BUBBLY BOOKS: Is Education Overvalued?

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BUBBLY BOOKS: Is Education Overvalued?

by Vikram Mansharamani, PhD

College graduation is a time of great joy, of optimism, of forward-looking enthusiasm.  Indeed, the very term “commencement” implies a positive new beginning.  Unfortunately, this is not universally the case in America.  Many students this year will graduate with questionable educations and mountains of debt; as more students go off to college and borrow money to do so, student loan debt in the United States is likely to top $1 trillion this year, exceeding credit card debt for the first time in history.

Might our strong belief in the value of an education be misguided?  Is higher education in America a bubble about to burst?  As a student of booms and busts, I have developed a framework for identifying unsustainable price dynamics, which are as applicable to higher education as they are to tulips, Japanese real estate, and Internet stocks.

Two primary dynamics seem to telegraph bubbly price action regularly through history’s great speculative eras.  First, an unquestioning faith in the asset’s value leads to an ever-increasing universe of buyers, despite price increases.  Second, the availability of “easy money” or “loose credit” is often driven by policies that generate significant moral hazard.   Higher education in America today exhibits both of these warning signs.

The argument in favor of education is based on average salaries for differing education levels, and on the surface, the numbers are compelling.   According to data from the U.S. Census Bureau, average earnings in 2008 for those with an advanced degree were ~$83,000, compared to ~$58,500 for those with a bachelor’s degree.  This compares to high school graduates’ average salaries of ~$31,250.

Recent research from the Pew Research Center provides confirmatory data in the unquestioning faith in the value of an education: 94% of parents with children under the age of 17 indicate they expect their children to go to college.  There is a broad universality of this view, with 93% of parents who did not graduate from college and 97% of those who did subscribing to this aspiration.

Despite these responses, only 5% of those surveyed by Pew indicated higher education provided excellent value for the money (57% say it does not even provide “good” value).  Further, a college degree ranks fourth (work ethic, social skills, and technical skills all rank higher) in terms of perceived life success factors.  Enrollment data does not reflect this concern.

The number of American college students has risen from approximately 9 million in 2009 to approximately 13 million over the past ten years.  Enrollment in the for-profit education sector has been particularly brisk, rising at multiples of the overall higher education growth rate, with 2009 enrollment growth in the 20%-25% range.  Marginal students have been wooed by this sector and have sought education in droves.

TOTAL FALL FULL-TIME COLLEGE ENROLLMENT IN AMERICA
(Source: College Board, Trends in College Pricing 2010, Figure 17a)

During that same time period, the price of a college education (i.e. tuition) has risen faster than inflation.  Tuition and fees at public, four-year institutions have risen on average at 5.6% per year more than inflation over the past decade.  While private college tuition has risen at a less dramatic rate (~2.5%-3.0% more than inflation), it was significantly more expensive to begin with.

Increasing participation of price- and value-insensitive buyers, check.

In its noble quest to provide educational opportunities to all Americans, the Department of Education has administered over $500bn in federal financial aid to students seeking post-secondary education over the last five years.  For the academic year 2009-2010, the College Board estimated that total federal aid was approximately $147bn, a 136% increase over the past ten years, a growth rate faster than either enrollment or price increases might explain.

TOTAL FEDERAL FINANCIAL AID ($MM)
(Source: College Board, Trends in Student Aid 2010, Table 1)

The securitization market has fueled this development.  Just as mortgage backed securities enabled rapid growth in housing finance, so too have student-loan asset backed securities (SLABS) enabled rapid growth in education finance.  The dollar value of SLABS grew from approximately $76mm in 1990 to over $2.6 trillion by 2007.   SLABS are deemed by some investors to be government sponsored securities (Sallie Mae played a major role in enabling this market) and due to the full recourse nature of student loans (i.e., filing bankruptcy does not eliminate them), many investors believe the risk of loss to be small.  The rapid and brisk lending pace has enabled even marginal borrowers to obtain education loans without question.

Evidence from the for-profit sector is particularly concerning.   Despite low completion rates (less than half of students who start finish their program), many for-profits receive close to 90% of their revenues from government financial aid sources. From 1987 through 2000, the industry received federal financial aid (Title IV funding) of between $2 and $4 billion per annum.  In 2009, the industry received over $21 billion.

Easy money supported by moral hazard, check

One of the philosophical underpinnings behind the US housing bubble was the belief that all Americans should own their homes, even if they borrowed to do so.  A similar philosophical belief has taken hold in higher education.

An increasing percentage of graduates are finding themselves burdened with student loans upon graduation; less than half of the graduates in 1993 received loan repayment coupons with their degrees.  In 2008, more than two-thirds graduated with loans, having borrowed double what their 1996 counterparts did.   Almost 50% of those with student loans indicate repayment makes it hard to make ends meet, and around 25% indicate student loans impact career choices and delay the purchasing of a home.

Parents, students, bankers, investors, and policymakers alike should reconsider the value of education and ask the uncomfortable but critical question: Is higher education an overvalued asset?  Much of America has come to question the value of $1,000 per square foot homes.  The time has come to reconsider the value of $1,000 per week education.

Vikram Mansharamani, Lecturer at Yale University, is the author of the recently released Boombustology: Spotting Financial Bubbles Before They Burst (Wiley, 2011).  He has been an active participant in the education bubble, having acquired a bachelors degree from Yale University, two masters degrees from MIT, and a PhD from the Sloan School of Management.

Boombustology and Value Investing: Why Context Matters

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Boombustology and Value Investing: Why Context Matters

By Vikram Mansharamani, PhD

As one who has fought with global equity markets during the past 20+ years, I remain confused by the typical value investor’s belief that “top-down” issues are not worth contemplating. Why is it that Graham and Dodd investing (as practiced by many value investors) downplays the role of context in the investment process? Wouldn’t the prudent investor want to understand risks and uncertainties relating to the environment in which he/she is investing?

Perhaps because I have spent a great deal of time investing outside of the United States, I have never had the luxury of dismissing macroeconomics, politics, or the actions of other investors. Consider Indonesia before and after the Asian Financial Crisis. Investing in the best companies at reasonable prices did not protect you. The utter bloodbath in the currency markets destroyed dollar returns. Likewise, many value investors faced steep losses during the second half of 2008 and the first quarter of 2009. Herd behavior and self-fulfilling dynamics unfortunately drive these dynamics.

Most of the time, Third Avenue’s Marty Whitman is correct that macro-factors are neither predictable nor important. However, this is not always the case, and just as extreme valuations merit attention, so too might macro extremes matter. How can we value investors effectively determine if we are at an extreme, and should therefore worry a bit more about the context? Surely it is worthwhile to know if a particular asset class is a bubble about to burst. Such an insight might allow us to tilt the balance of the errors we inevitably make towards errors of omission, rather than those of commission. While we may miss gains, we might avoid painful losses.

I have developed a five-lens framework for identifying financial bubbles before they burst. The first lens is microeconomics. In direct contrast to established economic theories of equilibrium, there are occasionally times when higher prices generate demand (rather than, or in excess of, additional supply). Such conditions are particularly prone to self-fulfilling dynamics likely to create bubbles.

The second part of my framework focuses upon credit conditions and the cost of money. While First Eagle’s Jean-Marie Eveillard has rightly highlighted the dangers of using leverage for investors, the same concern is valid for an economy in aggregate. If the foundation of prosperity is built on borrowed funds, it is only a matter of time before instability ensues. One of the primary culprits of such excessive borrowing can be found in overcapacity/malinvestment.

The third lens in my framework is psychology. We humans are unfortunately not the strict, economic-optimizing agents that social scientists might model us to be. We are plagued by cognitive biases that manifest themselves in overconfidence and anchoring upon irrelevant numbers. One of the best indicators of hubris is found in the phrase “world record price.” Whether paid for a building or a piece of art or a bottle of wine or a commodity, such prices are usually a sign of speculative juices running wild.

Fourth, political developments matter. Governments (particularly democracies) are subject to popular sentiment and as such, are willing to change the rules and/or generate moral hazard by bailing out the least prudent of market participants. Price distortion and politically motivated subsidies, handouts, and taxes can also alter incentives in a dynamic manner.

Finally, popular sentiment and herd behavior can affect securities prices more dramatically and potentially for longer than fundamental developments might. As such, understanding the actions of others and linkages to relevant markets has the potential to shed insight upon contagion risk.

In aggregate, these five lenses provide a probabilistic framework for increasing the odds of accurately identifying bubbles before they burst. Consider the case of China today. Let’s apply my five-lens framework to China.

China today exhibits many of the tell-tale signs of a great speculative mania. Higher prices in many of its asset markets are generating demand more rapidly than supply. Consider property markets in which leverage and prices seem to be rising together in a highly reflexive, self-fulfilling manner. Higher prices are generating demand more rapidly than supply. The cost of money is inappropriately cheap, driving mal-investment and creating overcapacity. Ghost towns and vacant malls are increasingly visible manifestations of this problem. Confidence is bubbly, with skyscrapers rising, art markets booming, and conspicuous consumption on the rise. Chinese buyers have set world record prices for art, wine, pigeons, and even dogs! Moral hazard runs rampant, and national-provincial dynamics are generating GDP growth through unnecessary construction. Perfectly usable infrastructure has been destroyed and rebuilt in pursuit of GDP. Finally, amateur investors seem ubiquitous, and the largest developers today are state-owned enterprises using money from state-owned banks to buy land from the state.

Clearly, the ramifications of a Chinese slowdown would have material impacts upon commodity markets, emerging markets, and even the S&P 500’s business and earnings mix. In short, how China goes, so goes the world economy. It seems highly imprudent for investors to not consider the possibility of a meaningful slowdown in China’s economy.

I am not suggesting that we value investors abandon our focus upon the analysis of individual securities. We should not. Finding margins of safety from intrinsic values remains the most sensible method of investing. I am merely suggesting that when we do invest, we should be cognizant (rather than dismissive) of the environment and context in which we are operating. As eloquently summarized by Seth Klarman, we should all “invest bottom-up, but worry top-down.”

Vikram Mansharamani, PhD
Vikram Mansharamani is the author of the recently released Boombustology: Spotting Financial Bubbles Before They Burst. He is a global equity investor based in Boston and has taught a popular seminar called “Financial Booms and Busts” at Yale for the past two years. More information can be found at http://www.boombustology.com

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