Our $1.3 Trillion Government-Assisted Student Loan Crisis June 3, 2015 by Gary Halbert of Halbert Wealth Management

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2 IN THIS ISSUE: 1. US 1Q GDP Revised to Negative Territory as Expected 2. The Controversy Over the Government s 1Q GDP Reports 3. Could the US be Headed for a New Recession? 4. Student Loan Debt at Record High How Did This Happen? 5. Student Debt is Ruining Credit Scores & Bad for the Economy 6. Is Record Student Loan Debt Really a Crisis? Overview I have been wanting to address our exploding student loan crisis for over a year now, but the topic didn t seem to fit into the normal themes I tackle. Yet in fact, it does: It represents just one more financial/debt crisis facing our country that will surely impact the economy and the investment markets at some point. Student loan debt in the US topped $1 trillion in 2012 and by most estimates is over $1.3 trillion today. There are several reasons why student loan debt has skyrocketed the disappointing economy, stagnant wages and the fact that more young adults have been staying in (or going back to) college longer rather than accepting low-paying or part-time jobs. Add to that the fact that college tuition has gone up significantly every year. What many Americans don t know is that the federal government has largely taken over the student loan program since the current occupant of the White House has been in office. In so doing, the standards for qualifying for student loans have dropped significantly. As a result, even more people are getting student loans and becoming more dependent on the government by design. But before we get into that lively discussion, let s take a look at last Friday s GDP report which reduced 1Q economic growth from modestly higher in the initial report at the end of April to decidedly negative (-0.7%) in the latest revision. We will also look at the latest controversy over whether the government s estimates of 1Q GDP in recent years have been understated. Because the second estimate of 1Q GDP was decidedly negative, that has forecasters swiftly downgrading their estimates for 2Q GDP growth. We will round-out today s economic discussion with a question I raised last month: Could the US economy already be moving into a new recession? While I doubt it, we should at least think about it. Let s get started. US 1Q GDP Revised to Negative Territory as Expected Page 2, 2016 Advisor Perspectives, Inc. All rights reserved.

3 The US economy shrank at an annualized pace of -0.7% in the first three months of the year, according to government data released Friday morning a tumble for a recovering economy that until recently seemed poised for takeoff. The Commerce Department initially reported a slight gain of 0.2% in late April, but the consensus for the second estimate was -0.8%. A larger trade deficit and a smaller accumulation of inventories by businesses than previously thought accounted for much of the downward revision. There was also a modest downward revision to consumer spending growth. In the 1Q, consumer spending rose only at a 1.8% clip, down from 1.9% in the initial report. The increase in spending was well below the 2.4% average since the US recovery firmly took root in Unless consumers spend more, the economy is unlikely to grow much faster in light of new headwinds such as a strong dollar and ongoing weakness in business investment. The 1Q contraction, the country s third in the aftermath of the Great Recession, provides a troubling picture of an economy that many figured would get a lift from cheap oil, rapid hiring and growing consumer confidence. Instead, consumers have proved cautious, and oil companies have frozen investment all while a nasty winter caused havoc for transportation and construction, and the stronger dollar widened the trade deficit. Though the US has shaken off nasty quarters in the past, including the 1Q of last year, this time the rebound doesn t appear to be so dramatic. Over halfway through the second quarter, economists say growth again appears to be below expectations. Previously, many analysts expected 2Q growth of 3% or more, but are now paring those forecasts back to around 2%, or even less in some cases in light of last Friday s downward revision for the 1Q. If the 2Q is 2% or less, that would leave the US with its Page 3, 2016 Advisor Perspectives, Inc. All rights reserved.

4 worst first-half performance since The downward revision to GDP was not the only bad news in the report. Corporate profits plunged by the most since Adjusted pretax corporate profits fell 5.9% in the 1Q after falling by 1.4% in the 4Q of last year. Profits have not declined for two months in a row since the middle of the recession. The Controversy Over the Government s 1Q GDP Reports Many analysts have long suspected problems with the government s method of seasonal adjustments in its GDP reports, especially in light of chronically weak first quarters. Notables such as Federal Reserve Vice-Chairman Stanley Fischer and former Reagan economic adviser Martin Feldstein have recently asserted that GDP is less useful as a short-term economic indicator especially with regard to its 1Q estimates which have been consistently low in recent years. The problems with the government s 1Q GDP estimates have been particularly acute since the US exited the recession in mid From 2010 to 2014, GDP has grown an average of just 0.6% in the 1Q, compared with almost 3% in the following three quarters. Now we have yet another 1Q GDP disappointment in addition to those shown in the chart above. The Commerce Department has acknowledged that there may be flaws in the way they seasonally adjust the GDP numbers, in particular the 1Q estimates. Seasonal adjustments, done correctly, are supposed to smooth-out such large swings from one quarter Page 4, 2016 Advisor Perspectives, Inc. All rights reserved.

5 to the next. The underlying pace of annual US growth might not change, but it should show less unpredictability. Mindful of the criticism, the US Bureau of Economic Analysis which produces the actual GDP numbers for the Commerce Department recently acknowledged flaws in its approach to estimating GDP and said that changes will be made which could lead to multi-year adjustments of 1Q GDP this summer. In the meantime, market forecasters are paying closer attention to a recently created tool from the Atlanta Federal Reserve Bank called GDPNow, which it says gives a better sense of how fast the economy is actually growing. The current GDPNow estimate for 2Q growth is only 0.8% versus around 2% for most forecasters, as noted above. Could The US be Headed for a New Recession? I mentioned this possibility in my May 19 E-Letter. A recession is defined as two or more consecutive quarters of negative economic growth, as measured by GDP. With last Friday s report, we know that 1Q growth was negative. And just above, I noted that the Atlanta Fed s GDPNow estimates 2Q growth of just 0.8%. What if that number is too optimistic? The point is that if 2Q GDP growth should fall into negative territory, a new recession will have begun. Let me be clear: I m not predicting this will happen; I mention it only as a possibility. Should it happen, it would potentially be quite negative for the high-flying equity markets. If the Atlanta Fed lowers its 2Q GDPNow estimate to below 0.0%, I will certainly let you know. The government s first estimate of 2Q GDP will not be released until the end of July. Finally, before leaving our discussion on the economy, let s look at the latest economic report for the city of Chicago, which is arguably already in a recession. On Friday, the Institute for Supply Management reported that Chicago s Purchasing Manager s Index (PMI) plunged to a low of 46.2 in May, far below pre-report estimate and the 52.3 reading in April. With the PMI, a reading above 50 indicates the economy is expanding; a reading below 50 indicates a slowdown. The survey in April (52.3) showed an expansion of business activity for the first time in three months. The pre-report consensus among economists was for a rise to 53.0 in May. So it was quite a shock when it plunged to I mention this particular report since Chicago is a bellwether for the Midwest, much of which is teetering on the verge of recession. The PMI is a popular gauge of overall business activity. Student Loan Debt at Record High How Did This Happen? When I attended college in , I worked my way through school at Texas Tech in Lubbock. My lower middle-class parents weren t able to help me much financially, but I was fortunate to find good Page 5, 2016 Advisor Perspectives, Inc. All rights reserved.

6 jobs with flexible hours that allowed me to pay my undergraduate costs. In 1974, when I decided to go to graduate school in Phoenix in the fall of that year, I knew I would not be able to find such a high paying job in Arizona, nor would I be able to work hours per week if I wanted to get my Master s Degree in one year, which was my goal. So, in order to finance my graduate studies, I had to get a loan to supplement my continued education. So where did I go? I went to my local bank, not the government. I took out a $5,000 loan in my own name, and if I remember correctly the interest rate was 8%. I had to qualify just as any other borrower. For the record, I paid back every penny of that loan. Things are vastly different today. The federal government has taken over the student loan market. Banks are pretty much out of the picture, except as loan servicers. The lending standards are much more lenient. It s as if the government wants more students to get into more college loan debt. As you can see in the chart above, student loan debt topped $1 trillion in 2012 and is currently estimated to be $1.3 trillion. Aggregate student loans have been increasing steadily for years. With every passing semester, more and more money is borrowed to pay for tuition, books, housing and other student living expenses. Student loans have increased even as other forms of consumer debt have decreased. [Note: HELOC above is home equity line of credit.] Over 40 million people in America have outstanding student debt. As a result, student loans are now, after mortgages, the largest source of household debt, outstripping credit cards and auto loans. Page 6, 2016 Advisor Perspectives, Inc. All rights reserved.

7 Not surprising, most of the outstanding student loan debt belongs to people under the age of 40. Those under 30 have about 40% of outstanding student loan debt, while those ages 30 to 39 have another 33% according to the Fed s data. Also not surprising, the recent Fed report indicated that student loan default rates are much higher than previously thought at 11-12%. Student loans have a much higher rate of delinquency than other forms of borrowing where defaults have been trending lower since 2010/2011. The delinquency/default rate is highest among those under age 40, accounting for almost 60% of past due loans. Student Debt is Ruining Credit Scores & Bad for the Economy The Fed s analysis of Equifax data shows that student debt is having a negative impact on young borrowers credit scores. That can affect their ability to finance a home or car, the cost of borrowing, and even their employability. Increasingly, prospective employers check credit scores before hiring. This is holding young people back from the consumer economy. Increasing numbers of young adults have moved back in with their parents rather than buy a house or rent an apartment. In recent years, student debt holders have also been less likely to obtain an auto loan than other college-educated people in their age group. If large numbers of young people are prevented from fully participating in the consumer economy if they're not able to buy things that doesn't just harm them personally. It hurts the entire economy, which means it affects almost everyone. Is Record Student Loan Debt Really a Crisis? Page 7, 2016 Advisor Perspectives, Inc. All rights reserved.

8 The latest data we have on student loan debt are for the Class of 2014 which graduated with one discouraging distinction: They were the most indebted class ever. A little over 70% of last year s bachelor s degree recipients left school with student loans, up from less than half of graduates in the Class of The average Class of 2014 graduate with student loan debt owes an average of $33,000, according to an analysis of government data by Edvisors, a group of websites focused on planning and paying for college, and The Wall Street Journal. Even after adjusting for inflation, that s nearly double the amount borrowers had to pay back 20 years ago. The question is: Does this constitute a crisis? On the one hand, student loan debt has been increasing each year for decades, as shown in the chart above, so that does not suggest it s a crisis. On the other hand, the impact of having to repay a large amount of money early in one s career, versus not having to repay loans, will have a significant impact on his/her net worth and spending power in the consumer economy down the road. While exploding student debt may not yet qualify as a crisis, something is very wrong when 70% of bachelor graduates have student loans averaging $33,000 and rising. A big part of the problem is the fact that most all colleges and universities raise their tuition every year in good times and bad, typically by several percentage points more than the rate of inflation. Four-year college tuition increased over 112% from 1990 to 2010, while the average family income stagnated. The government (under both parties) has encouraged students to take out loans, which have skyrocketed since President Obama took office due to relaxed standards and extended repayment terms. But apparently even that is not enough. Now Mr. Obama and some other Democrats want to make community colleges FREE, as he proposed in his State of the Union address back in January. Some liberals in Congress are calling for Page 8, 2016 Advisor Perspectives, Inc. All rights reserved.

9 all public colleges and universities to be free (see article below). Never mind that to do so would require a big tax increase on the rest of us. What else is new? Apparently, that s what Obama wants to do and sadly, most colleges would have no problem being paid by Uncle Sam instead of indentured students. That would make even more young voters dependent on the government. That s what this is all about. Best regards, Gary D. Halbert Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent. Halbert Wealth Management Page 9, 2016 Advisor Perspectives, Inc. All rights reserved.