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September 20, 2010

The Amazing College Debt Bubble
Teaching One Student Costs Only $1,456 A Year?

By Andrew Gillen

News that student loan debt, at $830 billion, exceeded credit card debt for the first time has sparked renewed interest in the financing of college and its implications for students. Largely ignored in the discussion, however, is the shadow debt, which consists of unorthodox methods of borrowing for college, including home equity loans and lines of credit, retirement account loans, credit card debt, and run-of-the-mill bank loans. Because these borrowing instruments often have many alternative uses, we have to rely on surveys to determine how much of the total amount borrowed in each category is devoted to paying for college. The most comprehensive such survey is conducted by Sallie Mae and Gallup. Their findings indicate that shadow debt adds just under $30 billion to the annual borrowing for higher education (see this link for more details on the calculation). As shown in the table below, when this is added to the $96 billion in college specific loans, we can conclude that Americans borrow roughly $126 billion a year to pay for college.

CAU_table.gifOf course, there are a number of caveats to this number. To begin with, this is at best a back of the envelope calculation, and better data would allow for a more accurate picture to be painted. In addition, some of this may not be borrowing in the normal sense of the term. For instance, some well off families may pay for tuition on a credit card to receive the rewards associated with their card, and then pay off the balance immediately. There is also the fact that some of the education borrowing is not used solely for education. I knew people who used student loan money to purchase a car, or a big screen TV, and even breast implants. At the same time, not counted are informal loans from family and friends. Thus, $126 billion is the best estimate we have for the amount of money that Americans borrow for college.

Enough Blame to Go Around?

This heavy debt load is causing much suffering, and whenever there is suffering, it is tempting to blame it on some easily vilified scapegoat. The for-profits seem to be serving that function these days, and while they are by no means blameless, there is plenty of blame to spread around.

First up are students and parents. While earlier generations that paid only a few hundred dollars a semester can perhaps be forgiven for continuing to believe that college is a nearly risk-free decision financially, today's students do not have that luxury. Exploding tuition and the related horror stories about crushing debt loads appear regularly in the media. Yet students and parents largely ignore these warnings. The views that more (formal) education is almost always a good thing and that the loans needed to finance it are "good debt" since it is an investment are both widespread and contribute to the problem. While true to an extent, these views can be and are being carried too far by some, blinding some individuals to the dangers of debt.

The government also shares blame for the high debt load. Part of the problem is that the government seems to be encouraging too many students with little prospect of graduating to borrow money to attend college. As Professor X lamented , "we are not comfortable limiting anyone's options. Telling someone that college is not for him seems harsh and classist and British, as though we were sentencing him to a life in the coal mines. I sympathize with this stance; I subscribe to the American ideal. Unfortunately, it is with me and my red pen that that ideal crashes and burns." The abysmal graduation rate at many colleges indicates that either too many students with poor prospects of graduating are being encouraged to enroll, or that colleges are not very good at teaching struggling students. Either way, the students that fail or drop out must still repay what they borrowed, but without the higher earning power that college graduates typically enjoy.

Moreover, the federal financial aid programs are not well structured. One particularly problematic culprit is loose lending standards. Figures from the Department of Education reveal that 35% of dependent students from families making $100,000 or more received Federal Stafford loans, and 16% received the subsidized variety (where the government pays the interest while the student is in school). Subsidizing the well-off in this manner is questionable on egalitarian grounds, even more so when there is reason to believe (as my own and other research indicates) that this is likely to lead to higher tuition and reduced affordability.

But by far the largest share of blame for the tsunami of debt falls on the colleges themselves. As Robert Martin argues, "higher education finance is a black hole that cannot be filled." Colleges have nonetheless attempted to fill the hole with student borrowing. Such greed, when filtered through a well-functioning market, need not be a cause for concern as the market channels it into useful and productive activities. Unfortunately, the higher education sector cannot be characterized as a well functioning market. The lack of adequate measures of outputs or outcomes is primarily responsible for this, but there are other contributing factors including the non-profit or public status of most institutions, the principal agent problem, and peer effects.

What Are Wake Forest and Yale Doing?

One consequence of the dysfunctional market for higher education is that we end up in an arms race that yields misspending on a massive scale. The resources devoted to administration, athletics, new buildings, and low payoff research is simply staggering. The most recent example comes from Jay P. Greene, Brian Kisida and Jonathan Mills, who report that "Wake Forest, Yale, MIT, Harvard, and Dartmouth spend more solely on administration per student than the average university spends on everything per student. The nearly $75,000 at Wake Forest and the nearly $60,000 at Yale per student spent on administration must buy some truly excellent administration." All of this money must come from somewhere, and as state budgets continue to be squeezed by the economic turmoil, colleges will increasingly turn to students, and the students will increasingly turn to debt.

The human cost of such massive debt is incalculable. While many, such as myself, are managing to repay our borrowing without too much pain in terms of loss of career choice and/or a lower standard of living, many others are not so lucky. When debt loads are high, borrowers are forced to accept a lower standard of living, and often feel they cannot choose a less lucrative but more enjoyable career. Some are forced to put off marriage and children, move back in with their parents, and otherwise delay the traditional milestones of adulthood. But even these folks are viewed as lucky by the few who simply do not and never will make enough money to repay their loans. These unfortunate few have even had hope taken away from them.

If we as a country continue down this road, the future for tomorrow's graduates is not promising.

We can catch a glimpse of that future by looking at the current state of law school and humanities Ph.D programs. There are a plethora of new blogs and writers exposing the mismatch between the cost of attending law school and the number of jobs available that pay well enough to allow graduates to repay their debt. Similarly, the plight of English Ph.Ds has been documented for years. Both of these fields suffer from a mismatch between the number of students hoping for a career in the field and the number of jobs available that pay high enough to allow students to repay their debt. Since that mismatch explains much difficulty in repaying debt, we can take comfort that it is not more widespread. But a labor market mismatch is not the only method to realize difficulty repaying debt. If the debt load of students in general continues to grow, their experiences with debt repayment will increasingly mimic those of disgruntled lawyers and English doctorates.

Is There Hope?

Is there any hope that we can lighten the debt load on students? Perhaps as time goes on, for whatever reasons, it will always cost more and more to provide a college education, and that cost will be increasingly borne by students. If that is the case, then maybe we are stuck with ever increasing debt loads.

This is very unlikely. Baumol's cost disease does apply to higher education, but it explains very little of the cost explosion. Bob Samuels recently calculated that given current class size and staffing patterns, "the total average annual instructional cost per student is $1,456." It should be emphasized that this figure was not arrived at by assuming cuts to current instructional spending. Rather, it represents what colleges currently spend on instruction. Similarly, Vance Fried has estimated that a first rate education could be provided with per student instructional costs of just $2,366.

Since these figures are only instructional spending, they don't account for other valid spending - colleges do need some administrators, and some buildings in which to hold classes. But there are other sources of revenue as well. Current levels of state appropriations are generally sufficient to cover all necessary non-instructional costs, including capital requirements. As Samuels summarized, "public universities charge on average $7,000 per student and they get another $8,000 per student from the state, but in reality, it only cost about a tenth of this amount to teach each student."

Perhaps the best way to put these figures into perspective is to realize that the $1,456 per student that colleges actually spend on instruction implies that the $126 billion that Americans borrow would cover the instructional costs for 86.3 million students. Using the higher figure of $2,366 for instructional costs, Americans' borrowing would still cover the instructional costs for 53.3 million students. And yet we only send 18.7 million students to college (and many of these are part time students). Alternatively, the entire instructional cost of the 18.7 million students we do send to college could be covered with between $27 and $44 billion dollars, even when counting part time students as full time.

This finding is both reassuring and depressing. It is reassuring because it indicates that such high debt loads are not inevitable. In fact, just a few decades ago, there was no student loan bubble, because the cost to the student and cost of provision were much more closely aligned. The current high debt loads are an artifact of peculiar circumstances that allowed the cost of college for students to deviate very far from the cost of providing a college education. If costs for students declined to where they should be, there would be no need for students to take out so much debt. Just as we now consider housing pre-2007 a bubble because of the deviation of housing prices from their fundamentals (such as price to rent ratios and price to income ratios), we will consider the deviation in the cost of provision and the cost to students of college to be a student debt bubble.

However, these findings are depressing as well because they indicate that the forces that resulted in the cost of college for students being so much higher than the cost of providing a college education are both widespread and systematic, implying that they will be very hard to overcome. In my opinion, the primary force leading to divergence is the striving for prestige / the educational arms race, which is in turn attributable to the lack of measures of output of colleges in terms of value added learning of their students. If that is the case, we will not see convergence between the cost of providing a college education and the cost to students until there are reliable measures of the outputs of colleges. While there are a number of attempts to create such measures, in the near future, there is little likelihood that they will succeed and achieve prominence, which means that the student loan bubble will continue to inflate.

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Andrew Gillen is the Research Director of the Center for College Affordability and Productivity.



Comments (20)

Matt:

The K-12 part of our education system has a similar quality-measurement (or lack thereof) problem. No one agrees on how to measure schools, especially across state lines.

I do think that the cost of college is the more pressing problem. It's interesting how we as a country are perfectly able and willing to say to K-12 schools: "your budget isn't going up, make do with what you have", resulting in the elimination of many extra-curricular programs. Meanwhile, when it comes to college we're willing to subsidize opulence, in both public and private schools.

A major contributing factor in my opinion is the obfuscated costs to the average taxpayer of the post-secondary school subsidies. The budget for your local K-12 school has a direct and visible impact on your property taxes. The cost of Dept. of Ed loans that may or may not be paid back, the direct subsidies to colleges, the indirect subsidies (e.g. NSF grants), all make it difficult for normal people to analyze the costs.

Duke:

There is another aspect to college cost/benefit analysis that I find overlooked recently, and that is the substance of the education. If one leaves MIT or Stanford with an engineering or hard science degree, the graduate's income potential is raised quite a bit and the likelihood of securing a position in those fields is good (in normal times). In that respect the cost/benefit is properly whether the added expense of MIT/Stanford is worthwhile as compared to some lesser known and less expensive institution. If one earns a degree in some garbage social science track (race/feminist theory come to mind), the cost/benefit calculus I think can almost never come up positive for the student regardless of where the degree is from, not least because there is an extremely limited market for that subject matter, primarily teaching it. Other tracks such as history, English and some specialties in the arts are not so one sided either way.
The appropriate metric is not so much college A versus college B versus no college, but cost/benefit has to drill down to the course of study.

Hans Carlson:

Much of the problem would vanish if student loans were dischargeable in bankruptcy, which they are currently not. Non-dischargeability means the lending spigot is turned on full. Of course, schools will take advantage of this easy cashflow to the customers (oops, students) by raising prices. Turn the spigot down to a trickle, and prices are almost certain to fall dramatically.

Niantic Rebel:

When laying the blame you need to also include primary, middle, and high school educators who unceasingly preach that all students must attend college. It has reached the point where many school systems are making a prerequisite to graduate high school proof of admission to a college.

jblog:

Want to lighten the college debt load for your kids? Do what we did. When they graduate from college next spring and the one following, my kids will have no college debt.

How? No, we're not billionaires. The answer is we saved.

While others were driving the latest BMWs and Lexi, we stuck to modestly priced (often, used) cars -- and ran them into the ground. While others jetted off to the Bahamas, we took modest family vacations at American beaches. While others bent the plastic until it broke, we paid off our credit card balances each month. Our longer-term debt load? Typically our mortgage and a car payment -- that's it.

So we were able to tuck away a significant amount of money for college.

And when it came time for our kids to go to college, we picked academically competitive schools that were within our financial reach. Both kids did well enough in high school to qualify for some merit scholarship money at the schools they attend -- not a lot, but it helped.

Frankly, I don't really think this is all that complicated and I don't know why more people don't do it. It's called having financial goals and living within your means.

How is this anything other than a cultural problem? We weren't so debt crazy 60 years ago and there were opportunities out there then for people to borrow enough money to ruin themselves. Look around you and see who we are today - self-denial is for losers and squares, man. We're edgy and hip and don't follow the rules, dude.

We're also totally bankrupt in almost every facet of our society.

How's that whole 60s cultural revolution working out for you?

TheOldMan:

When I attended UM Ann Arbor engineering school 30+ years ago, the engineering buildings were functional but old, built in the 30s. The business school was a bit newer, perhaps late-60s, early-70s. The rest of the campus was old, solid, functional buildings.

I stopped by in the mid-90s and almost all the buildings were new or under construction. Fancy student commons areas, shiny new buildings, health club facilities, etc... Do any of these fancy new facilities actually improve education or are they part of an "arms race" between colleges to entice students with "froo-froo" coffee shops, rock climbimg walls, and other fluff?

Sure the engineering building were hot in the summer (we just opened the windows), the steam heat varied from room to room in the winter, but I managed to get a valuable education w/o bankrupting my parents.

My point is that far too much money has been poured into non-education related fluff which then requires higher tuition to pay for it. Also the constant drumming that all children must go to college has provided an almost guarenteed clientele regardless of cost.

DRJ:

I think this is a profoundly important topic and I think the author for his excellent post. It occurs to me that there is another emerging component to the problem that will further complicate its solution.

I graduated from the University of Texas at Austin over 30 years ago. UT has admirably devoted many resources and significant funds in attracting minority and low-income applicants, many of whom are the first from their families to go to college. Many take out large loans to finance college, often with limited understanding about how hard it will be to pay back and which majors will make it easier to find good paying jobs.

To a certain extent, then, I expect this problem this will become a racial and socioeconomic issue as well as a financial concern.

DRJ:

I agree with the comment above that making student loan debts dischargeable in bankruptcy is a viable solution. However, making that happen will be more difficult now that the Obama Administration and Democratic Congress have rushed through legislation effectively nationalizing the student loan system. Rather than making them dischargeable, I frankly expect student loans to continue to be non-dischargeable in bankruptcy and perhaps even treated as priority debts the way we currently classify debt owed to the IRS.

notsofast:

The debt load for new students generally does isn't there anymore, if the student is paying attention at all.

Look up Income Based Repayment. Look who qualifies for it - virtually everyone, and well into 6-figure incomes in many cases.

Any student with a normal assortment of loans can, upon graduation, have some or all of the interest over the life of the loan written off, and possibly even a large chunk of the principal. A student with a nice fat 6-figure debt from a private school who lands a job for 35K a year will have a reduction in monthly payments from about $1500 to $250

After a set term - 25 years for us little people, and 10 years for special people (i.e., civil servants), the government writes off the remaining balance. There is a minimum payment, so those not working for the whole term may pay $5 a month and get virtually the entire amount written off.

Is this pretty blatant pandering to both students and universities, sure... not sure why it is still under the radar at this point.

Disposing of the debts in bankruptcy doesn't make them go away, it just means someone else has to pay them.

Let's see here, pension funds, states, cities, the Federal government, Fannie Mae, Freddie Mac, GM, Chrysler, families with monster student loans ... yep, that must be the fault of those for-profit schools! That's why we've got a problem with student loans!

The problem is in the mirror every day. We don't save for things and buy them with cash. We borrow and borrow and borrow and ...

mothergoose:

When our daughter went to orientation at Indiana Unviversity in 1991, one of the counselors told us about how this was a time to explore and that many students take 5 or 6 years to finish a BA or BS. We told her that we would only pay for 4 years for a BA..and both our children finished in 4 years. Schools encourage students to "explore" and to major in mindless things like "marketing with a specialty in retail sales" which raise the amount of loans and diminish the chances of a job which will pay for them.

Smackey the Frog:

Having ten years of university experience under my belt (5 y undergrad in a private institution, 5 y grad resulting in a PhD from a public university), I have given this some thought.

I think there's another side to this that's particularly troubling. I don't doubt that there are majors in number of schools that promote an extremely left-wing worldview, particularly in social "sciences" and humanities. A good number of these majors also have higher default rates. Therefore the taxpayers as a whole subsidize these extremist agendas, unknowingly, while legitimizing their very existence, and sustaining the professors who teach these anti-American philosophies.

I think we should consider that first, loan interest rates should be rated for their default risk according to the major. Even on a non-ideological bent, it makes no sense to be graduating thousands of students in majors for which there are no jobs.

Second, we should consider holding the schools themselves accountable for the success of loan payback. After all, they have been profiting on false marketing. I'm not sure but I think default rates are already calculated into federal loan eligibility requirements, but I think it's for the school as a whole, not the major courses of study as individual risks. Also, that's not a backward accountability, only for future loans. After a threshold default rate, the school should return the funds to the loan sources (parents, students, and government) if enough students fail to be employed. Of course, it would be a decade out before it could be determined, but it's a lot of money.

I know there are a lot of problems to those ideas, but universities have become 5 or 6 year parties for irresponsible kids who then struggle with loans they are not prepared to pay. The schools themselves are also not accountable for the money they spend, the waste is enormous.

CC:

Another factor in the increase in admin costs is the immense amount of money colleges spend to recruit students of color in their relentless pursuit of diversity. The price of these recruitment programs is not small, nor is the amount of financial aid needed for some of the recruited lower income students to attend schools charging $30k/year and upward.

cathyf:

You missed the point, K T -- discharging student loan debt in bankruptcy means that creditors must pay attention to the probability that students will go bankrupt when they make the loans and set their terms. You can be pretty darn sure that no one would loan you $120,000 to get a degree in gender studies if they faced the high probability that the money would not get paid back. And they would take a lot more interest in the students' GPAs and where they are going to school.

In fact, making student debt dischargeable in bankruptcy would either cause "reliable measures of the outputs of colleges" to be developed, or settle once and for all that they are impossible.

Others reading your blog and the comments see that you are replying to comments as well. Replying to comments is the key to discussion and you have to lead by example and reply to the comments to encourage others to reply as well .

Landon:

I discovered your site from wikipedia. It is cool. Pls continue this great work.

Robichard:

I tend to agree with some posters here who see this issue differently.Obama and a growing number of Dems want Brown to win.This is the only way to have obamacare killed and blame Republicans.They see this as a face saving solution for them in the eyes of the electorate and hope that such outcome will check the anti-democrat tide in November.

Zellmer:

If you try to understand why significant amount of people did not like the movie, you might see their point. You can't label them as ignorant, unintelligent, arrogant, narrow minded Indians.

I would not expect to be admitted to Harvard if my academic record was not competitive,EVEN if I put out a great effort.

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