The problems of student debt and loans are mounting

The UK university system is facing trouble on more than a few fronts. Some are struggling full stop as we note talk that they will not be bailed out. That comes on top of the issue of student loans and debt which makes me wonder how useful a degree is these days? Especially at a time of struggling real wages.  Although wages for some do not seem to be a problem. From UK Parliament in June of this year.

A table of vice-chancellors’ salaries in the Times Higher Education in June 2017 showed that Dame Glynis Breakwell, the vice-chancellor of the University of Bath was the highest paid university vice-chancellor in the UK; in 2016-17 she was paid a salary of £451,000. The table showed that vice-chancellors at six other universities also earned over £400,000 in that year.

Average pay was found to be £290,000 including pension contributions. You may recall that the University Superannuation Scheme became a hot topic for a while as there were strikes after suggestions that defined benefits needed to end. That was eventually resolved with higher contributions ( but not as high as originally suggested). Previously the total was 26% of salary split 18% employer and 8% employee.

The panel recommended that DB pensions could continue to be offered with contributions rising to 29 per cent — significantly lower than the 36.6 per cent from April 2020 proposed by USS, based on the valuation as it stands. ( Financial Times)

As an aside it was a shame that the Bank of England was not contacted as its research could be used to show that in fact such pensions have benefited from its policies. In spite of course of that fact that its Chief Economist Andy Haldane confessed to not understanding them. Oh well!

Moving on, payoffs to Vice-Chancellors had become an issue such as the £429,000 payoff at Bath Spa, £230,000 at the University of Sussex, and £186,876 at Birmingham City University. Coming back to pay the HM Parliament research showed that Vice-Chancellor pay had risen at an annual rate of 3.2% when other academic staff were restricted to 0.7%.

Student Debt

A glimpse of a potential future can be seen in the United States. Last night the US Federal Reserve updated us on total student debt at the end of the third quarter and it was US $1.563 trillion. One perspective is provided by the number below it for total motor loans which is a relatively mere £1.142.8 trillion. In terms of past comparisons the number for 2013 was £1.145.6 trillion for US student loans.

Noah Opinion on Bloomberg looked at it like this.

Many educated millennials would likely agree — since 2006, student debt has approximately doubled as a share of the economy……..The increase seems to have paused in the past two years, possibly due to the economic recovery (which allows students and their families to pay more tuition out of current income) and a modest  decline in college enrollment. But the burden is still very large, and interest rates on student-loan debt are fairly high.

His chart shows student debt being around 7.5% of US Gross Domestic Product and I can update his view because unless the US economy is growing at an annual rate of 5.6% then the burden is rising again.

Also the repayment issue is similar to that we have and indeed are experiencing in the UK.

Education researcher Erin Dunlop Velez crunched data that was recently released by the Department of Education, and found that only half of students who went to college in 1995-6 had paid off their loans within 20 years. Given the vast increase in the size of loans since then, repayment rates are likely to be even worse if nothing is done. Velez also found that default rates are considerably higher than had been thought.

There is another familiar feature.

What’s more, student lending has almost certainly contributed to the rise in college tuition, which has outpaced overall inflation by a lot. When the government lends students money, or encourages private lenders to do the same, it increases demand for college, pushing up the price.

In the  UK a lot of the inflation came in one go.

In the 2012/13 academic year, students beginning their studies could be charged up to a maximum fee of £9000 for first year courses compared with a maximum of £3375 in
2011/12 ( Office for National Statistics).

Whilst the weighting for university fees is low the substantial rise had an impact on the overall numbers.

In total, university tuition fees for UK and EU students added 0.31 percentage points to the change in CPI
inflation between September and October 2012. This was the largest component of the rise in the headline rate from 2.2 to 2.7%.

The CPI measure was particularly affected as it includes international and European Union students whereas the RPI only has UK ones meaning that the weight is around three times higher. That becomes quite an irony as we note the invariably higher ( ~ 1% per annum) RPI is used in the interest-rate on student loans. The road from being “not a national statistic” to being useful is short when it is something the public are paying or indeed Bank of England pensioners are receiving.

Comment

Let me start with some welcome good news. The Times Higher Education rankings show Oxford University at number one with Cambridge second and Imperial College ninth. My alma mater the LSE slide in at number 26. So we are getting something right as whilst it feels by hook or by crook our universities are highly regarded around the world. I think we do that a lot as we focus on issues ( the impact of the PPE degree course at Oxford on our political class) and maybe lose vision on the wider picture. Our institutions are often highly regarded around the world.

Also many more people are going to university as this from Gil Wyness at the LSE points out.

The UK has dramatically increased the supply of graduates over the last four decades. The proportion of workers with higher education has risen from only 4.7% in 1979 to 28.5% in 2011 (Machin, 2014). Rather than this enormous increase in supply reducing the value of a degree, the pay of graduates relative to non-graduates has risen over the same period: from 39% to 56% for men and from 52% to 59% for women).

However the issue of pay is a complex one as of course overall pay growth has slowed which if the workforce has become better qualified looks even worse. Also there is this which needs some revision I would suggest.

The expansion of universities helped raise growth and productivity (Besley and Van Reenen,
2013),

The financing side is much more shambolic though. The upside of the student loans era was supposed to make universities compete more, does anyone believe that now? Next comes the issue that a high interest-rate (6.3%) is used to raise the debt calculated like this by HM Parliament.

Currently more than £16 billion is loaned to around one million higher education students in England each year. The value of outstanding loans at the end of March 2018
reached £105 billion. The Government forecasts the value of outstanding loans to be reach around £450 billion (2017-18 prices) by the middle of this century.

No wonder the Bank of England dropped consumer loans from its credit figures! But more fundamentally debt is supposed to be repaid and yet we know most of this never will be. Yet along the way it will affect those who have it should they look to buy a house or have other borrowing.

The average debt among the first major cohort of post-2012 students to become liable for repayment was £32,000. The Government expects that 30% of current full-time undergraduates who take out loans will repay them in full.

The anthem for this comes from Twenty One Pilots.

Wish we could turn back time, to the good old days
When our momma sang us to sleep but now we’re stressed out
Wish we could turn back time, to the good old days
When our momma sang us to sleep but now we’re stressed out

 

 

 

 

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Carillion highlights the many problems of credit crunch era pension financing

This morning’s news brings us back to a problem which has dogged the credit crunch era. The advent of first official interest-rate cuts and then central bank balance sheet expansion was designed to pull economic demand from the future to the present. This poses an issue for pensions as it does for all long-term savings contracts as they rely on the future. The issue has become clearest when we look at a consequence of the widespread monetary easing which was reflected in a question on Thursday to ECB ( European Central Bank) President Mario Draghi which mentioned “10 Trillion” dollars of negative yielding bonds. If you start doing any sort of maths you find that the negative yields imply you will be getting less back in the future than you pay in now and that is before you factor in the impact of inflation. Who invests to make a loss?

Putting it another way here are the real yields as of today from Germany. Not what economics 101 would predict for am economy in a boom is it?

Just for clarity some of the nominal yields are negative as shown in the chart but even when they go positive they are negative if we allow for inflation prospects and estimate a real yield.

Carillion

This reflects the conceptual issue as we note that its business model was to take advantage of the era of monetary easing. Take a look at this from the House of Commons Briefing Paper.

Over the eight years from December 2009 to January 2018, the total owed by Carillion in loans increased from £242 million to an estimated £1.3 billion – more than five times the value at the beginning of the decade.

So it was able to borrow on a large-scale as we note an effect of these times which is often forgotten. Not only did it become cheaper to borrow for many purposes but there was an availability of credit meaning that Carillion could borrow ever more as well as cheaply. As an aside the banks would no doubt have been happy to make some business lending but as I reported many years ago now about Japan you don’t always get the sort of business lending you want as we note what it did with it.

In the eight years from 2009 to 2016, Carillion paid out £554 million in dividends, almost as much as the cash it made from operations. In the five years from 2012 to 2016, Carillion paid out £217 million more in dividends than it generated in cash from its operations.

Now let us skip to the pensions situation.

Carillion has 13 UK defined benefit pension schemes with 27,000 members. In January 2018, the trustees estimated that the schemes’ Pension Protection Fund (PPF) deficit (the shortfall compared to what is needed to pay PPF compensation levels) was up to £900 million

So shareholders got dividends and we know the directors were well paid and were able to think of the future. From the Financial Times.

Allowing clawback conditions to be changed a year ago, striking out corporate failure as a reason to take back bonuses.

Yet they were somewhat more forgetful about the futures of others.

When did this start?

Rather concerningly the problems were long-standing. From Josephine Cumbo in the Financial Times.

In written evidence to the Committee, Robin Ellison, chair of Carillion pension scheme trustees, said the trustees had tried to agree higher funding contributions from the company in 2008, 2011 and 2013.

Even worse there are higher estimates of the problem emerging from the woodwork.

In his letter to the committee, Mr Ellison revealed that the funding shortfall for five of the six Carillion pension funds he chairs widened from £508m in 2013 to around £990m in 2016 when measured on a “technical provisions” basis. This is the measure used to set contributions from the employer every three years. However, the “buyout” deficit, or the measure used by the Pension Protection Fund to value a creditor claim for the pension debt, is nearer £2bn according to Mr Ellison.

This brings us to the subject of the regulator as we wonder what it has been doing over the past decade?

On Monday, the Work and Pensions Select Committee published new evidence claiming that the Pension Regulator (TPR) was alerted to problems with the company’s main pension plans as long ago as in 2008, when the scheme’s trustees and the company were locked in a funding dispute.

We seem to be back to the issue of who regulates the regulators as this looks like the behaviour of yet another paper tiger.

What is a pensions deficit?

In theory this is easy as it is simply an expected future shortfall. The problem is that more than a few variables are unknowable such as investment returns, inflation and interest-rates and yields in the future. The modern era started in 1997 with the Minimum Funding Requirement which had an impact on the markets I was working in/on at the time. From HM Parliament.

it appears to have created some extra demand in the long end of the gilts market, which may have contributed to the depression of yields.

This led to the view that one of the aims of the MFR was to support the Gilt market. Then another issue arose which has continued which is the use of yields to value pensions as only a year later there was a big change for dividend yields in pension funds.

the dividend yield is no longer a reliable measure of “value” for UK equities – this is partly due to the abolition of tax credits on UK dividends in the July 1997 Budget, which
has changed companies’ behaviour over profit distribution, and partly because investors are willing to value shares on future long-term expectations, despite the
absence of dividends or profits

More recently we have seen corporate bond yields used for pension deficits but this has brought its own problems as central banks have intervened here. Firstly by making them more attractive by cutting interest-rates then reinforcing it via balance sheet expansion via bond buying. Then explicitly by actually buying corporate bonds as the Bank of England did in August 2016 and less obviously via the ongoing ECB programme as UK companies do issue Euro denominated bonds.

The irony of all this is that if you had bought long-dated UK Gilts two decades ago you would have done really rather well especially if you sold to the “Sledgehammer” buying of the Bank of England as it sent the market to all time highs with its panic inspired move.

What about direct contribution pensions?

These are simply ones where you put money in ( and if lucky your employer does as well) and it is invested and you make or loss depending on how the investments do. This is different to the schemes above where the employer promises a return based on your salary or earnings. According to the Financial Times just over a week ago the costs here are not quite what we are told.

The total cost of investing in popular funds, including those run by Janus Henderson, BlackRock and Vanguard, is up to four times higher than first thought, FTfm can reveal today. The Mifid II trading rules, which came into force this month, have forced asset managers to disclose hidden charges.

Some care is needed as platform charges are not caused by the fund management group but there are charges which are far from transparent.

Comment

There is much here to consider. The concept of investing for the future is simple and yet the credit crunch era has made it more complicated. For example there was a time ( and no doubt regulatory rules still suggest it) that the safest investment was a government inflation or indexed linked bond. No we see a time when in the UK and Germany you are pretty much guaranteeing yourself a loss in real terms if you hold them to maturity. If we look at conventional bonds they yield so little there is no fat on the bone as real yields are hard to come by.

Ironically this will have benefited some as if you had been holding bonds over the ,long-term then you are quids ( Dollars, Euros,Yen) in as we have been in a bull market. More recently equities have joined that party but here is the rub. In my opinion central baking easing has helped drive this too as current investors/pensioners benefit from borrowing from future returns. The claimed “wealth effects” must make it harder to make money going forwards as we note that like in Japan zombie companies which is what we are increasingly looking at with Carillion were indeed propped up.

Meanwhile I would suggested that especially if we consider their student debt burden millennials are unlikely to be able to buy a home and invest in a pension simply by giving up takeaway coffee and avocado toast.

Also I am pleased to report that the spirit of Sir Humphrey Appleby is alive and kicking at the UK Pensions Regulator.

The Regulator said: “It is too early to comment on whether with different information we could or would have taken action in the past or whether we will take action in the future, based on any new information that comes to light.” ( h/t @JosephineCumbo )

 

 

The ongoing UK problem with pensions

Today has brought a piece of news that is another element in an ongoing saga. It also brings into play some economic developments that are interrelated to it. Oh and a past manipulation of the UK public finances. From Reuters.

Royal Mail said on Thursday it would close its defined benefit pension scheme at end-March 2018 after a review found it would need to more than double annual contributions to over 1 billion pounds to keep the plan running.

Royal Mail, the British postal service privatised in 2013, said it was one of only a few major companies that still had employees in a defined benefits scheme, a type of pension that pays out according to final salary and length of service.

The company, which pays around 400 million pounds a year into the scheme, said it was currently in surplus, but it expected the surplus to run out in 2018.

There are various initial consequences such as threats of strike action from the postal union and something to cheer central bankers everywhere. From the Financial Times.

Investors were more positive about the plan, however. Shares in Royal Mail rose 1.6 per cent after the announcement to their highest level since January. JPMorgan Cazenove analysts estimated last month that markets have already priced in a £100m a year step-up in pension charges, and investors have welcomed signs of an end to questions over the scheme’s future.

UK Public Finances

Those who recall my analysis from 2013 will remember that this is another version of the Royal Mail pension scheme that was originally booked in the UK National Accounts for a £28 billion profit! How can you have a profit on acquiring something which is unaffordable? Later the methodology was quietly changed.

This reflects the shortfall between the £28 billion of assets transferred from the RMPP and the £38 billion of future pension liabilities that were consequently assumed by Government…….. Furthermore, the transfer of the assets no longer reduces borrowing as it did under ESA95.

To be fair to our statisticians and indeed Eurostat they did catch up with this manipulation eventually but of course by then the public’s attention had moved elsewhere.

Why are these pension schemes now so unaffordable?

The latest report from HM Parliament describes the problems and issues.

poor investment returns, associated with low underlying interest rates and loose monetary policy following the 2008–09 financial crisis and associated recession;8

 

rises in longevity that have been faster than was widely anticipated;

 

sponsor behaviour, including many employers taking contribution holidays when schemes were in surplus.

Only actuaries and economists can make rising longevity seem a bad thing! But if we move to the effect of low interest-rates there is this evidence from Deputy Governor Ben Broadbent to HM Parliament on this and the emphasis is mine.

First, I don’t think it damages the value of their assets; it pushes up the price of their liabilities. That is what happens when bond yields fall. The price of that bond and the present value of the liabilities go up. But it also pushes up the assets.

Even with such analysis Dr.Ben was forced to admit that schemes in deficit were net losers. But I find the overall idea that they lose on the swings but gain on the roundabouts simply extraordinary! Another example of Ivory Tower thinking. You see they have present gains although of course they will be across many markets but the real issue is that they have to pay for future liabilities and the answer misses of the fact that pension funds have going forwards to buy assets such as bonds which are much more expensive. Indeed in an odd but true development pushing up the price of ordinary UK Gilts via QE has in some ways had more of an effect on index-linked Gilts which are not bought! This matters because most defined benefit schemes have inflation based liabilities to pensioners.

The odd case of index-linked Gilts

Because ordinary Gilts offer so little interest these days and index-linked Gilts offer annual coupons based on the Retail Price Index ( 3.1%) if you need income then linkers look more attractive. Of course the price adjusted to this but this means that the Index-Linked Gilt market is in quite a bubble right now. It also means that it is in a way not fit for purpose as it is being priced on annual cash returns rather than inflation prospects as we see yet another market which has been turned into a false one by the central planners.

I have written before about how you could lose money by being right about UK inflation and this is why. So how do pension funds now hedge inflation risk?

The UK Gilt market

This has been on something of a surge recently or perhaps I should say another surge. Let me put an apology in with that because that has wrong-footed my stated view on here as I expected it to fall as inflation prospects deteriorated.  But  the ten-year Gilt yield is quite near to 1% and the two-year yield is 0.1% which is insane in terms of real yield with inflation heading to 3/4% depending on the measure used. Pension funds look a long way ahead so if we look at the thirty-year yield we see it has fallen to 1.63%.

Thus if we switch to prices we see that any investment now is at an extraordinarily expensive level. What could go wrong?

Actually according to HM Parliament defined benefit schemes tend to value themselves versus the higher quality end of the Corporate Bond market.

scheme funding statistics show that discount rates used by DB pension schemes for calculating liabilities since 2005 have consistently been around 1 per cent above gilt yields.

Can anybody spot a flaw in the Bank of England buying £10 billion of these ( £9.1 billion so far) to raise the price and reduce the yield?

Pre pack problems

Another issue was raised by Josephine Cuombo in the Financial Times.

Companies in the UK have used a controversial insolvency procedure to offload £3.8bn of pension liabilities, often as part of a sale to existing directors or owners, a Financial Times investigation has found…….

The FT investigation found that two in three pre-pack schemes entering the PPF involved sales to existing owners or directors. A string of prominent cases that used pre-pack arrangements, but where companies are still trading, include the turkey producer Bernard Matthews, the bed company Silentnight and the textile group Bonas.

In essence the schemes have found their way into the Pension Protection Fund which is backed by the industry thus raising costs for other schemes and pensioners get reduced benefits.

Comment

When the Bank of England looks at pensions it is hard to avoid the thought that views are influenced by their own more than comfortable position. For example in its latest accounts Ben Broadbent had received pension benefits valued at £104,586 in the preceding year. It is also hard to forget that just as it was telling everyone inflation was going lower back in 2009 the Bank of England piled into index-linked Gilts in its own scheme! But for everyone else involved there are no shortage of sharks in the water.

As to the befuddled and bemused Ben Broadbent he has views which question why we pay him at all!

One thing I want to get across today is not to confuse the low level of interest rates with monetary policy…….

Even though we are that last link and even though it is the MPC that sets interest rates, it is not a realistic question—I do not think it is a realistic premise to say low interest rates are because of monetary policy.

Until of course he can claim gains from his policies….

Let me sign off for a few days by wishing you all a very Happy Easter.