Student Loans as the New Indentured Servitude

(Cross-posted at The Atlantic Business Channel. Picked up at Huffington Post, where, given I’m still figuring out what I think about the issue, it’s something to see 300+ comments personally and strongly reacting to the topic.)

From The Wall Street Journal, The ‘Democratization of Credit’ Is Over — Now It’s Payback Time. Check out the lead:

NEW YORK — Karen King owes nearly $36,000, more than she’s ever earned in a year.

All day long, bill collectors call. She hunts for a second job, sometimes skips meals, and stays with other family members at a grandfather’s crowded apartment, trying to get out of debt and turn her life around.

She largely holds herself at fault. “Years ago, I lived for now. It was so stupid,” the 28-year-old says. “It’s depressing, but I can’t live that life anymore.” Now, she says, “I basically want to live for the future.”

Now go about halfway through.

Her biggest chunk of debt, $26,000, stems from student loans to pay for her two-year associate’s degree from a community college — loans now in the hands of collectors. The remaining $10,000 or so includes old credit-card balances, debt to a store that rents furniture, utility bills and back taxes. Another obligation is $400 a month she contributes to the rent on her grandfather’s two-bedroom apartment, where her mother, uncle and sister also live.

Rolfe Winkler caught this too. In addition to pointing out how the current recession is focused in large part on men, it’s also worthwhile to note that the current recession is devastating the young. Here’s BusinessWeek on “The Lost Generation.”

But let’s go back to the person in question here: How should we judge this young person profiled in the Wall Street Journal? Is going into a large debt load to pay for college the post-Risk-Shift American Dream? Or is it a form of Living For Now, and being irresponsible and short-sited? According to FinAid.org, the average cumulative debt among graduating seniors is about $22,500. She’s ahead of that ($26K/2 years), but what is an acceptable amount of debt to carry to educate yourself? As as Krugman notes, education is a key to our country’s successes. Why should we think of her as irresponsible, instead of someone rationally going into debt peonage, like a 17th century indentured servant, in order to take a small shot at bettering oneself – the new middle class dream?

The New Indentured Servitude

Jeffrey Williams, in Dissent Magazine, wrote Student Debt and The Spirit of Indenture, in which he provocatively referred to student loans as the new form of indentured servitude.

Why is this the new form of indentured servitude? Williams gives some reasons: The prevalence of this debt, especially among the young and the poor/working classes, the transformation from a rounding error amount to a significant burden amount over the past 30 years, the length of term, the idea of mobility and “transport” to a job, debt secured not by property but by personhood, and limited legal recourse. All these characteristics are similar. The limited legal recourse is noteworthy here, since unlike most debt, it isn’t dischargeable under bankruptcy, thus it doesn’t have a natural protection for the consumer receiving credit (a protection, the original synthetic put option, that our Founders were aware of enough to make sure it was provisioned for in the Constitution).

This is not to soft-peddle indentured servitude. Indentured servitude was a violent contract, with physical torture used to coerce labor. As economist DW Galenson noted, “The Company clearly felt that [beaten workers running away] threatened the continued survival of their enterprise, for they reacted forcefully to this crime. In 1612, the colony’s governor dealt firmly with some recaptured laborers: ‘Some he apointed to be hanged. Some burned. Some to be broken upon wheles, others to be staked and some to be shott to death.'” But let’s put on our Galenson Economic Historian googles and think of it as an economic efficiency problem. Indentured servitude, like student loans, are a form of consumption smoothing. And one thing that is needed for consumptions smoothing is good information about the future.

Learning Your Earning

Here’s a graph from University of Minnesota macroeconomist Fatih Guvenen’s Learning Your Earnings:

Think of these two lines as a dial between perfect knowledge and no knowledge. In this model, a consumer who knows what he’ll make over his or her life will consumption smooth (perfect, or ‘full’, knowledge, flat consumption line); one who is uncertain about what will happen next will rationally not. So if you know exactly how much you’ll be making in the future, large loans aren’t really a problem.

Now we are currently asking children, 17, 18 or 19 years old, to try and assess how much of a student loan debt burden they can handle vis-a-vis their future income over their entire lives. But, especially compared to their grandparents, uncertainty is so much greater now. The consumption smoothing line invokes a world where everyone with a college degree will get a stable, solid job with certainty (and your employer will, of course, pick up the health care tab).

The person in the Wall Street Journal article almost certainly had no realistic idea for what would be awaiting her on the other side of the associate’s degree, and she misjudged this terribly. And, from an efficiency point of view, it’s what makes this more perverse than the indentured servitude contract – people under indentured servitude had the job waiting for them. The clock was ticking for the firms who had set up the contract, and they needed to get their value. With student loans, they can sit there for decades, never dischargeable, always getting paid regardless of recession or job market.

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17 Responses to Student Loans as the New Indentured Servitude

  1. Mitch says:

    To many 17-, 18-, and 19-year olds, the debt amounts to funny money. Most teenagers have no real concept of anything beyond a few thousand dollars (whatever they earned working summer/after-school jobs in high school) and thus don’t understand what the burden of $20k or more in debt will be. “I’ll have to pay back $400/month? But I’ll be earning $3,000 pre-tax? No problem.”

    • chrismealy says:

      There are plenty more youngsters who don’t ever apply to college because they can’t imagine that they’ll ever pay off $30,000 in debt. Doing finance ain’t easy either way.

      I have an idea — instead of financing with debt you could finance with equity. If your investment in education is a winner, you repay back the lender with a share of your gains from the investment. Let’s call the lender “society” and the share of the gains “taxes.”

      • Thorfinn says:

        Milton Friedman came up with this idea a few decades ago, and Australia has implemented a version of this. It makes a lot more sense than handing out cash to people for making an investment which will pay off millions over the course of their lives, out of taxes levyed on everyone, including the poor.

  2. The latest JOLTS report had some interesting information in it. CR had a great chart

    http://1.bp.blogspot.com/_pMscxxELHEg/Ss9hzvGhqiI/AAAAAAAAGh8/Fd8ZEMIV8D4/s1600-h/JoltsAugust.jpg

    Looks like turnover is falling in general which would be dire news for college graduates especially when coupled with job offers being the lowest in the [brief] history of the data. This would lead one to believe that everyone with a job is hunkered down, thus no “normal” cycle of advancement of personnel opening up entry level positions for new talented bachelor and master degree holders.

    I know quite a few MBAs who are tending bar or waiting tables holding onto +100K in debt. They undertook the MBA and the debt because they were going to work for McKinsey or Goldman after their two-year odyssey of PowerPoints on Synergy.

    I read that article too this weekend, it appears that the young woman in question more than likely could landed her current position without having incurred the 26K in debt, as could my friends mentioned above. Looks like a bum deal now, but I guess only time will tell…

  3. Eric says:

    The Government fosters this…continually pass all manner of tax credits, loan supports, etc which feed through nearly-instantaneously to higher tuitions and result in higher debt loads. Education mortgages. Congress can’t get enough of this and will undoubtedly go ahead and do it again/make it worse just like they are right now with Fan/Fred.

  4. Dismal says:

    It amounts to a strong control mechanism, just like indentured servitude. “An education” is now required for even the lowliest of jobs so more and more people are forced to take on a ludicrous debt burden that they are told they will be able to pay off using “their education” (mostly a piece of paper that will be unrelated to any task performed by the person), even if this isn’t exactly true. It creates an atmosphere of uncertainty and desperation which makes for a very malleable general populace.

  5. Donald A. Coffin says:

    Where the bloody hell did she earn here Associate’s degree??? In Indiana (where I live and work) tuition for a full-time student for a two year degree would be about $6,000 (5 courses per semester). At $250 per course for books and supplies, another $5,000. Getting up to the $26,000 debt, that would leave $15,000 for other expenses. If you borrowed to finance your living costs during that two years, that’s one thing. But maybe not so smart.

  6. Ed says:

    But if people don’t graduate under a mountain of debt, how will employers be able to treat them like dog shit with no fear that they’ll quit and necessitate training a replacement?

  7. Taunter says:

    Great post, and well-deserved acclaim from the HP crowd.

    I would suggest that there are two things going on here:

    (a) Law of Unintended Consequences. The government has done its level best to subsidize education without doing anything to impact the pricing power of the schools. If the maximum a student can afford is x and the subsidy is y, the school simply charges (x+y), where it previously would have been limited to only x. The resulting real escalation in education pricing has done serious harm to recent graduates’ freedom.

    (b) Education as Experience versus Education as Skill. Unlike almost every other nation on earth, we sell post-high school education as an experience. The dream is to go to a school with a pretty campus and a fight song to sing at football games, to spend The Best Four Years of Your Life growing as a person. Doesn’t matter if you study Sanskrit poetry or mechanical engineering; just go. Even community colleges are sold on the idea that it’s a way to bootstrap your way into another social class. There is something deeply human about this – the need for a threshold experience – and time is more scarce than money, so I would be loathe to oppose it. That said, it does mean that people spend enormous amounts of money on a process that does not necessarily leave them with employable skills on the other end, at least in a poor employment market.

  8. ohwilleke says:

    There are a few more important aspects of the deal that bear mentioning. Student loans typically have far more generous deferment and reamortization options than other loans, in part, because they can’t get blood out of turnip. Some even have an income contingent repayment option. Amortization is ten to thirty years. One can dig out.

    I speak from experience. I finished my education in 1994 and I’ve had to defer them in a period of post-graduatation unemployment. My employer lost his biggest client a few weeks after I started working for him and it took a while to find a new job. While I’ve paid more than 90% of the very large loan, I still have some amount left owing fifteen years later. I could have pressed myself financially to pay this loan off faster, but at a tax deductible 3.35% fixed interest rate and very low monthly payment, other obligations are a higher priority.

    Legislation is also in place to allow loans to be forgiven after a decades of non-payment.

    The theory is that the asset you have received (education) is one that can’t be reclaimed by the creditor the way a car or house could be except through your lifetime earnings, which are the basis upon which the loan was made.

    Karen King will probably ultimately increase her future income enough to pay for her degree, and will probably get a job faster than her peers without jobs. After all, her investment did produce an associate’s degree which does have economic value. Lots of newly minted associate’s degree students have $26,000 of loans, and $10,000 of credit card debt, while bad, isn’t an inherently insurmountable sum, particularly when she has no one to support but herself.

    Her big problem is that she is unemploymed in the midst of the worst job market in her lifetime, and is not married to someone who is employed either. She’d be in no better position to pay if she’d been much more thrifty and limited herself to $3,000 of credit card bills. These kinds of debts that she has are tolerable if you have a job, but even without the student loans, her life would be pretty bad with any significant credit card debt and no job.

    While student loans as indentured servitude is an interesting story, credit cards and home equity lines of credit as unemployment insurance may be the more timely issue.

    The real losers in the student loan world are not the Karen Kings fo the world who incur the debt while getting a degree, but those who flunk out from private schools that often don’t offer creditable programs. They have the debt but not the intangible asset that was supposed to make it possible to pay back the debt.

    Of course, a debt obligation like student loans isn’t the only way to finance education. Many countries in Europe have free tuition and open admissions — and large numbers of students with no direction in life who are only slightly engaged with their studies and do miserable academic work. Australia has an option of going to school tuition free in exchange for a small lifetime tax on their earnings.

    • Chris says:

      Many countries in Europe have free tuition and open admissions — and large numbers of students with no direction in life who are only slightly engaged with their studies and do miserable academic work.

      Those people should be flunked out — unlike an American university, a European government-financed one isn’t dependent on keeping students around so it can keep collecting money from them. (If it runs with balanced books, the payment received from the government for one more student is equal to the cost of having them around. The government, meanwhile, has an incentive not to pay for “educations” that aren’t educating anyone.) They can come back in a few years if they’re ready to be serious (and if the degrees are really useful, a few years of working without one might produce that seriousness — don’t worry, this is Europe, there’s a decent minimum wage and other social safety nets, so they’re not going to starve or anything). Taxpayer-funded career counseling would be dirt cheap and potentially useful to such people, if you could find a good way to steer them to it.

      Free tuition (i.e. tax-financed) is a good idea, but open admissions not so much. They should at least screen for willingness to take the educational process seriously, otherwise it is so much economic waste.

  9. crack says:

    Generous deferments? They are mostly government guaranteed, they let you defer because they get more government guaranteed money at a ridiculously high rate for a risk free loan.

  10. Pingback: College and Debt « Taunter Media

  11. Matthew says:

    Too many people feel screwed. I felt screwed when I had debt. I didn’t blame Sallie Mae! There does need to be “advisors” for students who get between the student, loan officer, and student advisor. Someone real who has the students interest on top.
    Sure, S&M is corrupt to the max! They didn’t make students sign, only contributed to the brainwashing that everyone needs college.

  12. Jack says:

    Really think it out before going to college. Are you better off with a styling Masters Degree and a lifetime of debt than working for 10-20 bucks a hour without debt? Sorry, the second choice does not have a styling title! You probably won’t be able to pick up the “smart” chicks with the Masters degrees. Too bad!!! Can you ever live with yourself if you are an average person? Sure you can! Believe me, these people with syling jobs don’t own their homes…the banks do!
    Be easy with yourself and your expecations. You can do just fine without taking on debt. College does not have to be completed in 4 years. If you decide to go, try to do it without loans! Don’t be knocking up someone or getting knocked up while you are in college because you may end up having a sad story to tell like the others who somehow have 2 kids, no husband, a mound of debt and so on. It sucks for them but it doesn’t need to suck for you!

  13. Brian says:

    College or university students as well as parents just about everywhere are undoubtedly desperate for alternative “money means” to allow for advanced schooling. Now, with interest rates going up all over again, it’s tough to search out what exactly is working and what isn’t. College credit cards can be one way to aid in the preparation. Not merely will these cards provide for some necessary extra cash but can teach and develop financial and more over, personal obligations for the future.

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