PethGraph1.jpg

What Student Loans, College Financing, and Duff Beer Have in Common

The New York Fed:

Outstanding student loan debt now stands at $956 billion, an increase of $42 billion since last quarter.  However, of the $42 billion, $23 billion is new debt while the remaining $19 billion is attributed to previously defaulted student loans that have been updated on credit reports this quarter.1

 As a result, the percent of student loan balances 90+ days delinquent increased to 11 percent this quarter.And, as I blogged earlier, some sort of student loan bailout might be getting more likely.

All of this is an example of what I call the Duff Beer Phenomenon, named after Homer Simpson’s beverage of choice, which he once called  ”the cause of and solution to all of life’s problems.”

In the case of financing college, government is Duff Beer. Since 2000, tuition at public four-year colleges has risen by an inflation-adjusted 72%, or nearly 6% a year. At the same time, the real average earnings for workers aged 25 to 34 with only a Bachelor’s degree have declined nearly 15%, according to Citigroup.

PethGraph2.jpg

This raises two questions: First, are taxpayers getting value for the $65 billion a year in annual student aid and $100 billion in government subsidized loans? Second, could it be that student aid itself has a role the rise in tuition? Maybe, says a new Citigroup report:

Back in 1987, former Secretary of Education William Bennett suggested that “increases in financial aid in recent years have enabled colleges and universities blithely to raise their tuitions, confident that Federal loan subsidies would help cushion the increase. … Federal student aid policies do not cause college price inflation, but there’s little doubt that they help make it possible.” This has since become known as the so-called “Bennett Hypothesis.”

Indeed, analysis from Stephanie Riegg Cellini of George Washington University and Claudia Goldin of Harvard finds a 75% difference in tuition between federal aid-eligible and ineligible for-profit colleges, notes AEI’s Andrew Biggs. That’s an amount comparable to average per-student federal assistance. Riegg and Goldin also find that that aid-eligible institutions “charge much higher tuition … across all states, samples, and specifications” which suggests “institutions may indeed raise tuition to capture the maximum grant aid available.”

Some colleges may also take advantage of federal aid by reducing their own assistance. One study found that roughly four-fifths of the benefit students receive from tuition tax credits is lost through reduced student aid provided by colleges. Another found that “institutions capture 16 percent of all Pell Grant aid” with selective private colleges clawing back 79%, Biggs writes.

There’s already plenty of incentive to attend college. The average student loan balance is $25,000, while the average Bachelor’s degree holder will earn $1 million more over his lifetime than a high school-only graduate. Given how easily colleges can capture student aid from students who would go to college anyway, maybe it’s better to focus student aid on the truly poor.

Another option is using the venture capital model for student financing. Milton Friedman was in favor of “human capital contracts.” As I wrote for U.S.News & World Report back in 2006:

A student in need of college financial aid would go to a venture capital market and obtain investors in his education. In return for that equity-like financing, the student would pledge a specific percentage of his future income–as opposed to a loan’s fixed interest rate–over a specified period of time to be paid to the investor.

Eventually, human capital contracts could be combined into investment pools so the default risk could be spread over a large number of students. And as economist Gary Wolfram explains in a study, “As the market for these contracts developed further, shares in the funds would be traded in the same way that individuals purchase shares in such things as real estate investment trusts. This would create an economically efficient way to finance higher education that would allow students to graduate without having to fear that their future earnings would not be sufficient to pay their student loans.”

A radical idea? Only by the narrow standards of Washington policymaking.

  1. Crow
    James Pethokoukis

    Eventually, human capital contracts could be combined into investment pools so the default risk could be spread over a large number of students. And as economist Gary Wolfram explains in a study, “As the market for these contracts developed further, shares in the funds would be traded in the same way that individuals purchase shares in such things as real estate investment trusts. This would create an economically efficient way to finance higher education that would allow students to graduate without having to fear that their future earnings would not be sufficient to pay their student loans.”

    A radical idea? Only by the narrow standards of Washington policymaking. · · 8 hours ago

    I can see the rending of garments and gnashing of teeth on the Left now: “Conservatives want your children to be indentured servants to corporations!”

    As for Federal student aid, I’d eliminate it with the exception of ROTC programs. Each individual State can determine its own policies for public financing of students for its own university system. We also need a more reliable credentialing/apprenticeship system that doesn’t require a bachelor’s degree.

  2. Trace

    A few observations:

    1) As public policy investment, student loans still make a great deal of sense. Investing dollars to improve employability works and making it a loan rather than a grant makes even more sense.

    2) Part of this emergent problem stems from the massive numbers of students that entered the post-secondary system beginning in 2008 after being laid off. Today enrollments are down and those who borrow in the current environment are far more likely to repay, so this is a mouse in a python, not an inexorable trend.

    3) Student loan amounts do drive prices higher. In the for-profit sector, this is quite explicit, particularly among shorter-term, vocational programs because of a provision that requires that these schools collect no more than 90% of their revenue from Federal aid programs. This is meant to ensure students have “skin in the game” and appeals to lawmakers intuitively. However unskilled students studying for entry-level positions in say auto repair or medical assisting, have no resources other than what they can borrow. And so this means that as a practical matter, whenever student loan limits rise, prices have to rise accordingly. 

  3. Trace

    EVERYONE can benefit from post-secondary education. This does not mean everyone can benefit from a liberal arts degree or even a four year degree. But EVERYONE can improve their lot by acquiring additional skills. It is foolish to write that off. The alternatives are investments in welfare and prisons. 

    Chris Campion: There’s a host of problems in higher ed, but a lot of them can be traced directly back to the fact that:

    a.  There’s a federal student loan program, and

    b.  The educational system (at all levels) is absolutely convinced that everyone, and I mean everyone, can benefit from going to college.

  4. Trace

    As a practical matter, repayment on student loans does relate to the subject studied — accounting majors have among the highest repayment rates for instance — but it relates even more strongly to the affluence of the student. So the leisure studies student from an upper middle class family is a better loan bet for the Federal government than the inner city resident studying network engineering in many cases. There are loads of complicated and uncomfortable reasons for this, but means testing and/or major testing does not fix default issues.

    The federal government can do a far better job of scaring borrowers at the front end of the contract. The way it works now, they delegate this to schools and the borrowing is treated as a secondary formality rather than the very serious contract that it is.

  5. Trace

    The other thing worth mentioning is that the most idiotic major at Harvard will always repay better than the most pragmatic major at community college. 

    The point of the Federal loan system is to benefit society as a whole. If we have to eat some defaults to avoid eating even higher costs in welfare programs and prison costs, it’s a small price. 

    That doesn’t mean that alternative sources of funding aren’t a positive, but they will/can emerge if the market finds them effective and profitable. As in other areas however, those that don’t need to borrow have the lowest cost of funds. So as a matter of public policy private funding would chase socio-economic background before it chased major and it would chase high end institutions where public investment is least needed. 

  6. Cunctator

    This is exactly right. Would you lend your personal funds, say $70,000, to an 18 year old telling you he wants to pursue “Leisure Studies”? Would the University itself? Why is the government doing so?

  7. Garrett Petersen

    I’ve always loved this idea.  As it stands, students are the only people with an incentive to make sure their major will serve them in the labour market, but for one reason or another many students don’t get the proper information to make a good choice.  If the people providing the funding had an incentive to steer students into productive fields, it would be a good thing.  They would be like the insurance companies that run safe driving campaigns.

  8. Chris Campion

    There’s a host of problems in higher ed, but a lot of them can be traced directly back to the fact that:

    a.  There’s a federal student loan program, and

    b.  The educational system (at all levels) is absolutely convinced that everyone, and I mean everyone, can benefit from going to college.

    What this basically results in is that there’s an unending pool of applicants for a limited number of slots.  What happens when you have a product that more people want than you can provide?  The price goes up.  College employee salaries go up.  College buildings go up to house more students in more lavish dorms so as to attract more students to the college.  Colleges become convinced that they can do no wrong, since no matter what product they provide, more people want to matriculate than can attend.

    I’ve worked at a small liberal arts college in New England.  The arrogance at the highest levels, including the President, of what it is that they provide is astounding.  I think if a parent heard a Pres say “They’ll pay whatever it takes to go here”, they’d think twice about matriculation.

  9. Pilli

    I wonder what the derivative markets would look like once the loans were combined into investment pools.

  10. RightinChicago

    The Duff Beer analogy was a stretch that would have made Reed Richards jealous, otherwise it was a fine article. Incidentally, Homer described alcohol, not Duff as such, as the cause of and solution to all of life’s problems. The Devil is truly in the details.

  11. BlueAnt
    Erik Larsen: This is exactly right. Would you lend your personal funds, say $70,000, to an 18 year old telling you he wants to pursue “Leisure Studies”? Would the University itself? Why is the government doing so?

    I’ve always thought this is the natural end point of student loan origination.  You are considered a risk for every other type of loan you take out; why do we single out student loans and refuse to examine the risk wasting the investment?

    Of course, you wouldn’t want government programs doing this, because it would result in an inefficient classification of risk in the name of fairness.  Common sense tells us that straight “A” students going into business fields are the best risk, worthy of prime rates, while a master’s degree in puppetry is a poor investment.  But how do you codify that into bureaucratic rules?

    And how well do you think all the minority studies and communications/journalism majors will take it, when they start getting turned down for loans en masse?

  12. Lucy Pevensie
    Trace: EVERYONE can benefit from post-secondary education. This does not mean everyone can benefit from a liberal arts degree or even a four year degree. But EVERYONE can improve their lot by acquiring additional skills.

    6 hours ago

    Why?  Except because the high schools aren’t doing their jobs, even when they offer vocational education, and so people don’t graduate with the skills they should be able to get in high school. Other than that, I think this idea comes from two sources.  They are: 1) a response to the profit motive, because people see money to be made off of the backs of students who are tempted to overspend on education because student loans keep them from understanding the real cost and 2) a way to further infantilize young people who, a couple of generations ago, were able to support themselves, marry, and start families just fine at an age when a modern college student is probably just starting his sixth year toward an undergraduate degree.

  13. Lucy Pevensie

    Someone a few days ago suggested a great idea about the student loan problem: the schools themselves should be liable for any amount a student can’t pay back.  This would put out of business a lot of schools that are only harming kids by taking their money and giving them no useful skills. 

  14. Trace

    I’m sorry Lucy but this is ludicrous. So the schools are responsible for whether the students apply themselves? I suppose Weight Watchers should refund money to its customers when they regain lost weight? This is Occupy Wall Street claptrap.

    Lucy Pevensie: Someone a few days ago suggested a great idea about the student loan problem: the schools themselves should be liable for any amount a student can’t pay back.  This would put out of business a lot of schools that are only harming kids by taking their money and giving them no useful skills.  · 3 hours ago

  15. Trace

    I sincerely doubt you know much about this. High schools are teaching kids to read and write and doing a bad enough job with that. It is not also their duty to teach automotive repair. And vocational schools by and large have excellent graduation records and are required to maintain minimum job placement rates. They are more expensive than community colleges to be sure, but in terms of the net cost to the taxpayer for a well-trained, tax-paying and productive citizen are far less expensive.

    Lucy Pevensie

    Why?  Except because the high schools aren’t doing their jobs, even when they offer vocational education, and so people don’t graduate with the skills they should be able to get in high school. Other than that, I think this idea comes from two sources.  They are: 1) a response to the profit motive, because people see money to be made off of the backs of students who are tempted to overspend on education because student loans keep them from understanding the real cost and …

  16. Lucy Pevensie
    Trace: I sincerely doubt you know much about this. High schools are teaching kids to read and write and doing a bad enough job with that. It is not also their duty to teach automotive repair. And vocational schools by and large have excellent graduation records and are required to maintain minimum job placement rates. They are more expensive than community colleges to be sure, but in terms of the net cost to the taxpayer for a well-trained, tax-paying and productive citizen are far less expensive.

     

     

    Well, at least one of the local public school districts here in NC, Orange County, does a fine job with vocational education. They offer agricultural, health care, and limited “business” education as well as cross-registration with the community colleges.  Kids graduate with qualifications such as the ability to become a Certified Nurse Assistant, or to work in hair salons, or one of many other areas, yes, including automotive repair.  The only reason to discourage other school districts from doing likewise is, frankly, because greedy people want to make money off of the backs of students. 

  17. Lucy Pevensie
    Trace: I’m sorry Lucy but this is ludicrous. So the schools are responsible for whether the students apply themselves? I suppose Weight Watchers should refund money to its customers when they regain lost weight? This is Occupy Wall Street claptrap. · 1 hour ago

    Lucy Pevensie: Someone a few days ago suggested a great idea about the student loan problem: the schools themselves should be liable for any amount a student can’t pay back.  This would put out of business a lot of schools that are only harming kids by taking their money and giving them no useful skills.  · 3 hours ago

    Right. It makes much more sense for you and me to pick up the tab through our tax dollars when the kids can’t pay off their loans than for the school who talked them into taking out the loans in the first place to be responsible.

  18. Lucy Pevensie

    And as far as keeping kids out of jail: give them a skill and a trade that they can use to work and become independent when they are young.  Do you not think that one reason that young men end up in the drug trade is that they can start making money at the age of 14?  But you’d like to tell them to wait until they finish high school and then take out loans, guaranteed by you and me (the taxpayer) so that they can learn some kind of skill, and then start making money when they’re, what, 21?  And in the meantime they’re supposed to study, what? English literature? in high school, whether they have any academic interest or ability or not?  And what exactly is supposed to keep them in high school, studying things in which they have no interest and that they can see will not help them out in their future lives? 

    You clearly know something about what educational theorists think should happen, but you’re unable to consider any of the basic issues objectively.

  19. Chris Campion
    Trace: EVERYONE can benefit from post-secondary education. This does not mean everyone can benefit from a liberal arts degree or even a four year degree. But EVERYONE can improve their lot by acquiring additional skills. It is foolish to write that off. The alternatives are investments in welfare and prisons. 

    12 hours ago

    I didn’t say post-secondary education, of any kind, is not valuable.  I’m talking about college, specifically – and I said that the system assumes everyone, regardless of ability, will benefit from a college education.  That means they’ll take anybody who can pay the bill – which is why we have tuition rate inflation at 2X-3X the CPI.  We’re also talking about two different things here, to wit:

    1.  That any college education is worth it, at any price.

    2.  That any education received is worth it, at any price.

    You’re assuming a rosy-cheeked student at either a college or a trade school who dutifully shows up to class, works hard, and actually acquires knowledge and wisdom.  At least in our traditional college campuses, this is a demonstrably false assumption.  Else no one would flag out of school, never to return. 

  20. Trace
    You’re assuming a rosy-cheeked student at either a college or a trade school who dutifully shows up to class, works hard, and actually acquires knowledge and wisdom.  At least in our traditional college campuses, this is a demonstrably false assumption.  Else no one would flag out of school, never to return.  · 13 hours ago

    On the contrary Chris, I am taking a rather hard-nosed view that of all the social welfare programs my tax dollars funds. I would rather fund student loans for vocational students, knowing full well that half the students may default, knowing that 70% complete and 70% of those find work in their field. Vocational schools which provide students with a tangible and fungible good are 1000x more productive than any federal, state or local job training program. 

    Preventing unqualified students from obtaining worthless degrees is a problem — but its a marginal one in the scheme of things requiring a marginal change. 

Want to comment on stories like these? Become a member today!

You'll have access to:

  • All Ricochet articles, posts and podcasts.
  • The conversation amongst our members.
  • The opportunity share your Ricochet experiences.

Join Today!

Already a Member? Sign In