Shorting the Bubble in Higher Education

“In early 2004 another stock market investor, Michael Burry, immersed himself for the first time in the bond market…but he wasn’t thinking about buying mortgage bonds. He was wondering how he might short subprime mortgage bonds.” — Michael Lewis, The Big Short: Inside the Doomsday Machine

How Michael thinks he looks pitching 1517 to investors.

In the debate about which novel will prove to be the more prophetic — Huxley’s Brave New World or Orwell’s 1984 — each side’s case stands on which tool tyranny will rely on: for the fans of Orwell, government by guns, surveillance, and torture; and for the fans of Huxley, pleasure and the voluntary love of servitude.

Huxley certainly held the more counterintuitive view. It seems unlikely that anyone would come to take pleasure in their oppression. Nevertheless, Huxley’s dystopia also rested on a sound logic. All that coercion and force Orwell depicted requires effort and drains resources, and in the end it really is an imperfect undertaking. Some rebels will always slip loose into a system and sabotage its gears from time to time. “A really efficient totalitarian state,” Huxley concluded, is one in which an “army of managers control a population of slaves who do not have to be coerced, because they love their servitude.”

Today American society has taken on shades of both Huxley and Orwell. One has the feeling everything we do is being tracked. But where Huxley takes the lead by a wide margin involves a kind of exploitation we are seeing more frequently and with higher stakes— namely, entrapment by an ideal. Find an aspiration that guides the lives of millions and then lure them into a bad deal by having them focus on the sacred misdirection — which could be apple pie, the American flag, or a home in Boca Raton.

The American experiment and its exceptionalism were always driven by the idea of progress, but when the facts can’t support the story, we find denial.

For instance, as median incomes stagnated from the 1970s onward, rather than addressing the causes of the problem, governments have used policies to mask them.

We saw this with the peak of the housing bubble of 2005 to 2007. The American Dream, whatever it had been, was redefined as owning a home in a magical kingdom where the price of real estate only went up. Imprudent loans and refinancings papered over the fact that many Americans weren’t getting any wealthier. The aspiration was to own home — that was the misdirection — but in reality most weren’t as rich as they thought they were. Cab drivers in Brooklyn or strippers in Vegas might have felt richer because the bank said they legally owned a third home, but eventually the bills would come due. And it took a few years. It’s pretty amazing how long reality can be denied. But in the end millions were left with debt and bankruptcy.

Like a small number of other investors in 2005, the hedge fund manager Michael Burry foresaw the coming catastrophe. But what the others didn’t quite know was how to trade it. In order to short the housing bubble, Burry had to devise a form of insurance on mortgage bonds — credit default swaps — that would pay out as the loans underlying the bonds defaulted. His scheme was not popular at first. Only two investment banks would sell these newfangled financial products to him. But by 2006, credit default swaps on mortgage bonds became a multi-billion dollar market.

Now, in 2018, we have another aspiration, another entrapment by debt, and another bubble. It is being inflated by the lie that college improves the soul. Who could ever call into question the cultivation of the mind? And so The Wall Street Journal reports that total student debt has hit $1.5 trillion. Default rates for these loans have reached a twenty year high, with the Brookings Institute issuing an estimate that in some cohorts default rates may be as high as 40 percent by 2023. And this is with the global economy growing at a robust rate. If and when the business cycle slows in the coming years, expect these problems to worsen.

We have not investigated whether it might be possible to short these student loans, assuming they’ve been packaged in bonds. We are not clever hedge fund managers looking to devise arcane financial products. But we do see our work with 1517 as the optimistic short of the higher education bubble. By supporting founders outside the system, we aim for asymmetric returns on the positive story of advancing technologies. The more successful our founders become, the more glaring are the cracks in the edifice of a shambolic education system.