In Defense of the Indebted Kids

It’s graduation season again. Time to write about how totally screwed today’s college graduates are. They didn’t learn enough in school, certainly not enough about personal finance, they owe amazingly large amounts of money, and they have bleak employment prospects. (Note to college seniors: anybody over 30 who says they wouldn’t trade places with you is lying.)

This year, there is hand-wringing particularly over the debt part. Bargaineering asked last week if students should have credit cards at all. The credit card reform act passed by the House last week would ban the issuing of credit cards to those under 18. If that survives the Senate, it will mean that credit cards will join such things as alcohol that we expect young people to learn about on their own after they leave home. (Will there be big burly guys at the door of the bank checking ID?)

There can be no doubt that young people can do dumb things with credit cards. Nor do I doubt that they are more likely to do so than older Americans. In the immortal words of that guy who had the job before Obama “When I was young and foolish I was young and foolish.”

But when it comes to debt owed by college graduates, credit cards are a small part of the story. According to a recent study by Sallie Mae, the average credit card debt for a college senior is $4,138. I had a lot of trouble finding an up to date number for the average student loan burden, but in 2004 the roughly two thirds of graduates who had any debt owed an average of $19,202.

The deeply indebted early-twenty-something is almost a cliché of the personal finance world, particularly of the PF blogosphere. Often left unsaid in the many discussions of such situations is the implication that there is something terribly wrong with somebody so young starting life out so deep in the hole.

Of course, there are kids whose large debts are the result of foolish behavior that should be regretted. (And I am not excluding loans for tuition from this. College degrees are often, but not always, a good investment.) And there are some incredibly extreme cases out there. Free Money Finance ran an email from a 23 year-old who owed $265,000 the other day.

But big picture, and in general, I believe that starting your working life in debt is the natural, logical, and appropriate thing.

Suppose that you were a very precocious and Type A college freshman. Using your university’s economics library you work out a very detailed projection of your future earnings each year until retirement. And suppose that projection said that you would make almost nothing until graduation, a little more than nothing after graduation, steeply increasingly more through your twenties, and then about the same, perhaps with modest increases over inflation, from your mid-thirties to retirement. That’s a reasonable description of a lot of careers.

Now suppose that, being very Type A, you decided to plan out how much to save and how much to spend each year for the rest of your life. Would you decide to spend 90% of your income in every year until retirement, so that your standard of living started out destitute, was very comfortable just before retirement, and became modestly comfortable after retirement? Or would you decide that you would be much happier trying to maintain approximately the same standard of living throughout your life? If you were rational (in the economist’s sense of the word) you would choose the latter.

Maintaining the same standard of living throughout life means borrowing significantly in the early years, barely making any dent in reducing that burden until early middle age, and then paying it off and saving for retirement in the peak earning years. That’s obviously very abstract, and the real world has all sorts of complicating details, but as a general principle it makes rational sense as a lifetime plan for spending and saving.

Which is why I get very uncomfortable whenever anybody suggests a generic target savings rate. In my view, saving nothing at all as a 25 year-old may be fine, but saving 25% as a 55 year-old may be too little.

College graduates enter the adult world with debt, sometimes a lot of it. Of course they do. They’re supposed to. I’m not sure that I would switch places with the guy $265K underwater, but I’d think about it.

[Photo: Kit]

Credit Cards | Frank Curmudgeon | May 5, 2009 10:00 am

210 Comments

By Ryan, May 5, 2009 @ 10:18 am

You make some interesting contrarian points, but I disagree with a good portion of them.
Specifically, I would NOT want my lifestyle to be exactly the same from 22 through 65. From a social and psychological perspective, that would give me nothing to look forward to or anticipate. For most wealthy and successful people, happiness isn’t in the attainment of material goods, it’s in the pursuit of them.
From a financial perspective, it’s an even worse idea. It costs money to finance a lifestyle that you can not afford at the moment. This money that your hypothetical young adult is spending simply to service the “lifestyle debt” is ultimately money that he or she is not using to actually build a better lifestyle. So even excepting all the extraneous factors you excepted, the logic in your post would inevitably mean that the highest lifestyle achieved by this person would be lower than that which would be obtained by his more frugal counterparts. Of course, he would obtain this more meager lifestyle earlier, but what fun is that?
By ObliviousInvestor, May 5, 2009 @ 10:56 am

I’d agree that a college degree is generally a good investment. And I’d agree that standard-of-living-smoothing is at least a reasonable way to go.

Here’s my question though: What’s the IRR on the extra $100,000 spent on on a $200,000 degree vs. a $100,000 degree? (I’m assuming that the more expensive degree provides for a greater income level after graduation.)

Is it decent? Is it excellent? Is it awful?
By ObliviousInvestor, May 5, 2009 @ 10:58 am

Quick addition to previous comment:

…because if it’s a low rate of return, then (in terms of standard of living throughout lifetime) isn’t it a good idea to go for the less expensive degree?
By Nikc, May 5, 2009 @ 11:01 am

I don’t think the problem is with the (few) kids who take on debt by necessity and have a plan.

The problem is the (majority) kids who rack up tremendous amounts of debt in hopes that they’ll hit the lottery or gain a huge inheritance “some day.”
By funkright, May 5, 2009 @ 11:11 am

Most of your articles I like, but this article, no.

We need to have ensure that attending university or some other type of higher education doesn’t load up our students with mountains of debt.

Starting your working life in debt is NOT the natural, logical, and appropriate thing.. far from it.

It sets you up on a treadmill that provides no satisfaction.

It becomes a form of indebted servitude..
By Ryan, May 5, 2009 @ 11:42 am

Interesting question, Oblivious Investor; but almost impossible to answer. In short, I think it depends on the person, the degree, and the career field.
There are two insightful things I’ve read recently that somewhat pertain to your question.

1. Typically, graduates of top colleges earn more money than graduates of lesser-ranked colleges. But this study showed that it wasn’t the college experience or brand name degree but rather the type of person who could get into that college in the first place will earn more money than one who can’t. The study looked at people who had been accepted to a top college but attended a lesser-ranked one and found that there was no longer an earnings discrepancy.

2. College admissions officers and others love to talk about how, time after time, a college graduate, on average, will earn X million dollars more over a lifetime than a non-college graduate. The problem with this statistic is that there is a heavy numerical bias toward the stratospheric income levels (of course CEOs and very successful hedge fund managers went to college.) But their enormously high incomes pull the average too much for the intent of the study; much more than a minimum wage income pulls the other sample in the opposite direction. A better way to look at the statistics is with the median rather than the mean. With the median, the difference gets pretty negligible. And that’s before you factor in tuition costs and four years of lost earnings.

In summary, I think college is a great financial investment for a motivated person who wants to study something economically worthwhile, and then work in that field. For a motivated person who wants to study sociology or English, because learning is its own reward, that’s fine too, as long as you realize that you’re essentially spending for a luxury four year vacation. For the non-motivated folks who are borrowing heavily to go to college because it’s what you’re supposed to do, they’d probably be much better off learning a trade that excites them. Later on, when they figure out what they really want to do, then it might be a much better time for them to go. If not, no big deal.
By Mr. ToughMoneyLove, May 5, 2009 @ 1:38 pm

“But big picture, and in general, I believe that starting your working life in debt is the natural, logical, and appropriate thing.” I could not disagree more unless you are referring to debt to purchase a tangible, appreciating asset. A key economic concept explained in your post is that of financial planning based on consumption smoothing. Going into debt early in life to buy a home or other appreciating asset is one thing, because there may not be any other option. There are many options for avoiding student loan debt. It’s just that the education establishment, the government, and too many parents default to the loan option because it smooths cash flow for the colleges and delays the pain for the students. I have three sons, two out of college and one in. All of them have no debt, positive net worth, and positive cash flow. Their working colleagues with debt are so much worse off, even they notice it.
By SJ, May 5, 2009 @ 2:48 pm

I just graduated and i’d trade places with a college junior =)

@ Ryan:
“as long as you realize that you’re essentially spending for a luxury four year vacation”

BINGO!! Childhood has extended… heck I’m in grad school I’m spending even more time lol

@TML:
Debt isn’t a good thing. Duh. I think everyone agrees… In this case you are getting a college education and some happy experiences.

Also, I think one thing to consider is why do we earn money? We earn money to do other things.
The route 1 would optimize your net worth while route 2 would let you maintain a consistent level of pleasure in life. (Or approxly heh)

Would you rather live like a pauper for a long period in life and upgrade later lol? Or rather a gradual improvement? It’s the differential, how large an upgrade do you want?

Also, isn’t this just a question of levels of debt? Would anyone think subsidized loans of 10k or so is reasonable? How about 5k? I mean, that 200k+ guy really messed up but… a small amount of debt is okay right? It’s another one of those, case-by-case basis. Some guy getting an Engineering BS can repay that in… a few months vs. 200k in english. Ew.

The fundamental question is why go to college? It’s been advertised as the easiest/only way up the route to success. Let’s fix that right?

Random thoughts from a poor grad student =)
By Ryan, May 5, 2009 @ 4:51 pm

SJ,
I agree with all you said. As long as people really understand what they’re getting into with college, debt, majors, grad school, careers, etc. Give them as much honest information as possible early on so they can make their choices; and then they have to live with them.

But it’s misleading to say “You’ll make more money if you go to college” and it’s misleading to say “It doesn’t matter whether or not you go to college.”
By Enemy of Debt, May 5, 2009 @ 5:41 pm

“But big picture, and in general, I believe that starting your working life in debt is the natural, logical, and appropriate thing.”

Natural, logical, and appropriate? Have you seen the numbers of college students who start their working life filing for bankruptcy?

The reason people borrow money is because it is EASIER than working hard to save, and that is the reason we find ourselves in this troubled economy. The easy way is not the smart way.

I happen to agree with Mr. ToughMoneyLove!
By Robert, May 5, 2009 @ 10:51 pm

I tend to agree w/ Frank. It isn’t the end of the world to graduate from college w/ $15-20K in student debt. Typically, the interest rates are low and the options for deferment or other measures are reasonable.

I also don’t think it is unreasonable to ask the primary beneficiary of a college education to bear some of its cost. Since most teenagers aren’t able to save much by the time they’re college aged, borrowing the money is the logical alternative.

Granted, an anthropology major w/ $100K in debt is probably in for some pain, but is an engineering major w/ $25K in debt really that bad off?
By sam, May 6, 2009 @ 4:47 am

I think it is tough on the 20 somethings to save, they are not in the ideal positions that once were around. I think you have to be more proactive with your choices, and although I agree it is good to save for the future you still need to have fun now otherwise what was the point. I think the ideal thing to do is have a passive income, make money from home as well as your job don’t be so dependant on one income.
By Rob Bennett, May 6, 2009 @ 7:07 am

I strongly agree that it is an error in logic to think that there is one saving rate that should apply for all. Most of us earn little in our early years and then earn a lot in the years just before retirement. We should be saving a far higher percentage of our income when we are farther along in our careers.

Rob
By SaveBuyLive, May 6, 2009 @ 7:36 am

I agree with Frank in that it’s normal and a not the end of the world for college graduates to have some debt.

But that doesn’t mean that we shouldn’t fight like hell against it. If given the choice of graduating college with debt or not, I’m going with no-debt.

Debt severely limits a new graduate’s ability to save money (compound interest doesn’t work if you are too poor to invest), spend money (can’t buy things if you are spending every cent paying down debt) or have career flexibility (Hate your job? Tough! You’ve got debt to pay off).

And if you graduate in a recession then you’re pretty much doomed. Moving back in with mom and dad might cover your living expenses but it sure isn’t going to take care of the debt.
By hickchick, May 6, 2009 @ 7:39 pm

So what happened to all the people that still work their way through school? I don’t think the 40+ hours I was working affected my grades any more than a weekend’s worth of binge drinking affected others. It is still possible to work and go to school, despite the message of sitcoms where parents tell their kids that “school is your job”.
By nameless, May 7, 2009 @ 4:56 pm

I am a little surprised at this post. Having been a faithful reader for some time of this site I feel as though you have let your usual rigor down here.

First, you accept without question that college degree is a net good.

Second, you further accept without question that the incredibly high cost of private schooling is a net good.

If the goal is a quality education than it would appear that attending a high quality state university, thus putting the gross cost at closer to $40k would be the best option.

If the goal is high earning potential that the best course of action would be trade school or community college to learn the skills necessary to enter the field of your choice. Many high paying fields, from plumbing to carpentry to computer programming require very little schooling but a solid skill set.

Ultimately, to say that college graduates are “supposed to” enter the world with debt is to buy in to a myth that has been propagated by high cost universities and student loan lenders. Why else would Sallie Mae be opposed to a restructuring of the loan system to allow students to borrow directly from the government thus cutting rates by more than half?

Lastly, to assume that it is somehow better to pay off debt in one’s 20s in order to maintain some abstract idea of “lifestyle” rather than to begin saving money and earning the benefits of an additional 5-10 years of compounded interest just sounds foolish to me.
By Frank Curmudgeon, May 7, 2009 @ 5:39 pm

I accepted whithout question that a college degree is a net good? And that the incredibly high cost of private schooling is a net good? I didn’t mean to. I meant to tepidly concede that it could be a good idea from an economic point of view, by saying something like “College degrees are often, but not always, a good investment.”

I actually have fairly radical anti-college views, but given how well this post went over, I’ll keep them to myself for a while longer.