No Student Left Behind?

The Daily Reckoning – Weekend Edition
September 2-3, 2006
Baltimore, Maryland
By Kate "Short Fuse" Incontrera


Debt. It’s been a major them in not just these pages, but all over the more "mainstream" press lately. And with good reason. But there is one aspect of the debt monster that is often overlooked: student debt.

If you have put your child (or children) through college, you can attest to the fact that a college education is expensive – to say the least. Adjusted for inflation, tuition and fees at public universities have risen by 40 percent in the past five years. Even worse, if you look at college tuition over the past 30 years, you’ll see that it costs around triple of what it did in the 1970’s.

That said, it is nearly impossible for the average American to attend a four-year university without some sort of financial aid. AlterNet’s article, "Student Debt Crisis: Are There Any Solutions?" shows that "between 1993 and 2004, the percentage of students needing to borrow money jumped from 46 to 66 percent. Debt for graduates averages around $19,000 across public and private schools. Ten years ago, public school borrowers needed about $8,000. Now they borrow about $17,250 – a 65 percent increase, adjusted for inflation."

Student loans are a double-edged sword. While you are getting the money you need to obtain a degree, you’ll be paying for it for years to come – and for some it will take the rest of their adult life to dig their way out of student loan debt.

"2006 has been the worst in history for government action against student borrowers," continues the article. "In February, President Bush rolled out the Deficit Reduction Act, which cut $12 billion in federal student aid money. Part of the plan includes a hike in interest rates on federal student loans and loans taken out by parents. The interest rate on Stafford Loans to students rose from 5.3 percent to 7.14 percent on existing loans and to 6.8 percent on new loans. Interest rates for Parent Loans for Undergraduate Students (PLUS) loans increased even more dramatically, from 6.1 to 7.4 on existing loans and to a whopping 8.5 percent on new loans."

Once you add these rising interest rates to the equation, you have a situation not unlike the one we are seeing in the real estate market right now. But instead of defaulting on a mortgage payment and losing your home, students are finding it more and more difficult to complete or even begin their college education.

Like with most things, this has an interesting trickle-down effect. Toby Chaudhuri with Campaign for America’s Future estimates, "In the next decade, over 4.4 millions low- and moderate-income academically qualified students will opt not to enroll in four-year university degree programs, and another two million will opt not to enroll in higher education at all."

To try and dissuade prospective student from writing off a college education all together, places like the Interboro Institute step in. Interboro is one of the largest, fastest-growing profit-making colleges in the state of New York. They see to give low-income students who have not graduated high school an opportunity to earn a high school equivalency degree in 16 months.

While this sounds like a nice plan, a closer look at this institution shows something else. In late July of this year, a class-action suit was brought up against Interboro’s parent, EVCI Colleges Holding Corporation. The New York Times reports:

"The complaint, filed in Federal District Court in the Southern District of New York, alleged that cheating in determining whether students were eligible for federal and state financial aid was routine, not unusual, and that the company dismissed employees who failed to meet quotas in enrolling students.

"The complaint also quoted former employees as saying that admissions workers routinely changed answers and scores on completed exams used to determine whether students were eligible for federal and state financial aid, which accounted for more than 90 percent of Interboro’s revenue."

While EVCI denies these allegations, most people can put two and two together. Similar to waving an adjustable-rate mortgage under the nose of a pizza delivery boy, EVCI has been accused of "exploiting economically disadvantaged students for personal gain."

Sound a bit familiar? Think of all the Americans who had no business getting involved in the real estate market to begin with – the "subprime borrowers" – but were given the opportunity to buy a home with no money down.

In round numbers, half the people who bought a house last year have negative equity. As the housing bust deepens, their equity is going to get more and more negative every month.

But it’s not just recent buyers who have negative equity. With the refinancing boom, millions of long-term owners have borrowed all the equity out of their homes. Americans have treated their homes like piggy banks, taking the money out and spending on frills. This will not end well for a large portion of our country.

Short Fuse
The Daily Reckoning

P.S. Ever since the Enron debacle, you can’t open up a newspaper without reading about some CEO cooking the books – and now a scandal is permeating the real estate market as well. Folks who refinanced a year or two ago are finding out their homes are worth less than the appraised value. All over the country, appraisals have been inflated by lenders eager to make loans and real estate agents eager to close the deal whatever it takes.

Get all the fact here, and find out how you can protect yourself:

— Daily Reckoning Book Of The Week —

Going Broke By Degree: Why College Costs Too Much
byRichard Vedder

Richard Vedder is distinguished professor of economics at Ohio University and an adjunct scholar at the American Enterprise Institute. Trained as an economic historian, much of his work has dealt with the history of American labor markets and issues such as immigration, internal migration, slavery, and unemployment. After serving as an economist with the Joint Economic Committee of Congress, Mr. Vedder focused on public policy issues dealing with labor markets and governmental budgetary policy. In the past decade he has worked on issues relating to education at both the primary/secondary and university levels.

In this book, Mr. Vedder examines the causes of the college tuition crisis and explores ways to reverse this alarming trend. You can purchase your copy by clicking here:

Going Broke By Degree

THIS WEEK in THE DAILY RECKONING : Take a time-out from preparing for your holiday weekend and catch up with what you may have missed in The Daily Reckoning this week…

Family Business, Part II – 09/01/06
byBill Bonner

Money, sex, and hair loss are taboo subjects in our household. They are all things about which a middle-aged man thinks often, but rarely speaks."

Illusions of Prosperity – 08/31/06
by James Turk

"As the dollar suffers one of the great meltdowns in monetary history, gold will reclaim its place at the center of the global financial system, and its value, relative to most of today’s national currencies, will soar."

The Four Phases of Transition – 08/30/06
byByron W. King

"’In the face of Peak Oil and its multiple consequences…it seems imperative to get prepared to face all the inevitable shock waves. Every preparative step taken today will prove far cheaper than any step taken tomorrow.’"

Weather Windfall – 08/29/06
byKevin Kerr

"Money may not grow on trees, but oranges do, and this year, being long orange juice futures, or options on juice futures, could be as good as money."

Financial Mouse Trap – 08/28/06
byThe Mogambo Guru

"’I equate fiat currency like a mouse trap. The easy credit and instant gratification it gives you is the bait. The bar that is sprung when the bait is taken is called inflation.’"


If You Want to Outperform the Market…
byChris Mayer

Super investor Anthony Bolton once said: "If you want to outperform other people, you have got to hold something different from other people… the one thing you mustn’t hold is the market itself."

This is a timeless bit of investment wisdom that the great investors all embrace. Yet in the mutual fund industry, you find many "closet indexers." A closet indexer is someone who runs a mutual fund that is not an index fund – nor does it bill itself as an index fund – yet to a large degree, its portfolio matches an index (such as, say, the S&P 500).

So here you are, as a mutual fund investor, handing over your funds – presumably so a human being will intelligently and thoughtfully manage them – yet many mutual funds barely escape being index funds. And you are paying extra for this, mind you. Actively managed funds charge much more in fees than index funds.

A pair of Yale professors created a statistic, called the "active share" of a portfolio, which measures how much of a portfolio matches up against an index. So if you have a portfolio that is essentially a replication, with minor modifications, of the S&P 500 (let’s say), then your "active share" score will be low.

Also, the measure accounts for the weighting of your positions. So even if you own ExxonMobil, which accounts for 4% of the S&P 500, it could still raise your active share ratio if it makes up 9% of your fund, for example. You get a high active share rating by doing two things: owning different stocks and/or owning different amounts of those stocks. Those who make big bets – like Bolton – would earn higher active share scores.

So-called closet indexers, those with scores between 20-60%, made up about one-third of all mutual funds in 2003, up from practically zero in the 1980s. In other words, it seems that stock picking is becoming a lost art. The trend is for more and more funds to largely mimic an index. Which sort of brings up the question why invest with these people at all? Might as well shove your money in an index fund.

Well, not all fund managers have such low active share measures. In fact, most of the best investors have very high active share numbers. The Legg Mason Value Trust, run by Bill Miller, has an active share reading of 85%. That is a high ratio. Of course, Miller has beaten the S&P 500 for something like 15 years running – though that streak is in jeopardy this year. The Fidelity Low-Priced Stock Fund, another top performer, also had a high reading, 90%.

Interesting, too, that great money managers of the past also had high active share ratios. Peter Lynch, when he was running the legendary Fidelity Magellan Fund in the 1980s, routinely had active share readings of between 70-90%.

Lynch is particularly interesting, because a common criticism of Lynch – even among those who are otherwise market savvy – is that he had a big fund that "owned the market" and was fortunate to exist during a great bull market. The Yale study, however, indicates otherwise and confirms the conventional wisdom: Lynch was a great stock picker. (However, it is true that later in the decade, the fund’s active share readings plunged to the mid-50%s as the fund ballooned and its performance lagged. Lynch left in 1990.)

Finally, the active share measure seems to have some predictive power. That is to say, those who have high active share readings tend to beat those who don’t. Stock picking is a skill, after all.

Some other funds with active share readings above 95% include the Brandywine Fund, Longleaf Partners and CGM Focus – all with long track records of top performance.

All of this affirms the old wisdom – if you want to beat the market, you

are going to have own something other than the market. Editor’s Note: Christopher Mayer is the editor of Capital and Crisis andMayer’s Special Situations. Chris began his career in corporate bankingafter earning an MBA with a concentration in finance. He later startedCapital & Crisis, a monthly newsletter that gave Chris’ unique brand offinancial commentary a more regular and expanded format.

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