Tuesday, August 27, 2013

The Problem of Education Finance

The Problem of Education Finance

After receiving a report that details students’ growing dependence on financial aid, Secretary of Education Arne Duncan lauded President Obama for making more student aid available in the face of rising tuition costs.[1] About a month ago, the Secretary commended the president for reaching an agreement capping interest rates for 11 million students currently servicing federal loans.[2]  The student loan compromise with Congress is like handing a life jacket to someone who is about to go over Niagara Falls.[3]  Student borrowers are in trouble, and no one is doing much about it other than making more debt available.  Secretary Duncan acknowledges the escalating cost of college in his most recent press release, but only can bring himself to gently admonish states and private institutions to do something.

Business Divisions Part 1 (1999)

President Obama weighed in with a proposal last week to tie federal grants to a series of rankings that measure net tuition costs, graduation rates, and economic prospects of graduates.  The President’s idea requires Congressional approval and wouldn’t apply until 2018.   Even it became law it wouldn’t do anything for many years.  My guess is that President Obama’s idea would do little to curb tuition inflation.  Rather, it would create a financial hole for expensive, non-elite private schools.  In any event, the proposal doesn’t do a thing about the looming crisis of student indebtedness.

In 1972, when I first went to college, the average cost of a year in a four-year college was $2,047 ($10,880 in 2012 dollars).  Since I graduated the cost of has been rising  1.9% per year faster than inflation, driven by an annual real increase of 2.6% in tuition.  Since 1999, the cost of college has been rising even faster in real terms (2.8%), and public institutions have borne the brunt of the increase (3.5%).  Today, my year in college would cost an average $23,666.[4]

The rate of inflation in higher education wouldn’t be half as troubling if it weren’t being fueled by debt, particularly student loans.  The National Post Secondary Student Aid Study (NPSAS-12) released on August 13, 2013, shows that 71% of all undergraduates are receiving financial aid of some kind, amounting to about $10,800 per recipient.  Fully 42% of all undergraduates utilized loans averaging $7,100.  70% of graduate students receive an average of $22,000 in aid with 45% of them drawing an average loan of $21,400.

How fast is student debt rising?  To get an idea, I looked at the New York Fed’s report, “Household Debt and Credit” issued this month.[5]  The data in the report only goes back to 2003, when total student debt was $241 billion.  As of the second quarter of 2013, the total had risen to $994 trillion, an annual rate of increase of about 15% per year!  To put that figure in perspective, overall consumer debt has only risen 4.4% per year.  While mortgage debt is still the biggest consumer obligation at $7.8 trillion ($8.4 including home equity loans), household real estate is worth $18.4 trillion.[6]  In other words, an asset backs the mortgage, even if the value of that asset isn’t as high as it was in 2008.  By the way, auto debt is $814 billion, and has only grown at a rate of 2.4%.  Student loans are big, growing fast, and backed by nothing more than a student’s ability to eventually pay principal and interest. Trouble is brewing.

Which type of consumer loan has the highest delinquency rate?  Student loans at 10.9%.  Credit card delinquencies are running at 10% and mortgages at 4.9%.  While mortgage and credit card delinquencies have fallen since the Great Recession, student loan delinquencies have risen. 

What happens if the delinquency turns into a default? The Federal government informs us that “the consequences of default can be severe, and then goes on to list eleven bad things that are likely to happen.[7]  And thanks to 11 USC 523(a)(8), student loans cannot be restructured or forgiven in bankruptcy.  As horrible as defaulting on a car loan or home loan can be, the consequences aren’t as dire.

While tuition continues to rise substantially faster than inflation, state support for higher education has been cut by $8.7 billion or 11% between 2008 and 2012.  Your state tax bill may have fallen a tad, but the short-fall has been made up by increases in federal aid, particularly Pell Grants, which aren’t subject to sequester.  The remaining gap has mainly been filled by student debt.

The student debt problem is not nearly as large as the mortgage crisis of 2007.   However, it is concentrated in a key demographic that has been critical to our economic prosperity and upward mobility over the years.  The children of the wealthy will enter the work world largely debt-free as they always have.  Millions of others will discover that they can’t move forward because they are weighed down in debt. 

[3] To see a more colorful critique of student loans, see, “Ripping Off Young America: The College-Loan Scandal” by Matt Taibbi in Rollingstone. http://www.rollingstone.com/politics/news/ripping-off-young-america-the-college-loan-scandal-20130815
[4] Digest of Educational Statistics, US Department of Education, Table 381 (2012)
[5] http://www.newyorkfed.org/research/national_economy/householdcredit/DistrictReport_Q22013.pdf
[6] Flow of funds Report, Federal Reserve, Table B100 (1Q 2013)
[7] http://studentaid.ed.gov/repay-loans/default#what-are-the


  1. Having been on the faculty (in an administrative capacity) at Georgia Tech, I believe I can say with certainty that university administrators and members of faculties live high on the hog compared to 30 years ago. The combined influx of (1) high tuition receipts, facilitated by student loans; (2) direct or indirect athletic revenue; and (3) clever fund-raising from alumni has made this high standard of life possible. It's an outrage, and as one might imagine nobody in academics wants to change the status quo.

  2. Chuck
    Education suffers from many of the same problems as Health Care, They are both labor intensive businesses, and as such must run inflation rates that are above the average rate of inflation. The idea is well laid out in "The Cost Disease: Why Computers Get Cheaper and Health Care Doesn't" by
    William J. Baumol, Monte Malach, Ariel Pablos-Mendez, Lillian Gomory Wu, David de Ferranti, Hilary Tabish, Lilian Gomory Wu

    The idea is very simple. If the economy consists of two basic sectors, a productive computer driven sector in which inflation is flat or falling and a labor intense sector, especially services, the labor intensive sector always has to have above average inflation.

    While some faculty members in certain fields have seen extraordinary increases in compensation, there are plenty of faculty in liberal arts and at community colleges who have seen their real wages fall.

  3. Andy,

    Baumol's argument is insightful and relevant to comparisons of inflation rates between sectors, but it does not address my concern. We can't simply throw our hands up in the air and say, it-is-what-it-is. If the average rate of inflation is (to pick a number) 2%, there is still a heck of a difference over the long run between a higher education industry whose average annual inflation is 4% and a higher education industry whose average annual inflation rate is 6%. That's the delta I'm concerned about. Or to use a different economic approach, it's too much money chasing too few goods (i.e. butts in seats).

    AAUP data from 2008 indicated that the mean salary of UNC-CH full profs was $143K. Not a bad life, given the high degree of forward certainty that comes with it. Perhaps professors in some disciplines are lesser paid, but necessarily other disciplines would be higher paid. In addition these positions enable many professors to have substantial derivative income -- again, not uniform across all disciplines -- and they often enjoy perks that are rare in the private sector, i.e. the tuition benefit for children of Duke faculty.

    Meanwhile, the overall cost of operating the typical university has continued to rise even though a much larger percentage of the actual teaching burden (compared to 25 years ago) has shifted onto adjunct faculty and graduate assistants whose compensation is quite low.

    And given that most universities are operated on the basis of cash flow not a true P&L, the construction programs of these universities are a major cash sink. As the NCSU website says about the Park Alumni Center, "the building features Italian marble flooring, double curving staircases and a grand reception room with 28-foot ceilings, crystal chandelier lighting, walnut-trimmed fireplaces and a full wall of windows onto the lake." I've been inside, and it's posh relative to the executive suite of every RTP corporate office I've visited.

    Community colleges are a different story. I have no criticism whatsoever for community colleges. They have been victimized by their larger brethren. And by the way, relative to Baumol's argument, haven't the community colleges found ways to increase productivity and mitigate their inflation rates?


  4. Chuck
    I agree that compensation to faculty is a problem, but singling out UNC-CH or the Park Alumni Center doesn't get at the issues. For UNC-CH to attract and retain faculty they have to compete with the big, privately endowed school who have been driving the salary race. I'll post the top 10, and you'll recognize them as the elite universities with the connections to money management to drive their endowments. As for the rest of NC, UNC-CH and a few other schools are the exception. Take a look at the rest of the list. The salaries aren't extraordinary.

    As for the Park Alumni Center, I thought it was built along with Centennial Campus which was not constructed with any State dollars.

  5. I agree that the Alumni Center wasn't built with state dollars, but I think the state/non-state dichotomy is not relevant. Ultimately, most of the cash receipts are fungible. Some cash receipts are earmarked or restricted, but university administrators are quite facile at moving the money around in such a way that earmarks and restrictions don't really impede what the administrators and trustees want to accomplish. Administrators who don't develop that skill never rise to power at big universities or don't keep their jobs for long if they fail to exercise it.

    I also agree that the competitive environment -- whether it's for top faculty, top athletes, top grants, and so on -- causes an arms war among the top universities. Some schools use athletics as fuel for the arms war; others rely on endowments; still others have various sources (e.g. DoD funding into MIT and Georgia Tech). The arms war is, in my thinking, one reason why college prices at the top universities inflate faster than even Baumol would say they should.

    So how does one stop an arms war, or at least reduce its intensity? I don't think you can stop it one combatant at a time. The student loan program is a good lever, if the White House and ED choose to use it.

    And lastly, I agree that the mid-tier universities aren't competing in the arms war. But that's not to say that they don't aspire to. How many mid-tier and low-tier universities -- even community colleges! -- are ramping up their athletic programs? Follow the money, as a wise man recommended.