The next bubble: student loans and Academia

posted at 10:58 am on February 5, 2009 by Ed Morrissey
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Picture a market with overpriced product, driven by government-subsidized consumers that create an artificially high demand with overextended debt, on which major institutions rely as investments.  A description of the American housing market, 1998-2008?  Sure, but it also describes the American college market, and Kathy Kristof writes for Forbes that Academia may be the next bubble to pop:

Misguided easy-money policies that are encouraging the masses to go into debt; a self-serving establishment trading in half-truths that exaggerate the value of its product; plus a Wall Street money machine dabbling in outright fraud as it foists unaffordable debt on the most vulnerable marks.

College graduates will earn $1 million more than those with only a high school diploma, brags Mercy College radio ads running in the New York area. The $1 million shibboleth is a favorite of college barkers.

Like many good cons, this one contains a kernel of truth. Census figures show that college grads earn an average of $57,500 a year, which is 82% more than the $31,600 high school alumni make. Multiply the $25,900 difference by the 40 years the average person works and, sure enough, it comes to a tad over $1 million.

But anybody who has gotten a passing grade in statistics knows what’s wrong with this line of argument. A correlation between B.A.s and incomes is not proof of cause and effect. …

Offsetting that million-dollar income discrepancy is the $46,700 four-year cost of tuition, fees, books, room and board at a public school and $99,900 at a private one–even after financial aid, scholarships and grants. Add all this to the equation and college grads don’t pull even with high school grads in lifetime income until age 33 on average, the College Board says. Even that doesn’t include the $125,000 in pay students forgo over four years.

It’s impossible to recap Kristof’s thorough reporting here; one has to read the entire column.  One difference between the housing subprime market and what Kristof describes as the student subprime market is the lack of government guarantees on the most profitable of the loans.  Lenders can do better by avoiding government purchase of the paper, as they can avoid some of the restrictions.

Otherwise, the student lending market carries most of the same characteristics of the housing meltdown: exaggerated claims, predatory lending, and overburdened borrowers who quickly learn that they’ve gotten in over their heads.  Many of these loans come at credit-card interest rates, as the regulations do not impose a cap.  What happens?  Students default, ruining their credit for years and leaving the lenders and their investors with empty pockets.  SLM, called Sallie Mae, has lost 80% of its shareholder value thanks to what it called “nontraditional lending”, although its CEO mananged to cash out in 2007 with $72 million in stock sales before the bill came due.  If that sounds familiar, see Franklin Raines and Fannie Mae.

The root cause of this impending bubble is the same for the housing market.  Politicians decided that all students should go to college, just as they decided that all people should own their own home.  Those are certainly admirable goals, but prescriptions for disaster as public policy.  Rather than create public colleges with no requirement for tuition, which would have been the honest way to implement that policy but completely unpalatable as a spending plan, the federal government pushed for tuition loans, upping the demand at universities.  With billions of dollars flooding the market and consumer demand dramatically rising, prices increased across the board, predictable from the basic economic law of supply and demand.  When prices increased, the subsidies increased, which increased demand and pushed prices higher, creating a vicious cycle … exactly as it did in the housing market.

Government has to get out of the lending markets altogether.  If politicians want to subsidize education, they should create more supply and lower the price in order to create the increased accessibility they want, not create bubbles in lending markets.  Better yet, government should stay out of it altogether and let the market take care of itself.

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