Borrowing for your college from your Uncle Sam — Doug Criscitello

Doug Criscitello, Executive Director of MIT’s Center for Finance and Policy

Doug Criscitello, Executive Director of MIT’s Center for Finance and Policy

From The Hill

Let’s consider student loans for a moment. Many of the candidates for president have promised relief of some sort from the high cost of college tuition.  That’s not surprising considering that 40 million Americans currently hold student loans and that debt incurred for education now lags only mortgage debt as a source of consumer indebtedness—logging in at the astonishing total $1.2 trillion. And, here is the rub, most of that debt has been loaned directly by the government and, as the current policy debate illustrates, students who borrow from the government don’t necessarily have the same expectations and sense of repayment obligation to their lender – as those receiving loans from a private financial institution.

Decisions made in the 1990s to transform the US government’s role in providing student loans, from that of a guarantor to a direct lender, were driven primarily by budgetary rather than policy considerations. Direct lending had a clear advantage because it had a dramatically lower price tag than the guaranty program at the time. And when private lenders became reticent to assist students during the darkest days of the 2008 financial crisis, direct loans from the government became the primary source of student loans in the US and the guaranteed student loan program was abolished.

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Imagine if robo advisers could do emotions — Andrew Lo

MIT Sloan Professor Andrew Lo

MIT Sloan Professor Andrew Lo

From The Wall Street Journal 

At a conference last year, I was approached by an audience member after my talk. He thanked me for my observation that it’s unrealistic to expect investors to do nothing in the face of a sharp market-wide selloff, and that pulling out of the market can sometimes be the right thing to do. In fact, this savvy attendee converted all of his equity holdings to cash by the end of October 2008.

He then asked me for some advice: “Is it safe to get back in now?” Seven years after he moved his money into cash, he’s still waiting for just the right time to reinvest; meanwhile, the S&P 500 earned an annualized return of 14% during this period.

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At last, Obama stands up to the big banks — Simon Johnson

MIT Sloan Prof. Simon Johnson

From MarketWatch

Not surprisingly, at least some people at the Securities and Exchange Commission have reacted negatively — this is stepping onto their turf, after all. And the lobbyists are, naturally, out in full force.

But with sufficient White House willpower, the administration can see this through. What is needed is a change in the rules set by the Department of Labor, which has jurisdiction over retirement-related issues.

No doubt industry defenders will claim that current practices benefit small investors — a point disputed directly by the CEA. The broader and more interesting question is: Where are the statesmen in the financial industry? Where are the leaders who push for a race to the top, by better serving their clients’ best interests?

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Here’s why negative interest rates are more dangerous than you think — Charles Kane

MIT Sloan Senior Lecturer Charles Kane

MIT Sloan Senior Lecturer Charles Kane

From Fortune

Europe and other parts of the world are in for big risks.

Desperate times call for desperate and somewhat speculative measures. The European Central Bank (ECB) cut its deposit rate last Thursday, pushing it deeper into negative territory. The move is not unprecedented. In 2009, Sweden’s Riksbank was the first central bank to utilize negative interest rates to bolster its economy, with the ECB, Danish National Bank, Swiss National Bank and, this past January, the Bank of Japan, all following suit.

The ECB’s latest move, however, was coupled with the announcement that it would also ramp its Quantitative Easing measures by increasing its monthly bond purchases to 80 billion Euros from 60 billion Euros — a highly aggressive policy shift. The fact that the ECB has adopted this approach raises two key questions: What are the risks? And, if the policy fails, what other options are left?

Negative rates are an attempt by the ECB to prod commercial banks to lend more money to businesses and consumers rather than maintain large balances with the Central Bank. In essence, it is forcing the banks to leverage its balance sheet to a higher level or the ECB will penalize the banks by charging interest on their deposits. Historically, such a practice would be highly inflationary, however, with oil prices falling to record lows combined with a slowdown in global growth, inflation is not feared. In fact, inflation is desired at a manageable level, as this would promote near-term growth in the economic markets.

This does not mean, however, that the ECB’s policy does not present risks. First, if the commercial banks decide to pass on the cost of the negative rates to their customers — in other words, they charge customers for keeping their savings in the bank in the same way central banks are now charging the commercial banks for keeping their money – the customers might simply withdraw their savings. In a worst-case scenario, this could create a run on the banks in Europe with customers hoarding their money rather than paying interest on deposits. This would inhibit the free flow of funds through the financial system — ironically, the very reason that negative interest rates were implemented in the first place.

Read the full post at Fortune.

Charles Kane is a Senior Lecturer in Technological Innovation, Entrepreneurship and Strategic Management Goup and also in the Global Economics and Management at the MIT Sloan School of Management.

Why the good people of Illinois should care about a Puerto Rico bailout — Ike Brannon and Michelle Hanlon

MIT Sloan Professor Michelle Hanlon

MIT Sloan Professor Michelle Hanlon

From Crain’s Chicago Business

It’s become increasingly clear that Congress will need to provide some sort of assistance to the bereft government of Puerto Rico. The island has been in recession for a decade and holds $72 billion in debt it cannot fully repay; its pension plan is nearly bankrupt.

While there’s widespread agreement that something must be done, there’s not as yet any unanimity as to what this something should be. How Congress resolves this issue should be watched closely by the taxpayers of Illinois, because it could end up worsening the state’s finances.

Puerto Rico arrived in its current fiscal throes by borrowing money to postpone difficult tax and spending decisions whenever possible—a strategy that everyone in Illinois would recognize. Until quite recently it could borrow at rock-bottom rates, thanks to the generous tax breaks its lenders receive on their interest at the local, state and federal level. Eventually, lenders began to fear that they might not get repaid, and capital markets began demanding sharply higher interest rates before they just stopped lending to them altogether.

One proposed solution is to allow Puerto Rico to avail itself of Chapter 9 bankruptcy. Under Chapter 9, municipalities and public agencies can get court protection to reorganize their finances, but a state cannot. However, the island’s government and the U.S. Treasury argue that this isn’t sufficient: While over two-thirds of Puerto Rico’s debt would be covered under a Chapter 9 bankruptcy, they propose a legislative change that would allow all of its debt to be covered by bankruptcy protection, an unprecedented step.

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