Sound investment requires rigorous attention to fundamentals, primarily the cost and value of any given economic endeavor. While not every consumer is practiced in the requirements of accurate valuation—economic application aside, U.S. students as a whole are distinctly average in mathematics—the mechanics of valuation are routinely complexified, if not obscured, by the psychological haze through which the analyst, professional or otherwise, must pass. The task is not merely to adjudicate between numeric values. It is to navigate the gray terrain between dreams and reality.
The reality is one defined by return on investment and the sundry considerations such a calculation might include. The dream is the reason we do the calculus in the first place.
The American Dream
Taxi drivers, student borrowers, and those saving for retirement engage in their respective activities for a similar purpose. All are seeking, on some level, economic security in the form of income, education, or prospective future income. Success in that endeavor puts them in some way closer to that poorly defined, rarely achieved, and not uniquely American dream (for nearly everyone desires economic contentment). Given that some 80% of U.S. residents feel that “the American Dream” is beyond their reach, the noun dream is, perhaps, aptly chosen.[1]
Hitting the Road
The in-depth New York Times investigation into the market for New York City taxi medallions over the weekend is a fitting study in a dream deferred. Most of the city’s taxi drivers are immigrants, folks whose English is elementary but whose drive for a better life has found them behind the wheel in our nation’s most dynamic metropolis. An unglamorous profession, driving cab historically has been a rather reliable means of reaching a middle-class lifestyle.
Drivers can either work for a company or own their car outright. To enjoy the higher income afforded by the latter, however, drivers must own one of the coveted tin medallions New York City requires independent operators to affix to their cabs. But there’s a limited number of medallions available, making ownership the dream to which those willing to work hard aspire. But since 2002, the medallion price has been rising. From 1995 to 2002, the badge would set you back a pretty reliable $200,000. Since then, though, prices have quintupled, surging after 2010 and finally collapsing from $1,000,000 in 2014 back toward the $200,000 baseline today.
The story is one of uninformed borrowers, aggressive brokers, banks following the market, and millions made by everyone but the drivers. In addition to wildly inflated prices in the first place, double-digit interest—in an era of ultra-low financing costs—have left drivers’ liabilities unmanageable, leading some taxi owners to commit suicide. For many others, it has meant bankruptcy. While competition from Uber and Lyft have dominated the headlines, it has not been ride sharing that has most changed the economics of New York cabbies. Until prices peaked, it was certainly the dramatic increase in the cost of the medallions required to drive.
It is a testament to the trials of bubbles and being overleveraged—the unfortunate reconciliation between dreams and reality. Even in 2019, drivers with revenues of $144,000 annually can see take-home pay of just $17,000 after expenses and interest, the reduction of principle deferred to some other time.
Hitting the Books
A much greater amount of leverage has accumulated in the student-loan space, with total obligations nationwide currently exceeding $1.5 trillion. The college degree, like a taxi medallion or owning a home, is a means to an economic end, in addition to the real social and psychological benefits of a well-trained mind.
Since the turn of the century, there has been a change in the scholastic journey—the cost.
This is somewhat different from the price. Prices for a college education vary widely. The market is much more diversified than that of taxi medallions. Private, public, in-state, and out-of-state all carry different price tags, as do prestige, local cost of living, and even one’s major (STEM degrees can cost twice as much as those in the humanities).[2]
Further, the price of college has not risen quite as dramatically as some reports would indicate. It has increased faster than inflation but at a slower rate since 2008 than it had previously. We will consider only four-year public institutions here. They saw 4.1%, 4.2%, and 3.1% annual increases in inflation-adjusted dollars over the last three decades. Ultimately, the advertised price of a college education is today twice what it was 20 years ago. The realized price—that is the amount paid after consideration of grants, scholarships, and tax benefits—has risen apace, but it is likely less than one might think. For our public universities, the bill is $3,740 a year (list price is $10,230). Room and board runs considerably higher, around $11,000.[3]
Given the increased earnings, even at $40,000 a year, college is still a rational investment. The price, though, does not fully reflect the cost. Average student debt for the class of 2016 was north of $37,000.[4] The median borrower, though, racked up just $17,000 in debt.[5] The average total for the four-year public university was 25% higher at $21,250.[6] In summary, some students have a lot of debt. One-third, however, have none.
Taxi driving can earn a decent living, and college degrees can be wise investments. The “can” in those statements depends on the cost—of a medallion or an education.
The Dynamics of Debt
Debt costs a lot, even if the price is low. Coincident with the rise in college prices has been a decline in grants and state aid.[7] Debt has composed a larger portion of the financing. College attendance peaked in 2011, meaning the loans financing that bulge of millennials were issued at higher rates than we saw for the rest of the decade. Refinancing loans held by the government at lower private rates eliminates the opportunity for debt forgiveness.
Graduating into a depressed job market, many students deferred repayment, allowing the balance to grow.
Perhaps the greatest tragedy is the college completion rate. In 2011 some 30% of students admitted to college did not finish a degree. That jumps to 54% at four-year for-profit schools.[9] That is the definition of unproductive debt. First, there is much geographic disparity in this data. States with weaker economies, which arguably need more education the most, have some of the lowest completion rates.[10] Second, more spending does not necessarily improve the outcome, as demonstrated by the “noise” in the scatter plot below.
To be sure, policy from the late 2000s has accelerated the trend. In 2008, the cap on federal Stafford loans was raised from $23,000 to $30,000.[11] No effective safeguards were instituted to ensure that education they bought had the prospect of repaying the loans—or even understood the contracts they were signing. Such was the price of the college dream.
Common Ground
The bank that lent to the taxi driver says it was the consumer’s choice to finance the asking price of a cab medallion. Despite the lucrative fees, inflated interest, kickbacks for its sales personnel, and extraordinarily loose lending standards, the inability of the borrower to reliably service the loan implicates the cabbie, not the bank. Let us note, though, that such lending practices are illegal for consumer loans. Medallion loans, however, are classified as business lending.
This is somewhat similar to students finding themselves saddled with unserviceable debt loads given the salaries their degrees are likely to earn. A primary difference is that schools do not lend their students the money for tuition. The government does. This is only a minor difference, though, as many banks sold off their medallion loans before the bubble popped and garnered significant fees along the way for their participation. In the end, lending drove revenue for both the bank and the school. Those loans were assumed in pursuit of the American dream. Amid the dominance of that narrative, neither of our respective consumers properly valued what they got versus the reality of the obligations they incurred.
While it can be argued that these consumers should have properly estimated the end result of their economic options, it also is highly unethical for professionals with asymmetrical knowledge to willingly aid and abet such economic suicide.
The Retirement Gamble
The same is true in the investment industry. Since the advent of the 401(k), managing retirement funds has largely become the purview of the individual. Retirement is the quintessential capstone of the American Dream. If you work hard for 40–50 years, you can have your rest and relaxation, time with grandkids, and even the opportunity to be generous when you enter your golden years.
The gradual migration from defined-benefit, company-sponsored pension plans to defined-contribution vehicles has not been kind to the American worker. A 2018 Northwestern Mutual study concludes that 21% of Americans have no retirement savings. Another 10% have less than $5,000 in savings. Some 33% of Baby Boomers of retirement age have between nothing and $25,000 set aside.
Others have been more fortunate or diligent in their retirement preparations. The average retirement account has a balance of $103,700.[12] Actuarially, that’s still less than one-10th of what the median worker needs to save. This is the other side of the debt coin: insufficient savings.
Those who have managed to save, however, have not necessarily freed themselves from the pack. The dominant narrative in the investment space is “set it and forget it.” It is increasingly passive and valuation agnostic. The belief that prices will ultimately go up is not wholly different from the belief that the taxi medallion will in the end pay for itself or that the college education is worth its price regardless of cost.
This may be why Roth IRA accounts for individuals 65–84 years old are 63% invested in equities.[13] With safer assets offering historically low yields and the U.S. 10-year note, net of inflation, just skimming the zero-bound, it’s understandable that workers are reaching for higher returns. This is especially true as life expectancy expands. But the buy-and-hold strategy works only if you buy and hold—and do so long enough to realize both underlying economic growth and mean reversion of fickle investor sentiments. Vicious bear markets have a way of shaking such resolve, especially if the funds in question are as desperately needed as those for many retirees today.
Dreams are
captivating, inspiring us, but also distorting perspective. Mathematics
routinely offers a useful dose of realism. Working out the numbers, today’s
market is historically overvalued. Don’t pay a $1,000,000 for a token worth far
less, buy a degree that cannot pay for itself, or purchase stock priced well above
its intrinsic value. Reality, comfortable or not, is the surest road that might
lead to your dreams.
[1] https://www.cnbc.com/2017/09/19/less-than-20-percent-of-americans-say-theyre-living-the-american-dream.html
[2] https://www.insidehighered.com/quicktakes/2017/01/09/study-finds-variation-costs-different-majors
[3] Page 12. https://trends.collegeboard.org/sites/default/files/2018-trends-in-college-pricing.pdf
[4] https://www.forbes.com/sites/zackfriedman/2018/06/13/student-loan-debt-statistics-2018/#28a6827f7310
[5] https://www.pewresearch.org/fact-tank/2017/08/24/5-facts-about-student-loans/
[6] https://trends.collegeboard.org/student-aid/figures-tables/median-debt-institution-type-2013-14
[7] Page 3. https://trends.collegeboard.org/sites/default/files/2018-trends-in-college-pricing.pdf
[8] https://www.forbes.com/sites/prestoncooper2/2016/05/11/most-student-loan-interest-rates-fall-to-ten-year-lows/#7a53152d602b
[9] https://www.forbes.com/sites/prestoncooper2/2017/12/19/college-completion-rates-are-still-disappointing/#ce2315f263a3
[10] https://trends.collegeboard.org/student-aid/figures-tables/total-federal-and-nonfederal-loans-over-time
[11] https://www.usnews.com/education/best-colleges/paying-for-college/articles/2018-09-11/see-how-student-loan-borrowing-has-risen-in-10-years
[12] https://www.bankrate.com/retirement/average-401k-balance-by-age/
[13] https://www.cnbc.com/2019/03/20/baby-boomers-are-putting-their-retirement-savings-in-jeopardy.html