Insights on School and Career Choices from the Student Loan Bond Market

The Wall Street Journal’s outstanding series on the job market, college, and young people (“Generation Jobless”) continues  today with an interview with a leading investor in the student loan bond market.  I asked a while back for reader help in finding examples of student loan bond documentation – and my thanks to the commenters who responded as well as a couple of experts who sent me links.  This WSJ article talks about this market and what the experts look for in evaluating these bonds – and what they infer from the student loans they evaluate:

Investors like Mr. [Daniel] Ades have a unique view on the future for America’s job-seekers. Their investments depend onaccurately predicting young people’s ability to repay their loans, which means they obsess about everything from employment rates by profession to the long-term earning potential of young graduates.

Historically, investors have assumed 25% to 30% of student loans bundled into their bonds will default. But today they are baking in between 30% and 40% default rates among the current crop of graduates, said Chris Haid, a director in asset backed trading at Barclays Capital. Even those assumptions are a best guess and defaults could ultimately go higher if unemployment rises, Mr. Haid said.

This analysis translates into some surprising insights for students and policy makers. For example, in the current economy, it may make more sense to enter a technical college than to go to law school.

The advice to go to a technical school – meaning a two year vocational school or community college – rather than law school is based on the following:

In terms of picking a school, technical colleges may be less prestigious, but their low cost relative to the higher wages they deliver makes them attractive, according to Mr. Ades.

Tuition at public two-year colleges in the U.S. will cost $2,963 a year on average in the 2011 academic year, compared to $28,500 a year for four-year private colleges, according to estimates by non-profit group The College Board.

“It’s not just about where you can get the best education,” he said during an interview in the Miami Beach office of his hedge fund, Kawa Capital Management. Students should pick schools where the payoff from higher salaries upon graduation exceeds the cost of the education by the widest margin, he contends, especially when the job market contracts.

By that arithmetic, technical colleges come out on top, Mr. Ades said. “We’re in a skills based economy and what we need is more computer programmers, more [nurses],” he said. “It’s less glamorous but it’s what we need.”  Law school, on the other hand, can end up a sucker’s bet in periods of high unemployment, experts in student loan-backed bonds say.

One understands the point, but it is worth pointing out that Mr. Ades is focused upon whether a student will repay the loan.  In that case, the decision where to go to school and how much to borrow will favor a more secure job even at a much lower salary over a higher but riskier job possibility, since the criterion is the ability to repay the loan and not to maximize the expected income value over time.

Which is to say, Mr. Ades favors low volatility and low risk, all things equal, whereas a student might well favor much higher volatility and higher risk if the criterion is income maximization. However, in a period of high unemployment and lower job possibilities, whether for all jobs or for the higher end jobs, then the strategy for loan repayment and income maximization tend to converge.

However, I invite comments to evaluate Mr. Ades’ strategy, and my suggestion that what he wants and what students want are not precisely the same thing.  Please be civil and on-topic.

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