Tuesday 19 January 2016

How Did University Degrees Become Subprime Mortgages? Part II

If you made it to the end of my last post you will have the same question I did.

Why did Finance Companies and our ersatz Mr. Finance Company Guy arrange a mortgage for Michelle, our hypothetical mortgagee,  when he should have known quite well from experience and the numbers that she would likely be unable to pay it off?  To answer this question we have to introduce a bond trader on Wall Street in New York.  We can even give him a real name.  We can call him Howie Huble

because Howie Hubler really exists and he is the most infamous example of what was happening in the bond markets in 2008.  A bond like a mortgage and like money is a kind of IOU.  It’s a piece of paper that says someone owes someone an amount of money.  Bonds have always been considered good, solid, conservative  low-risk forms of investment.  Usually bonds were IOUs from big companies or banks or even countries, but any kind of debt can be incorporated into a bond and resold to investors.  Unless you are an investment banker you have to get used to the idea that one person’s debt is always someone else’s investment. For the most part, debt is what financial markets buy and sell.

Leading up to 2008, bonds were being created by bundling together a lot of subprime mortgages.  Imagine that Michelle’s mortgage and 99 other mortgages just like hers were put together in a bundle.  All together they would create a bond (or what was called an “asset-backed security” or "collateralized default obligation") which, on paper, was worth 17 million dollars.  Howie Hubler and his ilk on Wall Street would turn around and sell that 17-million-dollar bond to pension funds, banks, and other investment companies around the world.  The answer to our question, the reason Mr. Finance Guy gave Michelle the mortgage in the first place was because he could immediately turn around and sell it to a Hublerite on Wall Street, and the Hublerites would sell it inside a bond to investors all over the world.

Pause and take note that, despite what we are constantly told about capitalism, the people who were making the real money were taking no risks, in fact, as the saying goes, they had no skin in the game. Howie and Mr. Finance Company Guy got paid no matter what.  They could remain indifferent to the quality of the mortgages and bonds they were selling.  In fact, being attentive to the quality and viability of the paper they were selling would have been counter to their financial interests.  The only thing that mattered to them was that they move a lot of "paper" from Main Street to Wall Street to Global Markets.  The hypothetical 17-million-dollar bond I mentioned above was peanuts to the Hublerites on Wall Street.  Merrill Lynch, the company Howie worked for, was paying him 25 million a year and he complained of being underpaid.  Even after Howie lost 9 billion dollars on "credit default swaps" and was fired, he still walked away with a 10-million-dollar severance payment in addition to the millions he would have salted away over the years.

Confession of ignorance #2:  I hadn’t heard of Howie Hubler or “collateralized default obligations” nor did I understand how "credit default swaps" worked until I read The Big Short.  My general impression of how subprime mortgages were bundled into bonds and resold was correct but The Big Short gave me the details and explained how Mr. Finance Guy and Howie could make enormous amounts of money, for as long as the bubble lasted, by moving worthless pieces of paper around.  Actually calling these investments “pieces of paper” gives them more substance than they had in reality.  Not only were the transactions digital, but when Main Street Finance Guys couldn't keep up with the demand on Wall Street for more mortgage paper, some Wall Street gurus, as Michael Lewis reports,  figured out a way to create mortgages out of nothing.  When financial analysts went looking to see what was inside CDOs (“collateralized default obligations”); for example, to find "Michelle's mortgage," they came away saying it was impossible to say what was in a CDO.  

Think about it!  People were paying billions of dollars for CDOs but no-one was able to say exactly what was being purchased when you bought  a CDO.  No problem!  As we now know the government of the USA stepped in and purchased hundreds of billions of dollars worth of this bad, toxic, imaginary debt and all the perpetrators were let off the hook, except of course, Michelle and people like her who were evicted from their homes, lost savings and pensions and were forced into debt and bankruptcy. 

Parallel #2:  In both cases, Michelle’s mortgage and Michelle’s BA, a huge system has been constructed, an upside down pyramid, based on the assumption that Michelle is going to do what is expected of her.  Despite Michelle’s good intentions and hard work, the open question remains:  was Michelle being provided with the conditions which would allow her to succeed?  In the case of her mortgage, the evidence is now clear she had little hope of  paying off the mortgage and owning a house.  The whole venture was to be a losing proposition for her.  What about her BA?

I have to hold back the vitriol in launching accusations against Mr. Finance Company Guy who sold Michelle her mortgage, because in terms of education I am his homologue. I never consciously deceived or mislead a student, and remained convinced throughout my career that I was doing something beneficial for my students.  However, I suspect that the average Mr. Finance Guy could make the same claims about his mortgage customers.  

Like Mr. Finance Guy, I felt pressure to attract students and get them through the program.  I know lots of individuals who were conscientious and diligent, working to ensure that Michelle got the best education possible--and I count myself among them.  Overall, anecdotal evidence I’ve gleaned suggests that my undergraduates have done better than average in finding employment. Nonetheless it seems clear to me that just as the problem with the financial markets was that no-one was playing careful attention to the details of Michelle’s mortgage, no-one  is paying careful attention to the details of her BA.   As the system currently stands there is no incentive for anyone to be particularly attentive to the make-up and quality of the education that Michelle is receiving.  

For university professors interested in advancing their careers, far from "no incentive,"as I have pointed out in earlier posts, there is significant disincentive for any professor getting too fussy about the quality of their courses or teaching, or becoming preoccupied with the overall quality of education their students are receiving.  In universities there are only two roads to advancement: research or administration.  The cliché of "publish or perish" has more purchase than ever.  The number and salaries of university administrators has ballooned, while most of the teaching is left to lowly adjuncts and part-time lecturers who are destined to remain at the bottom of the ladder in terms of salary, job security and status.  

Are administrators and tenured professors concerned about the level of pedagogy in their universities?  The most interesting and telling aspect of this question is that we can't know the answer because the question never gets asked.  Lots of lip service gets passed around as part of every university's sales pitch but it is simply not something that professors ever discuss.

In keeping with a typical business model, universities are concerned with enrolment and completion rates.  The system offers no incentive for anyone to be preoccupied by what happens between registration and graduation.  The system is driven by ideology, narcissism, petty politics, turf wars and the obsessive compulsions of fastidious low-level administrators, but because there is little to no consensus about what students should be taught, there is no tracking or sharing of information about what students are supposed to have learned.  

My recent posts might create the false impressions in readers' minds 1) that I view university education as somehow comparable to the financial markets, and 2) that I have some silver-bullet solution in mind for how to fix university education for all times.  This comparison of universities and the financial markets is a demonstration of how disastrous the business model is for education.  I have seen numerous panaceas proposed to cure all that ills university education and invariably come away with the impression that there is no one solution to fit all situations.  The solutions that seem clear and viable to me are the ones who's outcomes are least predictable.  We need to empower those who teach, those who can facilitate effective teaching, and those who want to learn, and then, to quote Death of a Salesman, "attention must be paid" to what is happening to students every step of the way from pre-registration to career.

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