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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