disclosing the required information, this might not be the end of this story.

Crowdfunding in its various manifestations has been spreading rapidly and there are plenty of interesting resources around the internet. But it’s curious that there haven’t been more efforts to use the internet to enable widely distributed groups of people to buy up more major companies. Beer companies and sports teams seem like obvious candidates. While SEC filings are a small hurdle, there’s no obvious reason that the broader investing public couldn’t do a targeted takeover of any number of corporations through these kind of threshold pledge plans.

Like the far more controversial Bitcoin peer-to-peer currency, crowdfunding promises to decentralize and generally transform corporate finance around the world. Perhaps as campaigns like Buy A Beer Company become more common, the SEC will develop new protocols for facilitating these kinds of online purchases while still ensuring that potential buyers and sellers are being dealt with honestly and transparently. In the meantime, there’s going to be a real need for lawfirms or other organizations willing to perform the SEC filings for the coming surge in crowdfinanced buyouts.

This entry was originally posted at The HLPR Blog: Notice and Comment.

Disclosure is not the cure-all liberals want it to be

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This entry was originally written for HLPR Online: Notice & Comment.

Disclosure rules have become a kind of last resort for policy makers looking to reduce institutional corruption. There have been proposed disclosure rules for economists, particularly those who had strong ties to the financial sector. Others have called for general transparency for any academics who receive private funding for their research or who testify before Congress. The Affordable Healthcare Act imposed new disclosure requirements for physicians, and Dodd-Frank requires increased transparency into executive compensation. And until recently, disclosure had reasonably broadbipartisan support as a partial fix to the torrent of campaign spending that was opened up by the now infamous Citizens United decision.

The motivating idea behind all these proposals is that by revealing funding sources and other conflicts of interest, corruption will become apparent and the most egregious activities will be driven from the marketplace. Politically, these regulations probably owe much of their support to the fact that they’re generally viewed as consistent with free market principles. Recently, even that has come into question. Conservatives and industry insiders have expressed worries that disclosure rules add costs and stymie speech. There’s plenty to read aboutthat debate, but it basically boils down to the fact that Republicans benefit more by keeping disclosure rules lax.

Before Democrats go on championing disclosure laws as the solution to all forms of institutional corruption, however, they should recognize its limits. While transparency is a crucial element of anti-corruption regulations and is necessary to police many of our public and private institutions, it would be a terrible mistake to stop pursuing substantive conflict of interest regulations and accept disclosure as the solution to all forms of corruption.

As Cain, Moore, and Loewenstein phrased it, that there are times “when sunlight fails to disinfect.” Treating disclosure as an end-in-itself requires a misplaced faith in the ability of markets to answer all of society’s problems. And there is emerging empirical support that disclosure rules often fail to accomplish their purported goals. I’ve tried to separate out at least two reasons to be skeptical about disclosure’s ability to eliminate conflicts of interest:

1) Because disclosure often comes into play when there are significant information asymmetries, more information does not enable policymakers, voters, or consumers to make better decisions. If a patient goes to a doctor who says he met with a drug rep before prescribing a certain medicine, the patient is not able evaluate whether or not to take the medication. He’s not going to ask another doctor or know how to assess the risks involved. Similarly, when an economist is testifying during a financial crisis before the Senate, how is a Senator to properly discount testimony that has industry support? The element of duress makes the ineffectiveness of disclosure rules even more pronounced.

2) Disclosure in many ways legitimates conflicts of interest by telling politicians and professionals, in effect, ‘so long as you told everyone what you’ve done, whatever questionable activity you engaged in was presumably acceptable.’ It might even be making behavior worse. As research by Cain, Moore, and Loewenstein revealed, disclosure seems to give experts the impression that they have dealt with the ethical problems posed by their conflict of interests and can sometimes exacerbate the extent to which expert statements become self-serving. As Courtney Humphries at the Boston Globe noted, policymakers may be treating disclosure as a panacea and refusing to address the conflicts of interest that are the real source of corruption.

Beyond this, disclosure reinforces the patently false norm that markets self-regulate. And naively supporting disclosure legislation risks lending weight to the deregulatory ideology that has already produced so many harmful conflicts of interest at the core of our political and financial systems. There are certain arrangements, that no matter how transparent, are simply incompatible with good government or a stable financial system.

 

The Ivory Bubble

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This entry was originally written for the HLPR Blog: Notice and Comment.

I should be clear: I am delighted to be graduating with my degree. But in commemoration of my final week of law school, I’d like to use this opportunity to consider the macroeconomic implications of the increasingly hard-to-deny bubble in American higher education. Pointing out this bubble’s existence has become a kind of de rigeur exercise among online commenters. The basic point is this: the cost of higher eduction continues to rise rapidly while the real risk-weighted value of a degree declines.

Nevertheless, American families, banks, and even the U.S. government continue pouring more money into this depreciating asset. There are speculative aspects to the higher education industry (like online for-profit degree mills), but what’s driving this bubble is a Hobson’s choice: even if higher education is a scam, not having a degree looks like an even worse fate. Like housing, education is almost an economic necessity in our society. That is precisely why the housing crisis has been so virulent, and it’s why an education bubble is so troubling. What many commenters have found particularly ironic about this whole situation is the complicity of our most esteemed educational institutions in translating that necessity into massive profits and ballooning endowments.

Malcom Harris’s excellent article for the most recent issue of N+1, Bad Education, explores some of the bubble’s causes and the likely economic impact of its burst. This quote provides a helpful reference point:

Since 1978, the price of tuition at US colleges has increased over 900 percent, 650 points above inflation. To put that number in perspective, housing prices, the bubble that nearly burst the US economy, then the global one, increased only fifty points above the Consumer Price Index during those years.

The comparisons to the housing bubble don’t end there. As it did with housing, the government provides massive educational subsidies and tax-incentives. The federal government also provides massive education loan guarantees to primary lenders, which encourages bad (i.e. subprime) lending. In other words, banks have no incentive to perform credit evaluations on the students receiving the loan. Because of federal programs like the recently-discontinued Federal Family Education Loan Program (FFELP), banks face little risk when lending $240,000 to an 18-year with doubtful job prospects. Harris also notes that a secondary market in education loans has developed. Like mortgage CDOs and other mortgage-backed securities, Student Loan Asset-Backed Security (SLABS) make it possible to invest in a diversified pool of education debt.

So with all the pieces in place, what would a burst in the higher education market bubble look like? As students find their degrees don’t translate into jobs, they’ll eventually default and file for bankruptcy. Federal law prevents discharge of student debt unless the student can demonstrate “undue hardship,” an extremely difficult legal standard to satisfy. The debt could plague student borrowers for much of their adult lives, making it harder to go back to school, change jobs, get loans, and buy homes. Although, given the relatively small size of the secondary market in education debt, a financial panic is far less likely, a flood of defaults could strain the whole economy for decades. And with high unemployment among recent graduates, these effects are perhaps not far off.

One major difference from the housing bubble is that a flurry of educational defaults would not trigger a comparable problem in asset pricing. That is because the federal government has already announced, in law, how it would pay lenders if default rates get too high. So while students get stuck with a lifetime of debt, lenders have, in effect, a government insurance program. In the worst case scenario the lenders still get paid at least 75 cents on the dollar. For the larger economy, that’s far better than a bottomless hole. But a 25% drop in price could still potentially call into question the real worth of major holders of education debt and cause broader economic disruptions. In terms of moral hazard, this policy still puts taxpayers and students on the line for loans that probably shouldn’t have been made.

As in the housing crisis, this bubble is primarily squeezing America’s middle class. And while consumers may have appeared greedy in taking out subprime mortgage loans, it’s much harder to blame parents for sending their kids to college. Universities, creditors, and the federal government need to reassess how higher education is priced and financed in this country. Education debt should be dischargeable in bankruptcy. The government needs to figure out how it can stop guaranteeing loans for limitless tuition hikes without disproportionately impacting poorer applicants. Universities face perhaps the most significant moral hazards here. Schools need to reign in costs, and more fundamentally, they need to confront how their business model squares with their own mission statements.

Photo Credit: Peter Vanderwarker

Opening the Guantánamo Files

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This entry was originally written for the HLPR Blog: Notice and Comment.

On April 24, the Guantánamo files, a cache of leaked documents containing dossiers on 759 detainees were made available to the public via a number of major news outlets and through the Wikileaks website. The Obama Administration’s early response is available here. Both the revelations of the documents themselves and way the leak was published are proving to be fascinating and important developments.

The documents–memoranda from JTF-GTMO, the Joint Task Force at Guantánamo Bay, to US Southern Command in Miami, Florida–have revealed information on detainees, on U.S. information-gathering practices, and on the conditions at Guantánamo.

Among the revelations so far:

  • Many of the detainees at Guantanamo are “not dangerous.” Among the prisoners were a senile old man and a fifteen-year-old.
  • More generally, the military’s risk assessment methods have considerable flaws that have resulted in the release of many dangerous detainees while less dangerous detainees were kept.
  • As the Guardian described, “US authorities relied heavily on information obtained from a small number of detainees under torture. They continued to maintain this testimony was reliable even after admitting that the prisoners who provided it had been mistreated.”
  • Suicides are a regular threat and form of resistance at the camp.
  • The documents contain accounts of abusive and coercive questioning. (see for example the file on Mohammed al Qahtani).
  • The U.S. listed the Pakistani Intelligence service as a terrorist organization.

The actual leak itself is proving interesting in its own right. The New York Times reported last night that it had not obtained the files from Wikileaks but from “another source on the condition of anonymity” and would be sharing the files with NPR and the Guardian. Wikileaks, which had obtained the files from Bradley Manning, reportedly did not share the documents with the New York Times directly but proceeded to leak them on its own site and in conjunction with other organizations such as the Washington Post, Al Jazeera, and others.

In explaining why some news organizations were cut out of the loop, David Leigh of the Guardian had thefollowing to say, “This is all because of Julian Assange’s feuding with the Guardian and the New York Times, and what he’s decided to do now is cut us out of it and distribute the files to a range of right-wing newspapers, including the Telegraph.” Although the story is still unfolding, the relationships between organizations like Wikileaks and traditional media outlets are certain to carry serious implications for understanding how journalism operates. (For an excellent overview of that discussion see Yochai Benkler’s A Free Irresponsible Press: Wikileaks and the Battle over the Soul of the Networked Fourth Estate). As Glenn Greenwald remarked today, “WikiLeaks has generated more newsworthy scoops over the last year than all media outlets combined.”