The WSJ is running a story saying the UK Treasury is going to announce a plan to force banks to separate their risk taking side (investment houses) from their safe and sound deposit (banking) side. This dear reader, is good news!
Of course, you might be saying – “wow that seems like a really good idea, why didn’t that rule exist before”? In fact, it is a really good idea and it did exist before. For it was from the very hard learned lessons of the Great Depression that such a good idea was born. An idea that helped keep our banking system safe, secure and sound for 80+ years. That is of course, until it was repealed!
Here are some highlights of what this will mean in the UK:
“The goal of ring-fencing is to insulate risky activities, such as trading, so that deposits won’t be put at risk by banks’ investment-banking operations. Proponents say it could also make a failing bank easier to unwind in a crisis. In backing ring-fencing, the British government is going much further than its counterparts in the U.S. and Europe.”
[sarcasm] Well that’s just crazy! Why on earth should deposit-taking banks that we trust to keep the foundation of the economy running (savings, checking, payroll, mortgages, ATMs, etc.) be prevented from making risky Vegas style bets on with our money?
“Mr. Osborne is also expected to reveal that he will require deposit-taking banks to hold additional capital, which could signal that the U.K. will go beyond tough new global rules on the amount of capital banks must hold to protect against losses—another example of how the U.K. wants to position itself as a leader on financial reform.”
[sarcasm] Again, this is just nuts! Do we really want our risk-adverse deposit-taking banks be on solid and sound financial footing?
The NIA definitely knows how to put together a solid video. They produced others in the past that are also worth checking out. However, it is important to take videos like this with a grain of salt. This video doesn’t totally cross the line, but definitely suffers from the same kind of one-sidedness that makes Michael Moore films so infuriating. The truth of the matter is that nothing is ever as black-and-white or as straightforward as potentially biased documentary-makers portray. Regardless, the video makes several good points and is worth a watch.
Here is a quick summary of what we found interesting:
Student loan debt now stands at $830 Billion in the US
The average amount of student loan debt of US students is $24,000 – but there are many students with hundreds of thousands of dollars
Colleges spend on average $14B a year in construction and campus expansion, and tens to hundreds of millions on sports teams, staff, etc. – Little of which actually adds to the value of the education.
Going to college no longer makes you “special” – of the 2009 graduating high school class, 70.1% enrolled in college.
Since, 1992, the US BLS reports that 60% of all college graduates have gotten unskilled jobs, or other jobs that do not require or benefit from a college degree.
The video provides a very interesting breakdown of the true cost of a college education which includes:
Supplies and books
Interest on debt
Regarding total cost: Their example for a 6 years of school, suggests an average total cost of $460k:
6 years at the average of $27,293 per year, increasing at the rate of 5.15% a year
$61,914 in interest on the loan debt
Lost income for 6 years at an average salary of $35,400 a year.
Law schools use misleading statistics like – 90% of our graduates find employment within one year. While true, this statistic includes those that got jobs at Walmart and in other non-legal professions.
Where the video gets a little silly:
Suggests that a high school student with $30k saved up for college would be better off using it all to buy physical silver than go to college — because the value of that silver will be enough to buy a median priced house in 4 years.
Suggests the mainstream media (MSM) is colluding with colleges to spread myths and hoaxes that benefit colleges.
One of the people interviewed suggests we may not have running water or other basic services within 4 years.
On more than one occasion alludes to or suggests investing a reckless amount of money in physical metals like silver and gold.
Regardless of where you stand on hyper-inflation and end of the world concerns, we would caution everyone about going crazy buying physical metal. Personally, I have done a lot of reading on the topic and think it is prudent to own at least some physical metal and by some I would suggest between 2% and 5% of your total net worth. Commodity prices can be very volatile (as we have seen in recent weeks with the price of silver going from 30 to 50 and back to 30 again). This means that if your net worth is $150k you should consider owning approximately $4,500 in precious metals. Consider using dollar cost averaging to dampen the effects of price swings. In this example, I would not buy 3oz of gold tomorrow, instead I would buy one today, one in 6 months and one this time next year.
One of the fundamental premises of Austrian economy theory is that markets must be free to allocate capital quickly and efficiently. When governments or central banks instead try to control or influence the allocation of money, no matter how noble a pursuit, results in larger, more complex and completely unforeseen problems. Call it the law of unintended consequences.
The problem with central planning, is that it generally indeed has the most noble of goals. Some recent examples of the last 50 years include:
Affordable housing for all / promote home ownership
Affordable education for all / promote higher education
This video, while a little dramatic, does a great job of highlighting these unintended consequences:
The general methods for central planning are financial incentives, or regulations. Focusing on financial methods, the government will either give you money to do something, give you money not to do something or penalize you for doing something. This can be found in the form of rebates, tax deductions, fees, penalties, criminalization, etc.
For this conversation, lets focus on the most common: giving or loaning you money to do something. One of the most common and obvious side effects of government influencing the public to do something is an increase in prices related to that service.
Here is an example we are all now familiar with: housing.
Over the years, the government did a lot to promote housing. This was undoubtedly done for both noble reasons (The American Dream, affordable shelter, supporting family structure, etc) and some more shady reasons (help builders, mortgage brokers and banks make a bundle in the process). Regardless of the reasons, the government did what it does best – it threw money at the problem, either via tax credits or subsidized loans:
Mortgage interest tax deduction
Property tax deduction
Home sale capital gains exception
Fannie Mae and Freddie Mac
Federal Housing Administration (FHA)
US Department of Housing and Urban Developer (HUD)
The result of all these incentives were obvious: as more and more people had more and more access to larger and larger sums of money via loans, etc., the price of homes increased. This is the basic law of supply and demand.
Education is no different. Just like housing, the government is encouraging and enabling the spending of money on education. Through various programs such as guaranteed loans through Sally Mae, grants, scholarships and more there are ever-increasing amounts of people who can spend ever-increasing amounts of money on education. The result is that prices rise.
It’s a vicious cycle:
Education is too expensive
Government provides loans so people attend school
The price of school increases as attendance grows
Education becomes too expensive
The government offers larger loans
The cycle continues…
The result: the cost of education rises faster than wages (people’s ability to pay) — and just about everything else for that matter. Because the price continues to increase, and the government and society continue to demand (and subsidize) affordability, the government creates an ever-increasing array of payment options. Including:
ESAs / Coverdell Education Savings Accounts – Like an IRA for education.
Education tax credits and deductions – If you spend more on education you can spend less on your taxes.
529 Plans – Because you can’t borrow enough, you should also be encouraged to save for college in a tax advantaged account.
Various Federal grants and financial aid programs – Loans aren’t enough, we can just give you some money.
Pre-paid Tuition and Guaranteed Education Tuition Programs – Lock in today’s prices by pre-paying for tuition. This is based on the premise that your state will make up the difference in the future.
Each one of these options all seem like a good thing. After all, who doesn’t want to promote education and helping people achieve their potential? But… take a look at what has happened to the price of education as all of these incentives influence pricing. The problem with incentives is that they focus only on enabling people to pay the rising prices, instead of asking why prices are rising in the first place. This madness is one of the reasons, I do not plan on “taking advantage of” my states GET or other 529 plans.
Here is a graph of the cost of a 4-Year college tuition, when compared to median household income and the Consumer Price Index (CPI):
As you can see, since 1977, the median US household income has increased by almost 3.6x, while the cost of education has increased more than 10X, thus the rate of “education inflation” is several times that of regular inflation. To enable this: government loans have filled the gap!
I think the fix to rising education costs and unaffordable education is for the government to simply stop “helping”, or at least help less. The easiest way to do this would be get rid of Sally Mae, or perhaps alter the way it works. The fact that Sally Mae backed loans (effectively all student loans in the US are Sally Mae backed loans), are 100% guaranteed and can never be defaulted on or discharged in bankruptcy is pure insanity. Essentially, student loans have zero risk to the agencies and banks that provide them and 100% risk to the students that take them out and the tax payers that fund them. Thus banks have no incentive to give student loans only to credit worthy borrowers, or at least borrowers whose education plan make sense (spending $150k to get a job making $35k for example does not make sense, especially if you could get a job making $30K without the education. You’ve just spent 150K before interest to earn an extra $5K per year).
Does this sound familiar? Do mortgage-backed securities, NINJA loans, To Big To Fail and the housing bubble ring any bells? Without risk, sanity is thrown to the wind. If risk was slowly and surely re-introduced to the student loan market the supply of new money would decrease, the demand for education would decrease and the prices would decrease, thus allowing more people to afford the education they want without the need for debt. And without an unlimited supply of applicants, colleges would have to become more competitive to command high education prices.
Much like the housing bubble, the education bubble is also plagued with consumers that have bought into the idea that education is worth the cost, no matter how high. And like the housing bubble, the risk of default is theoretically solely on the borrow — although waves of defaults would still wind up hurting the taxpayer. Many who borrow don’t know what it will cost to repay the loan, or even what their monthly payments will be, until the borrowing is already done. And without requirements to provide Truth In Lending disclosures, it’s incumbent on the borrower to figure it out — the lender doesn’t have to tell you.
On a final note, check out the following infographic that has been making its rounds on various PF blogs. It tells the history of students loans in the US, and might make you rethink the value of taking one out:
Of course, everyone knows that the US doesn’t have any money to pledge, but that doesn’t matter. We are after all running an annual budget deficient of over $1T on top of our $12T+ in outstanding debt; so what’s another $100M. It is in fact, nothing new for the US to live far, far above its means. What is interesting however is that China is living perfectly well within its’ means. Here’s the breakdown:
This is of course all funny money but look at this it this way:
US borrows $100M from “somewhere” (Fed printing arguments aside, it was probably China)
The Federal Reserve significantly scaled back the size of the capital hole facing some of the nation’s biggest banks shortly before concluding its stress tests, following two weeks of intense bargaining.
In addition, according to bank and government officials, the Fed used a different measurement of bank-capital levels than analysts and investors had been expecting, resulting in much smaller capital deficits.
The test itself (even in the more “adverse” scenarios) is not as stressful as thing already are ALREADY.
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