Deflating the Higher Education Bubble
While the crushing debt loads taken on by recent college graduates are not news to folks who read the right blogs, the idea of a higher education bubble has been receiving major media attention lately. Much of the coverage is driven by the complaints of protestors at the various Occupy events, who decry the bailouts received by big banks while they labor under debt that won't be forgiven.
Many of these protestors are college students or recent graduates that have taken on enormous levels of debt -- while the average debt of someone attaining a bachelor's degree is $27,803, there are many such graduates who end up well north of that figure. One young woman, Alecia Mahoney, graduated with a degree in public relations, no job prospects, and $78,000 in debt.
Most of this debt is the result of skyrocketing education costs. Since 1985, the CPI (Consumer Price Index) has increased by 115%, while the college education inflation rate is 498%.
In my home state of Illinois, the University of Illinois has gone from a four-year tuition cost of around $6000 in 1986 to $29,000 in 2010. Tuition at Northwestern University went from $11,031 in 1986 to $41,592 in 2011 -- and that's per year, without room and board. To get a bachelor's degree in Slavic Language and Literatures, a student would need to pay over $200,000 in tuition, room, and board. That's a lot of money to read Tolstoy in the original Russian.
How can colleges and universities get away with such increases? Partly because a college degree serves as a credential to employers who will pay graduates a higher salary (as much as a $15,000 difference for women). But a large part of the blame is the ease with which students can borrow large sums of non-collateralized money.
Nearly any college student today can easily borrow $28,000 via the federal Stafford or Perkins loan programs. Their parents can borrow the full cost of tuition, room, and board (minus any financial aid) using a federal PLUS loan. If a student can prove they are "independent" (essentially, that they have no family support structure), those limits rise to $57,500. Add in private loans, loans with deferred payments (but not deferred interest) while a student stays in school, and post-graduate loans (which can top out at well over $100,000) and it's easy to see how young adults manage to find themselves living with their parents and eating Cheerios for dinner well into their 30s.
A 25 to 34 year old woman with a bachelor's degree has an average annual salary of $40,100. If Alecia Mahoney was one of those “average” women and had a standard 10-year term to pay off her college debt, she would have to pay $897.63 per month in debt retirement. If she lived in Illinois, her monthly take home pay on a $40,100 salary would be $2,517. That means her monthly loan payment would be 35% of her entire salary -- more than is recommended for a mortgage payment. Not that she'd have much chance to pay any type of mortgage with the $1620 per month she has left over.
As a wise man once said: "Something that can't go on forever, won't."
College tuitions can't keep outpacing inflation forever -- and we've already reached a breaking point. But with a seemingly endless supply of "free" money being offered to teenagers (not known to be price-sensitive) and with the federal government guaranteeing 80% of all student loans, what incentive do colleges have for keeping prices down? It's far easier to recruit students with an endless supply of goodies, from iPads to posh dorm rooms to state-of-the-art football stadiums, than to compete on price.
My simple plan -- change the loan approval process.
The federal government feels comfortable handing out enormous, non-collateralized loans because they can't be discharged in bankruptcy. Unless you fall into an exceptional hardship case, that loan will be repaid, no matter what pain it causes. It is unconscionable to saddle a 22-year-old with $78,000 worth of debt, regardless of the culpability of her 18-year-old self for asking for those loans in the first place. We don't allow an 18-year-old woman to drink a glass of beer -- why can she sign for a $78,000 loan?
Let's instead front-load the pain. We need to give 18-year-olds a dose of reality -- there is a limit to how much debt makes sense, even for the great prize of a bachelor's degree in Slavic Studies.
The Stafford loan is actually a good starting point. It has a 10-year repayment window, so you've often finished repaying it before mortgages and kids really hit the wallet. But its maximum limits are too high -- especially for "independent" students. While it's sad that many kids find themselves without parental support, it's even worse to then saddle them with $50,000 in debt on top of that with no support system and no way out.
Let's go with something reasonable. A ten-year repayment window, so you know there's a light at the end of the tunnel. Pay down 10% per year, so you see real progress. And it shouldn't take more than 10% of the average salary. I call it the 10/10/10 Plan.
We'll use the average salary of all bachelor degree holders (around $45,000), which after state and federal income taxes and FICA leaves us with $2,779 per month. A 10/10/10 Plan would let you borrow $24,000 -- debt service comes to $276 per month. Leaving you with $2,500 per month to live a life.
You are not going to be able to attend Northwestern University for $24,000. Some things will have to change -- you may need to do your first two years at a local community college. You might have to get a job for a year or two before you can go to school, or join the armed services for scholarship money. You will have to be resourceful. But better to start thinking about how to scrounge up money when you're not in debt yet.
You'll also see some big changes at the colleges and universities. With the stream of “free” money gone and thousands of cost-conscious students looking at other options, price competition will begin in earnest. Maybe every dorm room doesn't need a flat-screen TV, maybe we don't need more administrators than teachers, and maybe inflation that outmatches the CPI four-fold isn't a sustainable business model.
As the federal government underwrites the vast bulk of student loans, the 10/10/10 Plan would have big effects right away. To make it even more effective, it should cover private loans as well -- for every dollar of private money you borrow, one dollar of federal money is taken away.
This 10/10/10 Plan is easy to understand -- I think I could even explain it to an 18 year-old.