It may not come as a surprise to you that President Biden’s debt relief program for students is coming under scrutiny. What likely will surprise you is the degree and range of the program’s short-sightedness and its myriad dubious goals.
Our friends at First Trust Advisory have looked into this and have written their comments. Hopefully, you will find them interesting and useful.
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
The Dow Jones Industrial Average fell more than 1,000 points on Friday (8/29), caused apparently by Fed Chairman Jerome Powell’s attempt to use a brief speech to channel the ghost of Paul Volcker. Obviously, this was part of the market’s worries, but the stage was set when the Biden Administration announced a student loan forgiveness program last week. The more we learn about this, the worse it looks.
The executive order would send an already very bad student loan system – a system designed more to create jobs for academics than to really help students – into overdrive, generating huge costs for taxpayers, soaring college prices, and a massive shift in resources toward the already bloated college sector, which already generates negative marginal value-added for both students and our country.
The Biden Administration says the changes would cost $240 billion in the next ten years. The Committee for a Responsible Federal Budget says $440 – 600 billion. A budget model from Wharton says $1 trillion. But even that $1 trillion figure might be way too low.
The key is that, as bad as it is, the cancellation of some student debt that already exists is only a small part of the policy change. The much bigger change, and the one that the market has finally begun to absorb, is limiting future payments on debts to 5% of income, but only after the borrower’s income rises above roughly $30,000 per year. For example, if someone makes $70,000 per year, then no matter how much they borrow they’re limited to paying $2,000 per year (5% of the extra $40,000). After twenty years, any remaining debt would simply disappear.
Think about the perverse incentives!
For the vast majority of students, choosing this “income-based repayment” system would be a no-brainer. And once they pick it, they wouldn’t care at all whether their college charges $35,000 per year (tuition, room, board, and fees), $85,000, or even $150,000. In fact, students would have an incentive to pick the priciest college with the best amenities they could find and pay for it all with federal loan money, because their repayments are capped. If you always wanted Rodney Dangerfield’s dorm room from the movie Back to School, you’re in luck!
Meanwhile, students would have the incentive to take out loans greater than what they need because they can turn the excess into cash for “living expenses.” Then they could use it to buy crypto, throw parties, or pretty much anything else. Who cares?!? The government would limit their future repayments.
And here’s what might be the worst part: colleges would have an incentive to enroll students even if they have horrible future job and earning prospects. By enrolling people no matter how poorly prepared they are, a college can charge whatever they want and get huge checks from the federal government. And the unprepared students won’t care because they really don’t have to pay it back. In effect, colleges could create massive and perfectly legal money-laundering schemes.
We are not legal experts and do not know whether the new proposal will be implemented fully. But, if it is, watch out: college costs are poised to skyrocket, and academia is courting a political backlash of enormous proportions. Meanwhile, the market is attempting to digest just how far from economic reality politicians have become. The political allocation of capital is a recipe for economic disaster.
Ron’s Market Minute – A Couple of Reminders
As markets continue to be volatile, it’s often a good idea to look at general market behavior, rather than looking at small chunks of market behavior.
So, first a reminder from Jeffrey Hirsh, the publisher of the Stock Trader’s Almanac. (By the way, the Almanac is one of the largest collections of historical market data you might want to examine.) The month of September, in most years, is the weakest month of the market year. That does not give us any guarantees, but merely points to the historical fact that it’s pretty common for September to be weak.
And now a chart (of course!). Another well-known collector of historical market facts (trivia) is Ned Davis. From time to time his publishing company produces an S&P Market* Composite, in which he averages the data from a one-year seasonal market cycle, the four-year Presidential market Cycle, and the 10-year average market cycle. When those averages are compiled into one line — indicated by the blue line on the chart below — that line represents what could be considered an average market at this current point in history.
In addition to the blue line depicting the S&P Cycle Composite for 2022, Davis has added an orange line showing this year’s actual return result of the S&P return. As is common, the actual market returns are NOT exactly what the cycles would predict, however they are reasonably close – if not in magnitude, at least in direction. And this year’s chart shows a historical tendency for markets to peak in September, followed by a drawdown into October, and then (after the political ‘stuff’) a larger market rally into the year-end.
We do not know the future, but it’s encouraging during these volatile markets to note that the year (so far) seems to be following the historical precedent. We’ll see.
Ronald P. Denk, CFP®
Denk Strategic Wealth Partners
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