The Market Ticker
Commentary on The Capital Markets- Category [Education]
2017-06-05 11:35 by Karl Denninger
in Education , 338 references
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It wasn't that long ago that I could resoundingly recommend that teens in the US who had an interest in any sort of "STEM" field go to college and get their degree.

I've not been able to make that argument for the "social arts" or the "liberal arts" for close to 20 years, but as recently as 10 years ago it was still an excellent argument, even at the inflated, debt-laden price, for STEM-related fields.

About five years ago I started to sound the alarm even in the STEM fields, as the offshoring and H1b abuse got bad enough that with few exceptions the risk had risen to unacceptable levels even in those fields, considering that your risk profile extends out at least four years from when you go to college and usually five or six.

Now, today, it appears I was right to be concerned -- and I can no longer make any sort of argument for post-secondary education at today's prices in the United States.

Monthly salaries plummeted 16 percent to 4,014 yuan ($590) this year for a second-straight annual decline, data from recruitment site show. The Ministry of Education estimates that 7.95 million will graduate this year, almost the population of Switzerland.

$590 per month?  That's about $7,000 a year folks.  Can you survive on that?  Nope; it's less than you'd make working part time in retail.

Now is there some "parity adjustment" for distance and putting the work over there?  Sure.  But how much?  Not six, seven or ten times as much!

That's the problem in a nutshell and it will immediately turn into personal financial suicide as soon as you take any sort of debt to attend school.

See, sunk cost is fine -- it's money you had, you spend it, and if there's no return on the investment (or one that's too small) you lose the investment but your future is not destroyed.

Do the same thing when debt is involved and you're done.

This country must pull the "federal financing games" out of colleges -- all of them, without exception, period.  That will force prices to collapse to what people can actually pay out of their pockets.

Learning is never bad but going into debt on a speculative bet when your competition makes 1/10th what you think you're going to earn is not only foolish it's downright suicidal and those who promote and promulgate such systems are defrauding you when they suggest that such is a "good investment."

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There's an interesting article in The Atlantic that contains a graph you should pay attention to:

This is the number of hours you must work at minimum wage to pay for a credit hour at Michigan State University.

In 1979 it was about 10.  Now it's about 60.

Note that a "full load" is generally considered over 12 credit hours per semester; let's take the minimum (you usually need 120 hours to graduate, so this would be a "five year" plan); this means you would need to work 120 hours (or about 10 hours a week) to pay for school while in school.  That can be done along with the academic load.  It also can be done during the summer. Note too that tuition is nowhere near the entire cost; the usual "all in" price is about double tuition expense, so you would need to work 20 hours a week to cover it.  Again, that's doable -- two 8 hour shifts on the weekend and an hour four nights a week, and you're good.

Today, at six times that cost, it cannot.

The conclusion, however, is backward:

Is it any surprise that so many students today are suckered into taking out non-dischargeable loans, in growing chunks, to pay for their bachelor's degrees?

Wrong answer.

The reason the price went up 600% is the availability of those loans.

That is, it was the financialization of education that made this possible, because it is through financialization that entities sit down and figure out exactly how much they can extract from others in a transaction, causing the price to rise right to that limit.  At the same time they lobby vigorously for "ever-easier-appearing" (but more-onerous in fact) terms that increasingly transfer the fruits of the result of whatever has been financialized from the buyer to the seller through that increased price!

The result of this paradigm and the unholy alliance between banks, Wall Street, Washington DC and the colleges themselves is that the marginal utility of college degrees for many, perhaps even the majority of students, is now negative.

Remember that the school, the lender, Wall Street and Washington DC do not care about individual outcomes.  They could give a damn about whether college is a good deal for you.

That is what happens when anything becomes financialized; the only metric that matters is the aggregate outcome for the financial chef; that is, his goal is to strip all but one penny of the benefit on average from the participants and keep it. 

The closer he gets to that goal the more money he makes.  He does not care about your outcome, only that in aggregate the pool of "buyers" keep just enough that the next group will come in the door.

In other words so long as they can point to a few rocket scientists that make $100,000 a year right out of school that you can only make $30,000 and leave school with $150,000 in non-dischargeable debt,  thereby virtually guaranteeing financial hardship if not outright bankruptcy, does not matter to them at all!

The colleges are not only aware of this they are willing participants in that they have their own finance offices that will help you arrange for your own fiscal destruction and, if they (or you) can talk your parents into it, theirs as well.

This must be stopped -- but until the financialization of education is reversed it won't be.  Until that day comes the best you can do is to take a long, hard look at the numbers and figure out how to get the education you want without taking any debt at all.  If that cannot be done given your specific set of circumstances then in most cases what you're proposing to do is objectively a bad deal.

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So by now you have three reasons to tell the college finance office to go blow a donkey when they "propose" that you go into debt to fund your education.  You can read them here, here and here again if you need to.

Now I'm going to give you the biggest reason of all not to do it, and it has to do with your personal wealth over time.

It's simply this: Statistically speaking you will never get rich working for someone else.

Oh sure, there are exceptions.  You might wind up working for the next Google before it goes public, and be far enough up the food chain that you get stock options and the company hits the home run in the public markets and those options vest and they're successful long enough for you to cash them out.

That's a lot of "ands", by the way, so let's put probabilities on it.

  • Working for the next Google: 1 in 10, if you work for a startup. 9 of 10 fail entirely.
  • Being far enough up the food chain to get a lot of options: 1 in 5, if you're high-skilled.
  • The company hits the home run: 1 in 10 again; from venture capital to IPO with nothing that blocks them in the middle somewhere due to a mistake.
  • The options vest: 75%, probably, provided you get the other three first.
  • The firm succeeds long enough to cash them out: Lockup periods and all, you know.  Maybe 50%.

So how's this work out?  .1 * .2 * .1 * .75 * .5 = 0.08% chance.

In other words, less than 1 in 1,000.

Still think this is a good path to getting rich?  Uh, no.

By the way, I still have some paperwork somewhere around here with a bunch of options that I was granted in a spin-off that ultimately did go public.  So I got 1-3, and guess what -- the firm failed anyway and thus the options were worth zero.

Oh well.

This, by the way, is why you never, ever count those options as part of your compensation when you're figuring out whether to take an offer in a non-public firm, even if it's planning to go public.  The odds are overwhelming that you have a nice small stack of pieces of paper with their highest and best value will be found in starting a campfire or your BBQ in a few years.

Now sure, there are exceptions.  Google has its share of millionaires, as does Facebook.  But remember that people win the Powerball all the time as well -- this does not make buying Powerball tickets a good investment.  In fact the lottery, just like options in non-public companies, are a stupidity tax to the extent that you actually expect either to be worth anything.

What options in non-public companies are is an incentive for you to work hard in an effort to make them valuable.  They do a very nice job of that, by the way, and my comment on the odds has nothing to do with whether they're proper to grant to people.  They clearly are, and they clearly serve a purpose, but the purpose isn't making you, the grantee, rich.  It's to do the firm's level best to spike your performance in your job to the maximum possible extent.

So how do you get rich?  You work for yourself.

Let me clue you in on a secret to working for yourself: It is utterly essential that your life overhead is as low as possible in order for you to succeed in working for yourself.

The reason is this: On average you will fail at least once, and probably more than once, before you succeed.  It is only through having a very low life overhead in the form of essential spending that you will personally be able to get through those failures without being rendered destitute, having creditors chase you, being thrown into the street or all of the above.

Don't be fooled either by the claim that you "have to" go to college to earn a good living.  That's a lie.  You can do a number of things that don't involve college yet make a darn nice living, and give yourself the opportunity for entrepreneurship.  How about plumbing or electrical work?  Both have no college requirement and reasonable apprenticeship or certificate requirements with you actually getting paid to learn the trade instead of the other way around.  There are dozens of others, from various forms of physical labor to intellectual labor such as web design, and the nice thing about all of them is that none require going into debt of any sort in order to gain the "first job", and most have a direct path into self-employment.

Now let's look at the economics.  Let's assume instead of four years in college you instead spend them apprenticing for electrical work.  Let's further assume you can make $15/hour doing so as an apprentice, then $25/hour once you have the certificate or license.  There are 2,000 working man-hours in a year, assuming 50 weeks of 40 hours and two weeks off for vacation.

So in the first two years you earn $30,000 each, and then $50,000 the next two.  You do not blow all of this on creature comforts nor do you go into debt.  Instead you stash 20% of your gross and live frugally.  In those first four years you have amassed $32,000 in savings and have no debt.

The college graduate, on the other hand, has $52,100 in debt and at the nice low current interest rates will be paying $522.35 a month on graduation.  The problem is that at graduation if he gets a $50,000 a year job he has $4,166 a month in gross income less the $522.35 in loan repayment, or $3,644.32 before taxes.

You, earning $50,000 a year at the same point in time, have $4,166.67 a month in gross income and no debt obligation at all.

Now let's assume two things: First, from that day forward you both live equally frugally and spend the same amount.  Second, the $32,000 the trade-follower amassed continues to expand.

Let's assume that inflation is 3%, or roughly historical averages (yes, that's 50% higher than Fed target, but it's reality over the last 50 years or so.)  Let's further assume you can earn 6%, or 3% after inflation, and that we will do so for 45 years before you retire.

That $32,000 the non-college-goer amassed turns into $440,467.55.

What's worse is that if you both live under the same standard of frugality from that point forward for the next ten years the non-college goer gets to add $6,268.20 to that balance every year for the first ten while the college graduate has to pay off the debt.

Now let's look at what happens.  The college graduate has zero saved at that 10 year point.  The non-graduate has $139,926.99, and both are living under the exact same standard.  The entire difference is the loan repayment the college graduate has to make.

Can he make this up over time with better salary?  Maybe.  How much does he have to make up?  More than you think.

Guess what happens in 35 more years?  The non-graduate has $1,075,490, and all of that is due to (1) living frugally during the four years while the college grad is in school and (2) socking away only the loan repayment he is not making during the next ten years.

By doing just those two things the guy who doesn't go to college has over a million dollars when he's 65.  Note that this is a quite-conservative set of assumptions -- if you can manage to get an 8% return (hint: not without a lot of risk you can't!) then that "nut" is over $2 million at age 65.

Note that neither of these guys stuck one penny in a 401k or 403b, or anything like it, from that 10 year point forward.  The college graduate is literally over a million dollars behind in retirement income at the point his student loans are paid off and he's also 14 years behind in contributing -- a crippling deficit that will require that he both make a hell of a lot more money and save more of it to catch up.

Now here's the other part of it.  Neither of these two guys will get truly rich doing this.  The college grad and non-grad will work for someone else and while both can find their way to retirement and be ok, neither is going to hit the jackpot and retire at 40 on this path.

And here's where the real bad news for the college guy who has to take out loans comes from.

During those first ten years the college grad can't start his own business because he needs that $500+ a month every month without interruption -- if he doesn't pay he's screwed, permanently.  There is no way for him to cut way back for the inevitable bad months while starting up a business where there is little or no income.

The non-graduate has the option at any point in time to split off from working for someone else, and after a decade or less he's going to be in a utterly excellent position to do so, assuming that he or she does good work.  And it is there, in entrepreneurship, that one finds the path to wealth.

Wealth, by the way, is not really about having a lot of money when you get to 65.  Wealth is actually about freedom.  The choice to change careers, to raise your kids and be there for their important times, to take a day or a week off when you want to, to "retire" at 40 and go do something else.  To have a kid that needs you there for him or her in some form or fashion so you back off on what you're doing and voluntarily accept far less economically for a while, because you can and in doing so you'll be ok. You can never do these things working for someone else; that set of options simply doesn't exist.

If you're a young adult there is one thing I will tell you above all else that will impact your economic success in life: Do not go into debt no matter how it's sold to you or what someone claims you can accomplish with it.

Either find another way or do a different thing.

How do I know this is utterly true and works?

Because I've been there and done that, both personally and in business.

That is, in fact, why I can write this column, and why you're reading it today.

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