A Dysfunctional System That Bankrupts A Generation


Wolf Richter
Zero Hedge
October 27, 2011

Tuition has done it again: up by 8.3% for universities and by 8.7% for community colleges, according to the College Board. Here in California, tuition increases are outright ridiculous. Much of it will be paid for with student loans (though grants, scholarships, other aid, and tax credits will cover some of it). Student loan debt will exceed $1 trillion by the end of the year—a stunning amount. But unlike other debt, it cannot be discharged in a bankruptcy.

The skyrocketing costs of higher education add to the strains already weighing down the middle class whose median household income has fallen 9.8% between December 2007 and June 2011 (Sentier Research) and whose real wages have declined 1.8% over last year (BLS) and around 9% since their peak in 1999.

We all support education; we want the next generation to be productive. So now, under increased pressure to “do something,” the Obama administration has come up with a Band-Aid, which includes income-based payment limits and ultimate debt forgiveness in certain cases—an accelerated implementation of program improvements that would have taken effect in 2014. Looking forward, it is likely that more taxpayer funded relief is on the way.

But the system itself is dysfunctional. The cause: a misalignment of interests within the complex relationships between students, universities, the student-loan industry, and the federal government.

Universities are businesses, and businesses have the natural purpose to charge the maximum price the market will bear. But unlike Walmart or the shop down the street, universities operate in a system that has become devoid of market forces, and when they demand higher tuition, the whole system falls in line to support those increases:

- Students want an education, and they have to get it within the higher education system. When costs go up, they can’t massively drop out; doing so would endanger their future. They can choose cheaper universities and community colleges, but they’re all within the same system, and they’re all doing the same thing: jacking up tuition and fees. And the very logical mechanism of “out-of-state tuition” ends up being a highly anti-competitive measure. So students fight tuition increases the only way they can: obtain more funding.

- The student loan industry profits from processing student loans and related government subsidies. Naturally, they encourage students to take on more debt. Risk would function as a natural brake for making loans. But in the student loan industry, there is little or no risk as the government guarantees the loans, and loans cannot be discharged in bankruptcy. Further, the amount of a student loan is a function of the cost of a particular school—which further reduces price competition between schools.

- The government, in constant need of voter support, will fund or guarantee whatever it takes to allow students to get their education. Any cutback would be perceived as a way to strangle the education of the next generation. The only option the government would have is limit what universities can charge, similar to the limits that the government imposes on Medicare providers, but that option is a non-starter.

As a consequence, university budgets have become huge. Administrator salaries, bonuses, benefits, golden parachutes, and pensions have shocked the public when they’re exposed in the media. Programs that have little or nothing to do with education swallow up more and more money. And sure, everybody loves to have well-equipped labs. The beneficial forces of market discipline have been wrung out of the system. Instead, it has become a mechanism for automatic and unstoppable tuition increases, made worse by cutbacks in state funding. The ultimate but innocent and well-meaning enabler: the setup of government guaranteed student loans.

At fault is the system itself. Like our healthcare system, it needs to be restructured and opened up to competition or to effective checks and balances when competition isn’t possible. Solutions won’t be easy, but with $1 trillion in student loans outstanding, there isn’t much room left before it will bankrupt an entire generation (while the healthcare system is on the way to bankrupting the nation).

And there are more government Band-Aids on the way: Obama’s Refi, A Special Tax For People Who Can’t Do Math

Wolf Richter  www.testosteronepit.com


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