Obama’s Remedy for Rising Tuition: More of What’s Driving It Already

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Following up on his State of the Union address, President Obama visited the University of Michigan on Friday to address the rising cost of education.  There, amidst a rapt crowd of collegians, he enthusiastically recommended a renewed commitment to the very policies that are driving those soaring prices in the first place.

Before examining Obama’s faulty solution to the still-expanding education bubble, however, it’s helpful to consider three key forces that contributed mightily to the real estate bubble that ruptured in 2007:

  • Easy credit. Progressively loose underwriting practices—encouraged by Fannie Mae and Freddie Mac and even forced upon the mortgage industry by the Community Reinvestment Act—made loans available to legions of un-creditworthy applicants, fueling demand and driving prices higher.
  • Low interest rates.  Spurred by political pressures which included George W. Bush’s promotion of an “ownership society,” the Federal Reserve’s manipulation of rates lowered mortgage payments, giving borrowers the ability to take on larger debts and bid prices higher.
  • Taxpayer money. In addition to various income tax credits and deductions embraced by both parties, the federal government’s implicit backing of mortgage guarantees offered by Fannie and Freddie promoted riskier behavior which translated into more loans being made with dubious underwriting.  That implicit backing later turned all too explicit when Congress approved enormous taxpayer-funded bailouts of Fannie and Freddie that to this point exceed $186 billion.  While that price tag already makes it the most expensive of any financial crisis bailout, the Congressional Budget Office expects the taxpayers’ tab to race higher still.

With the real estate example in mind, let’s turn to higher education costs.  The relentless ascent of college tuition is no secret, but the specific math is jarring:   Over the decade culminating in the current school year, in-state tuition at four-year public universities increased at a rate of 5.6% per year above and beyond the general rate of inflation, according to the College Board.  Increases at private schools adhered somewhat closer to the broader inflation rate, but still exceeded it by a hefty 2.6%.

While other factors are surely contributing to this trend (colleges’ antiquated practice of awarding tenure comes to mind), the same trio of forces that helped inflate the price of housing—easy credit, low interest rates and taxpayer money—has been at work in the education market for decades.  Unfortunately, that didn’t stop Obama from offering this hair-of-the-dog prescription to the nation’s college cost malady:

  • Easy credit.  Obama touted federally-funded student loans, which are offered without any credit check whatsoever—and which, by their very nature as a deferred debt, make consumers of education less sensitive to price increases and more willing to pay the asked price.
  • Low interest rates.  The rate on taxpayer-subsidized student loans is set to rise from 3.4% to 6.8% in August—a substantial jump, but to a rate that’s still quite competitive with other loans that aren’t collateralized by a home or a car.  As Mandi Woodruff reports at Business Insider, a higher rate could help bring the forces of supply and demand to bear, spurring parents and students to more carefully weigh the value they’re getting for the price charged by a given institution and perhaps gravitate to less expensive alternatives.  However, rather than letting market interest rates heighten the cost-consciousness of consumers, Obama vowed to seek Congressional intervention to keep the rate artificially low.
  • Taxpayer money.  After lauding his administration for having already secured an increase in taxpayer-funded Pell Grants, Obama pressed for more ambitious transfers of taxpayer money—either directly or through students—into the coffers of education purveyors.   His proposals, elaborated upon in a White House fact sheet, ranged from a permanent extension of the American Opportunity Tax Credit to $55 million to help educators “develop and test the next breakthrough (education) strategy” to a $1 billion “investment” in an inter-collegiate competition focused on keeping prices down—a scheme incongruously-named “Race to the Top” (I suppose “Race to the Bottom” didn’t play as well with focus groups).

The parallels between the housing and education bubbles are clear.  Where the former saw builders offering status-conscious consumers ever-bigger homes,  the latter is accompanied by colleges competing to offer the most lavish amenities—like those ubiquitous climbing walls and even resort-like outdoor pools.

And, as with the real estate bubble, there lies beyond rising prices another unintended consequence:  millions of Americans saddled with debt—an average of $25,250 for 2010 grads.   The worst off?  Those who fail to complete their education and have little to show for their effort beyond a big taxpayer-backed liability on their balance sheets.

What presidents, legislators and consumers usually fail to grasp is that well-intentioned government intervention that seeks to help consumers afford higher prices of any product only serves to inflate those prices further.  

Doubling down on Uncle Sam’s counterproductive strategies will likely pay dividends in the voting booth, but—at a time when the federal government borrows 40 cents out of every dollar it spends—it’s unbearable to watch the government plunge deeper into debt to fund policies that yield results precisely the opposite of their intentions.  That it does so without any authority granted by the Constitution only makes it more excruciating.

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12 Responses to Obama’s Remedy for Rising Tuition: More of What’s Driving It Already

  1. Geoffrey Sherwood says:

    There was a very comprehensive study done through year 2006 by The Delta Cost Project at American Institutes for Research which concluded that the main reason (but of course not the only one by a long shot) that tuition has been rising faster than college costs is that colleges had to make up for reductions in state-level taxpayer subsidies. Nearly every nation that boasts a highly-educated populace has state-subsidized higher education. The nearly universally-accepted purpose of this subsidization is to make education at quality institutions affordable to all. I think the commentary here has got the cart before the horse. The dramatic increase in student loans is a symptom, not a cause, of the rising costs of public education. If it is a cause in any respect, it is much more believable that it lessens the competitive instincts of for-profit universities. Is there any hard evidence that a significant cause of the increases in public university tuition is an increase in the availability of student loans, rather than tuition increases contributing to an increase in the need for student loans? There is no doubt that certain costs have contributed to the rising tuitions. The Delta Cost Project study cites the increasing costs in facilities maintenance, administration, and student services such as counseling, as additional factors. I don’t recommend swallowing the Delta Cost Project study hook, line and sinker. They seem to be relying primarily on cost surveys that are prepared by the colleges themselves, so it is certainly possible that some of the information is skewed. What college is going to come out and admit publicly that, yes, we’ve been spending like a bunch of drunken sailors? But the study certainly merits consideration.

    • LibertyMcG says:

      Thank you for your thoughtful contribution, Geoffrey. It certainly does makes sense that a decrease in state funding of schools would result in costs that were previously borne by state governments being passed on to students in the form of tuition increases. That said, it’s important to note that direct state funding of colleges surely results in even greater destruction of cost discipline than taxpayer-subsidized loans.

      That is, to the extent a major portion of a college’s operating costs were diffusely spread among the state’s taxpayers rather than presented to collegians and/or parents in the form of a tuition bill, those colleges had even less reason to tamp down their operating costs. With direct state support falling, public education consumers are now seeing more vividly the price that results from institutions that grew larger and less efficient thanks to high public funding. (Of course, even without state funding, many private non-profit colleges aren’t fully exposed to market discipline either, thanks to federal grants and their own endowments. And there are additional reasons why students and parents decide to spend more than they should on college.)

      This study (http://chronicle.com/article/Study-Backs-View-That-Colleges/38316 ) found a link between tuition grants and tuition growth; it’s only logical that subsidized loans would likewise distort pricing by similarly providing consumers with an external source of buying power. From Japanese real estate in the 80s to U.S. real estate in the 2000’s, there’s ample evidence that easily-acquired, low-cost credit contributes to rising prices.

      I feel that, while well-intentioned, easy student credit is part of a vicious circle:
      –Easy credit enables students to pay prices they couldn’t otherwise afford
      –Which reduces pressure on colleges to keep tuition down
      –Which dampens colleges’ motivation to contain costs
      –Which leads to higher prices
      –Which prompts government intervention to “keep college affordable”
      –Which enables students to pay prices they couldn’t otherwise afford …

  2. Means of Production says:

    Even the prepaid tuition program in which I enrolled my children may not shelter me from exploding college tuition costs. Some states are so strapped that they may renege on the promises they made to entice people into prepaid tuition programs in the first place.

  3. BK says:

    Glad also that i was referred to you. this has been a real peeve of mine. For all of the bashing of Wall St and banks, nothing, other than healthcare, has gone up like college costs – and i’ve seen studies showing how the quality of the college ed has gone down in the meantime, to boot. Finally, if you really want to get your shorts up in a bunch, go look at the endowments of some of these fine non-profit bastions of unabashed patriotism – the last time I did this was before the 2008 crisis, but several Ivy schools had endowments of $1-3mm PER STUDENT! With their expertise at managing money, an 8% return would not be ridiculous, so $160k per student in endowment return, plus they still post $50k in costs growing at 2x CPI. If these were banks, they would be hauled up in front of Congress. Sorry for the wordiness, it is your blog, afterall – you struck a chord…

  4. Doug says:

    Truly insightful. Glad I was referred to your blog. I’ll be back.

    • LibertyMcG says:

      Thank you, Doug, for your historic posting of the first-ever comment on LibertyMcG.com!

      • So now that I’m at a real keyboard, I’d like to specifically call out the point about how the subsidization of the education sector has resulted in massive malinvestment in the form of luxury amenities in the schools. This is an often overlooked effect of too much money being thrown at the schools.

        Another problem that’s more subtle is the curriculum bloat. In India, it takes an engineer less than 3 years to get a degree. This is because he’s not expected to fill a schedule with “interdisciplinary studies”, “humanities”, etc., but is expected to LEARN ENGINEERING.

        Not once in 16 years in software have I needed to know that the high-contrast color scheme in Renaissance paintings is called chiaroscuro. It’s nice to be well-rounded, but I had to put out money for that class which has no effect on my ability to produce software. In India and China, they don’t waste time with that.

        We probably wouldn’t waste time with it either, if we really understood the value of what we get out of it. But we can’t when the easy money policies distort all rational measures of value!

        Well-roundedness is a luxury for the rich. We are so deep in the hole, we need to cut those luxuries, and start thinking about real value.

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