Monday, March 26, 2012

The Higher Education Bubble

With almost a trillion dollars in loans outstanding and an estimated 27% of those loans more than 30 days in arrears, it's getting easier every day to predict the next segment of the economy to collapse.

Those who understand how the bubble-blowing combination of the Federal Reserve and government policy destroyed the housing market, fueled the dot-com bubble of the early 2000s, and shares some level of responsibility for every nationwide recession since 1913 watched in trepidation when "college for all" replaced "home ownership for all" as the entitlement mantra. It's starting to look suspiciously like they were right once again.

Fitch Ratings notes that the "The Federal Reserve Bank of New York recently reported that as many as 27% of all student loan borrowers are more than 30 days past due. Recent estimates mark outstanding student loans at $900 billion- $1 trillion."

How did this massive debt come to be? Just a few decades ago, it wasn't unusual for a student to work their way through college, paying the costs as they went with a combination of summer jobs and part-time work during the school year. What happened to destroy that model?

Think back just a few years, to those halcyon days when housing prices were climbing like an Apollo/Saturn on the way to the moon. We know now that those ever-increasing prices were in large part created by encouraging far more people than could afford it to jump on the home ownership bandwagon. When "college for all" replaced "homeownership for all" as the entitlement mantra, the hand rose to the wall and began to write.

Alex Pollock notes a number of other "provocative parallels" between the higher education market and the housing market.
There are provocative parallels between student loans and the mortgages that created the disastrous housing bubble. In both cases, the government promoted plausible goals— higher education and home ownership—to excess, through the overexpansion of debt to levels beyond the repayment ability of a large percentage of borrowers. In both cases, the government guaranteed much of the credit, putting the ultimate risk of bad debts on taxpayers. In both cases, debt expansion drove the price of the object being financed (colleges and houses) to heights sustainable only if debt could always be increasing. In mortgages, it could not, and the subsequent collapse raises the question: will there be a similar outcome with student loans?
SmartMoney points out that there are additional reasons for the increase in federal aid.
Recipients of federal Pell Grants have, by definition, limited means to pay for college, so they are likely to qualify for grants and price breaks given out by schools, too. But schools view a student's sources of federal aid before deciding how much to give on their own, rather than the other way around. The result is a crowding out effect, where some schools give less as the government gives more.
Not only do schools consider federal aid before granting price breaks, they recoup some of the grant money by increasing prices.
Lesley Turner, a PhD candidate at Columbia University, looked at data on aid from 1996 to 2008 and calculated that, on average, schools increased Pell Grant recipients' prices by $17 in response to every $100 of Pell Grant aid. More selective nonprofit schools' response was largest and these schools raised prices by $66 for every $100 of Pell Grant aid.

Aid from schools over the past decade has increased about half as fast as federal aid, according to the College Board.
In addition, colleges and universities have increased tuitions because, to put it bluntly, they can get away with it.
Perhaps worse for students than a crowding out effect is the Bennett Effect, named for William Bennett, who 25 years ago as Secretary of Education wrote for the New York Times, "Increases in financial aid in recent years have enabled colleges and universities blithely to raise their tuitions."

If subsidies puff up buying power and shift prices higher, as economics courses teach, could federal aid for college help create an affordability problem? After all, the federal government began spending more on college aid with the Higher Education Act of 1965 and the full funding of Pell Grants in 1975. Since 1979, tuition and fees have tripled after adjusting for inflation. That's much faster than the increase for real estate and teacher pay.
The Bennett effect brings to mind the growth in home size and features that accompanied the housing bubble. As loans became more readily available, homebuilders increased square footage and added luxury touches to attract homebuyers. In much the same way, colleges and universities upgraded dormitories and expanded extracurricular facilities to attract college students. And just as with the housing market, those additional features increased the size of the loans that purchasers were required to make to meet the increased prices in a circular flow that served to pump yet more air into the bubble.

The end result is that the average college graduate starts their new life saddled with $25,000 in student loan debt, and some students who attend prestigious universities for advanced programs end up with several times as much.

But back to that arrears rate. The 27% arrears rate (and a long history of similar bubbles popping) are signs that the education bubble will go the way of the housing bubble. But there's even more bad news.

Making matters worse, 2010 graduates suffered an unemployment rate of 9.1% when they graduated in 2010. Currently, the overall unemployment rate for young adults 18-24 is the worst since 1948, at 46%. This is down 7% since 2008. In addition, earnings are down 5% since 2008 against a 5% increase for the rest of adult workers, meaning that young adults have seen an overall 10% drop in income against the rest of the workforce.

And as if all that weren't enough, when business leaders are consulted, "college for all" looks more like a problem than a solution to our economic woes.
The rising cost of higher education, its indifferent quality, its resistance to change, and its lack of accountability are endangering the nation’s prospects for future economic growth, according to a report on the views of business executives that was released today by Public Agenda and the Committee for Economic Development... [B]usiness leaders say colleges’ inability to control their costs, lack of adaptability, and meager accountability have resulted in a dearth of qualified workers for the jobs the leaders need to fill.
All the signs indicate that a significant segment of college students are going to end up "underwater" when it comes to their student loans, with benefits from their degrees underperforming those expected. Even though college loans cannot yet be discharged through bankruptcy, rumblings are being heard that this should change. If that change occurs, the current 27% arrears rate can realistically be expected to skyrocket, as graduates walk away from their college loans the way that homeowners walked away from homes that have lost a substantial share of their value since they were purchased. The only ones left to pick up that tab will be the taxpayers.

...and that's all I have to say about that.

1 comment:

  1. The good news is, it's a lot harder to "flip" 4 years in college than it was to flip a house or a tech stock, so hopefully (hopefully!!) that will limit the bubble.