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Monday, July 25, 2011

The Burst of the College Bubble

"Enlightened statesmen will not always be at the helm." — James Madison

I have written several time about the great college rip-off and the role the federal government has the massive inflation of the cost of college. For years the U.S. Department of Education (a department I would like to see eliminated) has been making and guaranteeing student college loans. With a guarantee of being paid by the federal government banks have been making student college loans for years. This is the same policy that caused the burst of the housing bubble. With the policy that everyone had a right to a home the banks lent money to unqualified buyers, who they knew were unable to pay the loan back, with the knowledge they could pass the loans off to Fannie Mae or Freddie Mac. This caused an increase in house demand and the consequential inflation in the price of houses.

Over the years the same game has been played with student loans for college. Colleges and universities have escalated their tuition fees with the knowledge that potential students could get government guaranteed loans. This allowed the colleges and universities to expand their facilities and hire more and more professors. In essence it was plunder of the students and taxpayers for the benefit of the colleges. In many cases students are graduating with over $100,000 dollars in debt that will take them years to repay for a college degree with questionable value.

Michael Barone writes in Human Events that the college bubble is on the verge of bursting. Barone writes:

“When governments want to encourage what they believe is beneficial behavior, they subsidize it. Sounds like good public policy.

But there can be problems. Behavior that is beneficial for most people may not be so for everybody. And government subsidies can go too far.

Subsidies create incentives for what economists call rent-seeking behavior. Providers of supposedly beneficial goods or services try to sop up as much of the subsidy money as they can by raising prices. After all, their customers are paying with money supplied by the government.

Bubble money, as it turns out. And sooner or later, bubbles burst.

We are still suffering from the bursting of the housing bubble created by low interest rates, lowered mortgage standards, and subsidies to Fannie Mae and Freddie Mac. Those policies encouraged the granting of mortgages to people who should never have gotten them -- and when they defaulted, the whole financial sector nearly collapsed.

Now some people see signs that another bubble is bursting. They call it the higher-education bubble.

For years, government has assumed it's a good thing to go to college. College graduates tend to earn more money than non-college graduates.

Politicians of both parties have called for giving everybody a chance to go to college, just as they called for giving everybody a chance to buy a home.

So government has been subsidizing higher education with low-interest college loans, Pell grants, and cheap tuitions at state colleges and universities.

The predictable result is that higher education costs have risen much faster than inflation, much faster than personal incomes, much faster than the economy over the past 40 years.

Moreover, you can't get out of paying off those college loans, even by going through bankruptcy. At least with a home mortgage, you can walk away and let the bank foreclose and not owe any more money.

Peter Thiel, the co-founder of PayPal, is adept at spotting bubbles. He sold out for $500 million in March 2000, at the peak of the tech bubble, when his partners wanted to hold out for more. He refused to buy a house until the housing bubble burst.

"A true bubble is when something is overvalued and intensely believed," he has said. "Education may still be the only thing people still believe in in the United States."

But the combination of rising costs and dubious quality may be undermining that belief.

For what have institutions of higher learning done with their vast increases in revenues? The answer in all too many cases is administrative bloat.”

Private colleges and universities have been discounting tuition at unprecedented levels during the recession in a way that slowed down or reversed the growth in net revenue from tuition, according to a new report from the National Association of College and University Business Officers. The discount that surveyed colleges and universities offered for full-time, first-year students through grants and other forms of need-based and merit aid hit an all-time high of 42.4 percent in 2010, a jump from about 39 percent in 2007. The report estimates that 88 percent of students at the institutions surveyed received some institutional aid, and those students paid about half of the college or university’s sticker price.” So if you’re paying full tuition, you’re basically a sucker.

According to a report in Inside Higher Ed:

“The discount that surveyed colleges and universities offered for full-time, first-year students through grants and other forms of need-based and merit aid hit an all-time high of 42.4 percent in 2010, a jump from about 39 percent in 2007. The report estimates that 88 percent of students at the institutions surveyed received some institutional aid, and those students paid about half of the college or university's sticker price.

That increase in the discount rate came at the expense of growth in net tuition revenue. While net revenues grew at about 5 percent for five of the years between 2001 and 2007, tuition revenue dropped 0.3 percent in 2008, and grew only 1.8 percent and 2.8 percent in 2009 and 2010, respectively. That means that institutions did not gain nearly as much revenue as their tuition increases would suggest, and that many institutions saw gains in tuition revenue that lagged the inflation rate.

The association surveyed 381 private, not-for-profit institutions about how they discounted tuition in 2009 and 2010. The survey’s findings include a general trend toward more money being spent on institutional aid and a larger number of students receiving aid, both of which created financial difficulties for some institutions.

The report notes that increases in discounting “have come at a cost to a large number of institutions. Net tuition revenue has recovered for some institutions, but the rate of growth in net revenue remains below the average achieved before the onset of the downturn. Many institutions have implemented hiring freezes and other austerity measures to make up the resulting budget gaps.”

Discounting is part of a tug-of-war that colleges and universities play with their enrollment numbers and bottom lines. They place their sticker price beyond the reach of many potential students but make up the difference between that price and what a student can or will pay through institutional grants and scholarships. Proponents have argued that there are some psychological benefits to having a high sticker price, such as the perception of quality, and high discounting, such as the value a student perceives when he is offered a large package.

The strategy pays off financially when enough students can pay the sticker price. But when too few students pay sticker price, too many students need large aid packages, or enrollment numbers aren’t met, colleges and universities that depend on tuition revenue are put in a tight spot financially. Moody’s Investors Service reported last year that 15 percent of private institutions could face stagnant or falling revenues for the 2011 fiscal year because increases in discount rates outpaced increases in tuition rates.”

This condition will force colleges and universities to tighten their belts and begin reducing their costs. This is a good thing. It has happened to just about every other industry in the country and now it’s time for the academic elites and college administrators They will have to reduce their bloated staffs, put expansions of facilities on hold and figure out how to increase the qualities of their degrees. They will also have to evaluate, as did other industries, the courses they offer. Courses like women’s studies, African-American studies, Gay studies, and other such social focused courses will need to be dramatically reduced or eliminated altogether. Students are taking these powder puff courses to breeze towards a degree, a degree that will bring no hopes of future employment except within the academic community that will be downsized if the tuition bubble bursts.

David Swindle blogs in PJ Tatler:

“I have a special interest in this subject and you can expect blog posts from me on it regularly at PJ Tatler. From December 2007 through the end of July 2009 I worked full-time first as a student loan debt collector and then as an assistant manager helping oversee a team of such “default prevention specialists.”

To begin to understand just how screwed up the situation is it’s important to realize how federally-insured student loans are so different than other kinds of debt. As a “collector” I barely actually collected any money. Instead my job primarily entailed tracking down borrowers so they could put their loan back into forbearance or deferment so they would not default. Borrowers for loans dispersed between the early ’90s and the passage of ObamaCare have a wealth of perks for those who are unable or uninterested in making payments. Lose your job? No biggie, you’re eligible for 2-3 years’ worth of unemployment deferment. Have a job that’s not paying you much? Chances are you’ll be eligible to use some of your 3 years’ worth of economic hardship deferment. Have other bills that you’d rather pay instead of your student loan? No problem, Sallie Mae and many other lenders offer sometimes as much as FIVE YEARS worth of forbearance time. Well, what happens if you’ve burned through all the time and still want need time off from having to pay? Sallie Mae offered 3 years of Title IV administrative forbearance that had the same qualifications as the economic hardship deferment. Thus, as a collector I’d regularly come across borrowers who had gone YEARS without ever making a payment and the loan’s capitalized interest had just grown and grown and grown — much to the bank’s delight.

And what happens if someone actually does default on their student loan? First of all they have to be delinquent for around a year before that happens. At 270 days of delinquency the loan is eligible for default but it usually doesn’t actually happen until 330-370+ days of delinquency. (The banks are legally required to perform due diligence to try and prevent default. If adequate attempts have not been made to reach the borrower then it cannot be defaulted.) At default the guarantor (the federal government’s collection of your taxpayer dollars) reimburses the bank almost everything owed and the borrower’s loan is sold to a collection agency. At this point the debt will increase by another 20% or so in collection fees but the borrower will often have the opportunity to “rehabilitate” the loan to bring it back into good standing. Usually they do this by making a year or so of auto-debited or at least consecutive payments. Then the loan returns, though much larger. But what also comes back? ALL of their deferment and forbearance options are reset back to zero because it’s basically a new loan. Then the whole cat-and-mouse process of putting off paying the loan, trying to hide from collectors and skip tracers, and letting the interest capitalize more and more can just start again.

It should be pretty obvious why a system like this is unsustainable and doesn’t actually help anyone except the big banks and politicians in both parties.”

There’s a reason why federally-insured student loans cannot — and SHOULD NOT — be discharged in bankruptcy. Would you like to guess what happened when they could? People who were perfectly capable of making the money to pay back their loans — like doctors and lawyers — would just declare bankruptcy to clear the huge debts they had accumulated going through law or medical school. Who cares if their credit is trashed for a few years? They’re making more than enough money with the skills and credentials that they have just effectively stolen.

Education is not like other investments. If a bank loans someone money to buy a house, business, or a car and the borrower cannot pay the loan then there are means for at least recovering some value: repossess the car, foreclose on the house, or liquidate the business assets. But what to do when millions of people decide they don’t want to pay for the education and the life experiences they’ve just had over the course of (in some cases) a decade?

Here’s the straight dope: everyone who takes out their student loans is capable of making some kind of payments. Maybe not as large a payment as the banks want but that’s why income-based repayment programs exist. (And don’t bring up the already-granted exceptions of those who become disabled. The one correct exception to the rule is that yes, federal student loans can be discharged due to disability). All the various options added up together make it entirely possible for especially “hard luck” individuals to delay paying their loans for more than ten years (5 years forbearance + 3 years economic hardship deferment + 2-3 years unemployment deferment + 3 years Title IV administrative forbearance.) But of course you’re not supposed to do that. The options are supposed to just be used here and there and you’re supposed to be making payments and trying to pay off one’s debt, instead of finding creative ways to avoid it. Anyone who “cannot” make payments is really just choosing to spend their money on other things — just as our federal government is debating raising the debt ceiling because it refuses to talk seriously about choosing to end destructive entitlement programs (like this very one) that actually hurt far more than they help.

Given the way our culture from the President and leaders of both political parties regards dealing with paying debts at the government levels it’s not surprising that plenty of people are going to not take seriously paying their personal debt.

Everything has a cost. And the personal cost (never mind the costs spread out across the taxpayers) of the federally-insured student loan is that they can’t be discharged during bankruptcy. It’s just a different way of paying for the perks. Students who want to be able to discharge their loans in bankruptcy do have an option — private student loans. They aren’t much different than credit cards — they have much higher interest rates and no get-out-of-jail-free cards when you’re unemployed.

We need to remember that anytime anyone defrauds the government they are stealing YOUR money and your unborn grand-children’s money. (And when people default on their federally-insured student loans that’s exactly what they’re doing — they’re breaking the agreement they chose to make.) Perhaps if more citizens remembered that there’d be more interest in disassembling this financial black hole we euphemistically dub the “welfare state.”

Politicians, including Barack Obama , still give lip service to the notion that everyone should go to college and can profit from it. And many college and university administrators may assume that the gravy train will go on forever.

But that's what Las Vegas real estate developers and homebuilders thought in 2006. My sense is once again well intentioned public policy and greedy providers have produced a bubble that is about to burst.

1 comment:

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