The Ivory Bubble

Anthony Kammer 

I should be clear: I am delighted to be graduating with my degree. But in commemoration of my final week of law school, I’d like to use this opportunity to consider the macroeconomic implications of the increasingly hard-to-deny bubble in American higher education. Pointing out this bubble’s existence has become a kindof de rigeur exercise among online commenters. The basic point is this: the cost of higher eduction continues to rise rapidly while the real risk-weighted value of a degree declines.

Nevertheless, American families, banks, and even the U.S. government continue pouring more money into this depreciating asset. There are speculative aspects to the higher education industry (like online for-profit degree mills), but what’s driving this bubble is a Hobson’s choice: even if higher education is a scam, not having a degree looks like an even worse fate. Like housing, education is almost an economic necessity in our society. That is precisely why the housing crisis has been so virulent, and it’s why an education bubble is so troubling. What many commenters have found particularly ironic about this whole situation is the complicity of our most esteemed educational institutions in translating that necessity into massive profits and ballooning endowments.

Malcom Harris’s excellent article for the most recent issue of N+1, Bad Education, explores some of the bubble’s causes and the likely economic impact of its burst. This quote provides a helpful reference point:

Since 1978, the price of tuition at US colleges has increased over 900 percent, 650 points above inflation. To put that number in perspective, housing prices, the bubble that nearly burst the US economy, then the global one, increased only fifty points above the Consumer Price Index during those years.

The comparisons to the housing bubble don’t end there. As it did with housing, the government provides massive educational subsidies and tax-incentives. The federal government also provides massive education loan guarantees to primary lenders, which encourages bad (i.e. subprime) lending. In other words, banks have no incentive to perform credit evaluations on the students receiving the loan. Because of federal programs like the recently-discontinued Federal Family Education Loan Program (FFELP), banks face little risk when lending $240,000 to an 18-year with doubtful job prospects. Harris also notes that a secondary market in education loans has developed. Like mortgage CDOs and other mortgage-backed securities, Student Loan Asset-Backed Security (SLABS) make it possible to invest in a diversified pool of education debt.

So with all the pieces in place, what would a burst in the higher education market bubble look like? As students find their degrees don’t translate into jobs, they’ll eventually default and file for bankruptcy. Federal law prevents discharge of student debt unless the student can demonstrate “undue hardship.” The debt could plague them most of their adult lives, making it harder to go back to school, change jobs, get loans, and buy homes. Although, given the relatively small size of the secondary market in education debt, a financial panic is far less likely, a flood of defaults could strain the whole economy for decades. And with high unemployment among recent graduates, these effects are perhaps not far off.

One major difference from the housing bubble is that a flurry of educational defaults would not trigger a comparable problem in asset pricing. That is because the federal government has already announced, in law, how it would pay lenders if default rates get too high. So while students get stuck with a lifetime of debt, lenders have, in effect, a government insurance program. In the worst case scenario the lenders still get paid at least 75 cents on the dollar. For the larger economy, that’s far better than a bottomless hole. But a 25% drop in price could still potentially call into question the real worth of major holders of education debt and cause broader economic disruptions. In terms of moral hazard, this policy still puts taxpayers and students on the line for loans that probably shouldn’t have been made.

As in the housing crisis, this bubble is primarily squeezing America’s middle class. And while consumers may have appeared greedy in taking out subprime mortgage loans, it’s much harder to blame parents for sending their kids to college. Universities, creditors, and the federal government need to reassess how higher education is priced and financed in this country. Education debt should be dischargeable in bankruptcy. The government needs to figure out how it can stop guaranteeing loans for limitless tuition hikes without disproportionately impacting poorer applicants. Universities face perhaps the most significant moral hazards here. Schools need to reign in costs, and more fundamentally, they need to confront how their business model squares with their own mission statements.

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