18 August 2010

About Student Loans

There has been an immense increase in student loans for students at for profit colleges which are almost more expensive than comparable program at public college, and are frequently serving the students who are less likely to succeed in the first place. Student loans for students at for profit colleges have gone from $4 billion to $26 billion in a decade, and particularly at for profit colleges, the default rates on these student loans is exceedingly high:

[O]ne in every five government loans that entered repayment in 1995 has gone into default. The default rate is higher for loans made to students from two-year colleges, and higher still, reaching 40 percent, for those who attended for-profit institutions. . . .

For loans made to community-college students, the 15-year default rate is 31 percent. . . . While for-profits educate less than 10 percent of students, those colleges' students received close to a quarter of Pell Grant and federal-student-loan dollars in 2008, according to the College Board. And they accounted for 44 percent of defaults among borrowers who entered repayment in 2007 . . . .

Only 10 percent of community-college students took out federal Stafford loans—the most common type of federal education loan—in the 2007-8 academic year, and most borrowed less than $10,000, according to the College Board. At for-profit colleges, 88 percent of students took out Stafford loans, and nearly 20 percent of associate-degree recipients graduated with more than $30,000 in debt. Those borrowing rates reflect the higher cost of attending a for-profit college. In the 2009-10 academic year, the average for-profit institution charged $14,174 in tuition and fees, according to the College Board, and the average community college only $2,544. . . .

Two years into repayment, 11.9 percent of borrowers who attended for-profit colleges have defaulted on their federal loans, compared with 6.2 percent of those who attended public colleges and 4.1 percent who attended private colleges. . . . Three years out, for-profit colleges' default rate has nearly doubled, to 21.2 percent of borrowers, and the gap between the sectors has widened. . . . For-profits accounted for 16 percent of all the loans (other than consolidated loans) issued from 1995 to 2007, but 34 percent of the defaults. Thirty percent of loans made to students attending four-year for-profit colleges have defaulted within 15 years of entering repayment, more than twice the default rates at public and private nonprofit four-year colleges, which are 15.1 percent and 13.6 percent, respectively.

The differences are smaller at the two-year level, where 40 percent of loans made to students attending for-profits have gone into default within 15 years of entering repayment, compared with 31.3 percent of loans made to community-college students and 29.3 percent of those made to students who attended two-year nonprofit private college.

But, when student loans aren't paid, the provider of the education that the loans paid for typically deserves some of the blame. Students who successfully complete their educations and get good jobs can pay their student loans. It may make time, but the value that they received from their education makes it possible for them to pay them.

All too often though, student loan defaults involve students who have gotten a raw deal. They paid a lot for an education, but didn't end up getting the credential that gives that education value, or didn't successful start the career that they were led to believe that their education would permit them to secure. Because they incurred the student loan finances cost associated with getting an education, but didn't benefit significantly from getting it, they are strapped.

There is logic in not allowing student loans to be discharged in bankruptcy. Education can provided a lifelong benefit to a student, and unlike a car or a house, the future earning potential that it imparted can't be repossessed. The future earnings potential imparted by education also isn't lost simply because the graduate is briefly unemployed, and the theory is that student loans ought to recapture this value added. It may take ten or twenty years for a student to gradually repay this loan out of the future earning potential, but for students who actually can earn more, it is possible.

While the logic of student loans makes sense for students who actually graduate from traditional programs at public or not for profit educational institutions, it does not necessarily make sense for students who do not graduate, or who attend non-traditional programs at for profit institutions.

But, the problem with the status quo is that it doesn't take into account the situations where no significant future earning potential was imparted by education, or where the benefit is much smaller than the cost. If a college charges $40,000 for a babysitting certification program, and graduates make only $1 an hour more than child care professionals without certification, the future income imparted by the certification process will never be enough to pay for the tuition.

There is a class dimension here as well. Working class students are much more likely to attend for profit colleges, or to start college but drop out without getting any meaningful future income benefit than middle class or upper middle class students.

This isn't simply a matter of blameless higher education providers offering a service to students impartially making decisions about education as rational actors. For profit institutions of higher education have marketing programs specifically intended to skew a student's rational decision making process with false or misleading information and sales tactics.

Perhaps we should require educational institutions whose educational product's failure drives defaults on student loans bear some of the financial burden of those default.

Why not? This is what we expect originators of mortgage loans that can't be repaid to do if default rates are unreasonably high, and educational institutions are the de facto originators of student loans. The incentives involved is producing students who will not default on their student loans seem closely aligned with the incentives that educational institutions should have in any case.

A requirement to make bear some financial responsibility for student loans that go bad would also change the marketing incentives of for profit institutions of higher education. For profit higher educational institutions are always going to want to increase their market share. But, if they had financial responsibility for excess student loan defaults, the incentive would be to increase their market share of students who will leave the institution able to pay their student loans, rather than an incentive to simply maximize tuition revenues.

There is no need for an educational institution responsibility requirement to be limited to for profit educational institutions either. In fact, most public and non-profit operated educational institutions have low default rates and wouldn't have to make good on their responsibility. But, an unusually high level of student loan defaults are a sensible warning sign for any institution that it is not appropriately serving its students.

We are less worried about abusive sales tactics by public and nonprofit institutions of higher education, however, because they have different incentives. At public institutions, more students stretch limited higher education dollars thinner and satisfied graduates are necessary to secure political support in the long run; rather than worrying about making profits from students, they often operate on a "use it or lose it" instinct, so we aren't concerned about an underinvestment in providing educational services relative to other institutional costs. At private institutions, tuition is almost never sufficient to cover the full cost of educating students. Endowment funds and charitable gifts are necessary to make ends meet. So, unnecessarily increasing enrollment is financial drain that only makes sense if those students graduate and are successful and go onto give money to the institutions themselves.

This doesn't mean that students themselves don't share in the responsibility for deciding to spend too much on educations that won't benefit them very much, or for failing to complete their educations and thus failing to get the benefit from those educations. But, a student loan system that places the responsibility entirely on the shoulders of the students themselves fails to recognize that there are third parties who have a great impact on whether or not students make good choices about their educations, and who have the ability to change how education is provided in a way that would reduce default rates that have no responsibility and hence weak financial incentives to improve under the current system.

The student loan program relies on admissions offices in public and non-profit colleges to serve as de facto loan underwriters. At for profit institutions of higher education, however, this isn't happening.

Just as home ownership isn't in the best interests of everyone at every point in their lives, education, while generally a good thing and an important step on the road to achieving the American dream, isn't an unmitigated positive choice for everyone at all time at any price.

For profit education certainly makes sense if graduates, on average, are coming away with economic benefits proportionate to the cost of the education. And, the fact that a particular student fails is not an indictment of the institution if students are in general succeeding and this particular student's failure is an exception rather than the rule. But, education that costs more than comparable public or not for profit educational programs should be providing better results and should be held to higher standards, not more lenient ones. The fundamental principal of capitalism that gives it social utility as an economic system is that only firms that can add value should be permitted to survive.

One of the big arguments that has been made in favor of for profit educational institutions is that they serve students who often wouldn't have gotten an education without their marketing push. Affirmative action for all students who might not be getting a higher education without special attention is part of their business plan.

But, if those for profit educational institutions are producing students who are more likely to fail economically after the graduate and cost more than comparable public college programs, then the money that the public pays to make good on its guarantees of student loans that default from these institutions would be better spend on marketing for public colleges.

Community colleges with lower tuition lead to smaller student loans and a large share of students don't have to take out students loans at all to finance their educations, so they don't need to add as much to a student's future earning potential to make economic sense.

Also, keep in mind that at least in Colorado, community colleges are inexpensive because they have low costs per student, not because they have big subsidies. Tuition is a larger share of their revenues than any other public higher educational institution in the state. Community colleges in Colorado receive virtually no institutional support from the state general fund. They receive a little casino tax money. They receive some money in the form of higher education vouchers that are available to in state students in the same amount no matter where they go to college. But, no part of the higher education system, public or private, provides education at a lower cost, and none of the money received is diverted provide a profit to private investors.

Also, community college have no incentive to, and don't, lead students on. A very large share of all students who don't complete community college do so after a single semester of academic demands that they can't handle. Those students may be left with student loans, but a student loan from a single semester at a community college isn't huge, and the interest rate and repayment terms for a publicly subsidized student loan are generous, so even then, students may have a reasonable ability to repay it. Community college is financially a low risk proposition for the student and the governments that are providing the opportunity alike.

In contrast, a for profit college has a strong incentive to encourage students who clearly aren't likely to succeed in the educational program or the career that follows to keep trying in order to college more tuition under the current system.

If any institution is going to have a high failure rate, it should be public community colleges where the stakes are lowest, and the likelihood of default lower than it is at for profit colleges.

I'm not opposed to for profit higher educational institutions. I was a professor in one myself. But, they need to operate with the right kind of business model.

It is entirely appropriate for them to cherry pick by providing education only to students who can either pay full price without government assistance, and students who are likely to benefit enough to repay the student loans they incur at rates at least as high as those of public and non-profit institutions. It is entirely appropriate for them to offer only programs that have concrete economic value for students rather than the full array of academic offerings that ordinary public and non-profit institutions provide.

For profit higher educational institutions aren't in the business of providing universal education or advancing human knowledge for the sake of advancing human knowledge. But, they should have a win-win relationship with their students and do business without expecting government subsidies.

The niche in the higher education market where for profit higher education really makes sense is probably a "high end" of the market niche, not a "low end" of the market niche. For profit law schools and medical schools and M.B.A. programs probably make much more sense from a business model perspective, in the absence of significant public subsidies, than the niche that they are trying to fill now. Perhaps I am deluding myself, but I think that providing master's degree educations to financial planners at the "high end" of their profession serving wealthy clients who are often in places where there are no public or non-profit programs available, as I did, is also an appropriate niche for a for profit business model in higher education.

But, there is no good reason that the government should be in the corporate welfare business. It does make economic sense to subsidize higher education, but it doesn't make sense to subsidize shareholder in private corporations devoted to making a profit.

The simplest way to end abuses in the for profit higher educational sector is to avoid the incentives they have to profit by creating externalities and government subsidies. And the simplest way to achieve that end without micromanaging their practices in an area were innovative approaches may be key to success, is to make for profit higher educational institutions financially responsible when students at their institutions default at excessive rates. In effect, for profit higher educational institutions should be providing a partial guarantee of the student loan portfolios that they generate.

These incentives will probably force many working class and minority students out of for profit institutions of higher education. To the extent that this pushes them instead into public college programs with lower default rates and lower costs, this is good. To the extent that these students drop out of the system all together, funding outreach programs by community colleges may be a far more cost effective way to achieve this end that guarantees of student loans at high cost institutions with very high default rates.

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