CNBC recently aired a special report titled, “Price of Admission: America’s College Debt Crisis”, which explored the nearly 1 trillion dollar debt burden faced by college graduates. The program highlighted the experiences of several average Americans who took out fairly standard student loans to get their degrees, and now find themselves with a mountain of debt, disappointing job prospects, and no recourse to get out from under their massive debt burden. The show presented some compelling facts and figures to demonstrate the extent of the problem and exposed how “for profit” colleges like University of Phoenix use aggressive sales tactics to coax people into loans they can not afford.
But as I watched the program I found myself pleading to the television, “Just get to the root of it– why are college tuitions so high and why are so many students becoming debt slaves?” The very moment that thought popped into my head, the narrator said it, “So why are college tuitions so high?” Ok. Here it comes, I thought. Lay it on us. So why are college tuitions so high? Wait for it… rock climbing walls!
What!? CNBC’s analysis of the skyrocketing costs of college tuition led to the conclusion that colleges across the country were building lavish facilities, such as an expensive gym with a rock climbing wall, to attract students to their campuses. For good measure, the program spent about 5 minutes chasing a red herring in the form of a lavish conference for college administrators at a fancy winery in Napa Valley.
While it’s great that CNBC is bringing to light a serious problem that adds one more ingredient to the bubbling cauldron of crap that is our debt based economy, it is mind-boggling that a business network could fail to understand why we are in this mess to begin with. So why are we in this mess? First, why are college tuitions so high? Second, how did millions of Americans allow themselves to become debt slaves?
Why are college tuitions so high?
The chart on the right shows that since 1978, college tuitions have increased at three times the rate of inflation. How could that be? The advent of computers and the internet should be bringing the cost of education down as record keeping and administration has become much easier. Sure, colleges are spending money on new buildings such as fancy gyms, but they’ve always done that. Most colleges already have a good portion of their buildings already in place and fully owned. Not to mention, enrollment is rising to pay for new infrastructure. Competition from online colleges should be forcing brick and mortar Universities to keep prices low. Could it be that something else is going on? The chart below is very informative. It tracks the price of tuition, room and board at Yale University since 1787.
Whoa! What the heck happened in 1950 and 1979? The federal government got involved, that’s what. In 1951 Yale received its first research grant from the federal government. In 1958, the government started its first student loan program, the National Defense Education Act. Then in 1979, the government created the Department of Education (ED or DoED) which administers financial aid such as Pell Grants, and provides government backed student loans. (It should also be noted that leaving the gold standard in 1971 caused inflation to rise accounting for a good portion of the price increase, but as the first chart shows, college tuitions rose much faster than inflation during that timeframe.)
Like most government social programs, the Department of Education was created with the best of intentions– to help all Americans earn a degree, especially those who could least afford college tuitions. And like most government social programs, the DoED has made life worse for the very people it intended to help. According to Richard Vedder, economics professor and author of Going Broke by Degree: Why College Costs so Much, the percentage of low-income students is lower today than it was in the 1970′s before Pell Grants and government backed loans kicked in.
In 1950, it was not uncommon for people to put themselves through college. The tuition at Yale in 1950 was $600 per year. That equates to $5315 in 2011 dollars using the BLS inflation numbers. (To be fair, it equates to $17,421 using the shadowstats real inflation numbers which I often cite when discussing inflation.) The price of tuition for many public schools at the time was under $100 ($886 in 2011 dollars). Students could wait tables at night or get a summer job to pay their tuition, room and board. Today, tuition at Yale is $36,500 per year and the national average tuition is $26,273 at private universities and $7020 for in-state students at public universities. It’s much harder for a person to work their way through college today than before federal aid began.
If you follow the steps, it’s easy to see why federal aid and government backed student loans boost tuitions. Peter Schiff recently interviewed Kelli Space, a college graduate who created the website twohundredthou.com in an effort to solicit donations to help pay off her nearly $200,000 in student loan debt. (You can listen to it here.) In the interview, he goes all Socratic method on her to help her realize why her tuition was so high. It went something like this:
Schiff: If you couldn’t get the loans, what would you have done?
Space: I would have worked. (She later mentioned she could have lived at home and gone to a local college.)
Schiff: And would you be better off?
Space: Oh, so much better off.
Schiff: So all this aid didn’t help?
Schiff: But you know who got helped? Northwestern.
Space: Of course.
Schiff: They got that $20,000 (per year) that absent these loans they never would have got. How many of your friends were getting these loans?
Space: Pretty much everyone.
Schiff: What if nobody could get a loan to go to Northeastern?
Space: I think the student body would dwindle.
Schiff: And what would be the response by Northwestern?
Space: Umm… maybe lower tuition?
Schiff: Absolutely. You hit the nail on the head. They would lower tuition to the point where people could afford it. In fact, if government loans didn’t exist, you may have gone to Northwestern anyway because the tuition would be more affordable.
The fact is, without the government guaranteeing the loans of students like Kelli, there is no way any lending institution would lend huge sums of money to an 18-year-old high school graduate with no job and in many cases no clear career path. With the government guarantees (and since 2010, direct government loans), any prospective student can get a loan, which vastly increases the money pool to pay for tuitions and allows colleges to jack up their prices. When the money doesn’t have to come out of the student’s pocket and instead is in the form of an abstract loan that needs to be paid at some future time, prospective students are naturally less sensitive to price.
As government sponsored student loans make college more expensive, they simultaneously degrade the value of a college degree. Easy access to loans coaxed many students to attend college who may otherwise have chosen not to. A high school degree used to be worth something in the job market and a college degree was special. Today, with seemingly everyone choosing to go to college, a college degree no longer sets a person apart, but has become a prerequisite for a decent job. This trend almost forces people to attend college. Dr. Vedder estimates that 17 million college grads are doing jobs that could be done by high school students. I’m sure there are many more employees who have learned on the job in a profession that has nothing to do with their college degree.
But while the artificially high price of tuition is a problem, the bigger problem for many graduates is the oppressive debt burden they find themselves in upon graduation.
How did millions of students become debt slaves?
According to CNBC, in 2009, 67% of students graduated with debt averaging $24,000. The total outstanding student loan debt is over $880 billion. The official default rate on student loans is 7%, but that number only measures defaults in the first 2 years. Meanwhile, students can legally defer their loans for 3 years to postpone default. If all defaults were counted, CNBC estimates the default rate at 1 in 3.
The cost of these defaults is partially borne by the taxpayers, but the real damage is done to the students themselves. Student loans are a particularly insidious type of loan. If a borrower defaults on a home loan, the bank gets the collateral (the house), and the borrower loses her equity, but the loan is retired. In the case of student loans, if the borrower defaults, he continues to accrue interest costs and the lender can garnish his wages. The loan can’t be wiped out by bankruptcy. In fact, it can even outlive the student if the parents co-sign the loan. So why would so many people choose such an option?
[Before I continue, let me be clear that I am a huge proponent for going to college. It's lots of fun, there are tons of girls running around (or guys if you prefer), you can drink beer and stay out late without your parents hassling you. You can even learn some stuff. For many, a college degree or even a post-graduate degree is essential to enter their desired profession. For others, the general knowledge they receive, the people they meet, and their collegiate track record and degree will play important roles in their career paths. There are many factors involved in choosing to attend college and which college to attend. The discussion below simply deals with the financing aspect of the decision but by no means implies that it is the most important factor to consider.]
The CNBC special does an excellent job of highlighting the psychology behind the decision to go to the best college at any price. But the special fails to point out that it is a lack of financial education that allows students and their families to get into such financial trouble. (I view this as a failure of our educational system, but that’s another topic.) The fact is, students coming out of high school have very little understanding about how debt works or the time value of money. As the CNBC documentary demonstrates, many times their parents don’t understand those topics either.
The social forces in our society are all aligned to push students toward a decision to do whatever it takes to attend the school of their dreams, regardless of price.
The government wants to be able to claim they helped millions of students go to college so they’re more than happy to promote student loans. It’s the DoED’s main reason for existing.
The Colleges love this government sponsored windfall. The CNBC special highlights the aggressive and deceptive sales pitches of the “for profit” colleges that coax the poorest applicants to get financial aid and take out huge student loans to attend their colleges. But even traditional colleges have a strong incentive to up-sell the benefits of their school while downplaying the costs of student loans.
The Parents want the best for their children and are willing to make whatever financial sacrifices it takes to get them into the best schools.
The Students, of course, want to go to their favorite school. To an eighteen-year-old, the expense of financing a loan four years down the road is an abstract concept; but attending the school of their dreams is a concept that is very real.
The only thing counter-balancing these social forces is reality. The first reality is that we all don’t have the academic credentials to get into whichever school we prefer. (I was informed of that by some of the finest schools on the East Coast.) The second reality is that we can’t always afford our top choice. Without government student loans, it would be fairly obvious to people if they could afford a particular school or not. However, with easy loans guaranteed by the government and a lack of financial education to understand all of the ramifications of the loans, it’s easy to see why many people get into trouble.
Instead of making a prudent decision based on economic reality, students and families are swayed by the platitudes of guidance counselors and loan officers that proclaim, “Money should never stop you from going to the best school you can.” Really? Never? What if the career you’re interested in doesn’t really require a college education? What if a less-expensive school offers a comparable education at a fraction of the price? What if the price of tuition puts you in a debt hole from which you can never dig your way out?
The graph below can help shed light on some of the ways people’s perception of the value of college can be distorted. The graph makes a compelling economic case for education; in fact, the more the better. From a financial standpoint it clearly looks like a student would be justified in taking out a substantial loan to get more education. If you become a doctor or a lawyer you’re pretty much guaranteed a job with a high salary to pay down your loan.
But lets examine the graph a little closer.
The left side of the graph shows unemployment rate. While it tells us that 97.5% of people with doctoral degrees have jobs, it doesn’t tell us how many are actually doctors. Some may be assistants, teachers, or employed in some entirely unrelated field. A recent article in the New York Times titled, “Is Law School a Losing Game?” shows that even lawyers aren’t exempt from the debt trap as many recent law graduates can’t find jobs as lawyers and can’t pay their high loan expense.
The right side of the graph depicts median weekly earnings. In many ways this is a good measure because if they used mean weekly earnings, super high earners like Bill Gates, Mark Zuckerberg and Serge Brin, might skew the results to show “some college, no degree” as being the road to riches. However, all that the graph tells us is that the median worker, who most likely is working as a doctor or lawyer, is getting a good salary. It doesn’t account for the person with a doctorate degree who is working as a teacher or writer or is unemployed. Professionals make very good money, but unless they patent a cure for cancer or bring class-action suits against tobacco companies they don’t have as high of an upside as some other career paths.
The next thing that is important to note is that the chart doesn’t account for differences in the circumstances and abilities of the people in each category. It’s safe to assume that on average, high school dropouts are less intelligent, less motivated, come from a background with fewer opportunities, are more likely to get involved with drugs, etc. than the people who strive to become doctors or lawyers. We would expect the high school dropout population to have less job success than the doctorate population regardless of formal education. A more accurate gage of the impact of education would be to examine the employment statistics for people of similar backgrounds, personalities and abilities, who chose different levels of education. Unfortunately, this data is harder to accurately track.
That being said, it is certainly an advantage to have a college degree on a resume when competing for limited jobs. However, this advantage also tends to be skewed as people compare apples to oranges. For example, a college graduate entering the workforce in 2011 will have a huge advantage over a 2011 high school graduate applying for the same job. However, it’s less clear what the college grad’s advantage is over a high school graduate with four years of work experience in the desired field. It could be that many prospective employers would rather hire someone with four years of proven work experience, than someone with four years experience drinking beer and getting ok grades. Not to mention, the employee with work experience is probably already in the work force, and it’s a lot easier to keep your job than to get hired.
Another consideration that chart fails to point out is that the higher the salary (and presumably the debt), the higher the stakes for being unemployed. If a lawyer can’t get a job or has to settle for a much lower paying job, servicing the debt becomes impossible and the debt continues to rise. If the high school grad has to take a lower paying job, the difference isn’t as noticeable, and they’re not saddled with oppressive debt. The real risk of not being able to get a job right out of college, especially in today’s economy, is rarely factored into the financing equation.
Finally, the chart doesn’t take into account the four (or more) year head start in salary that a high school grad has over a college grad. In a world of compounding interest, time is money. The high school grad can save and invest immediately, while the college student is racking up and then paying down debt. Let’s take the example of a student at the average priced private college with ten-year student loan at 6.8%. We’ll assume Mom and Dad are footing the bill for room and board. Ten years after graduation they would have paid $104k to the school and nearly $40k to the bank in interest. The college graduate will presumably get a higher salary than his non-college counterpart, but he will also pay more in taxes both on a percentage basis and a total dollar basis. The high school grad will have had a roughly 14 year head start to begin saving and investing for retirement.
Obviously, this is not a complete analysis of all of the financial considerations of choosing a college. For example, an expensive private school or highly rated school may offer an environment where students can meet other smart, rich, well-connected people who may be instrumental in their career. There are all sorts of factors to consider.
The point of this exercise is merely to show how there is a bias towards over-valuing a degree which can lure people into the tempting loans made available by the government. Unfortunately, as tuitions continue to rise dramatically, from a strictly financial standpoint, college makes sense for less and less people.
How do we get out of this mess?
So basically, we have a government agency, the Department of Education, that has jacked up the price of college, diminished the value of a college degree, decreased the percentage of low-income student enrollment, and created a generation of debt slaves. And all of that at a cost of only $70 billion dollars a year to the taxpayers. As the congress is struggling to find even a billion dollars to cut out of our enormous budget, here’s $70 billion on a silver platter.
Would higher education cease to exist if we didn’t have a federal government department to run it? On the contrary; it would thrive. Perhaps there would be a short transition period where the DoED would scale down the federal loans over four years. Some private companies would step in to provide loans but they would be much more realistic. Colleges would likely vendor finance new students to some extent much like car companies provide loans to attract car buyers. Colleges seeking diverse student bodies and the very best students would increase their scholarships for bright, low-income students. Without a steady stream of guaranteed students, colleges would face an increasing need to innovate, become more efficient, and create programs and offerings students desired. But the biggest outcome would be that colleges would cut tuitions dramatically which would enable people to once again work their way through college or save up for a few years to pay for college without condemning themselves to a life of indentured servitude.