The Education Bubble
One test of skill for investors is the ability to spot a bubble. As I’ve had it recently described to me, a bubble exists when there is a mentality that prices in a certain area will always rise. Take housing, for example. The wisdom for many of the recent decades has been that housing prices will continue to rise - despite the fact that houses are depreciating assets much like cars.
Now think about education costs. When in our lifetime has anyone suggested that education costs will do anything but rise? “When your children graduate, annual tuition will be hundreds of thousands of dollars” we are conditioned to think.
This is a bubble.
The reason it’s a bubble is for the same reasons housing was a bubble: the overabundance of credit. Just like lenders who were essentially willing to give a homeless person a loan on a $200k house (with the confidence that the price would always appreciate), banks are willing to give high-school graduates with no jobs or assets hundreds-of-thousands of dollars to attend any-name college . . . just like the other 52% of Americans who say they’ve attended “some college.”
But with the credit-crisis in full swing, executives for Sallie Mae have described the student loan situation as a “train wreck.” More and more banks are dropping out of the student loan business, including Sallie Mae, because lending to students is no longer profitable.
A recent article in the New York Times has highlighted one effect of the contraction of the education bubble. Those lenders that are still in the student loan game are dropping students attending 2-year colleges.
Michelle McClain, 40, who is studying to become a teacher, learned on Friday that she would have to find a new lender after Citibank dropped William Jessup University. The news angered her.
“The loan is between me and the lender,” Ms. McClain said. “I’m the one that’s taking out the loan, I’m the one whose credit is in jeopardy if I don’t pay it, I am the one totally responsible for the loan, and as long as I’m going to an accredited college, I don’t understand why it would make one iota of difference where I am going to college.”
It doesn’t take a rocket surgeon to figure out why Ms. McClain’s bank refused to extend her further loans to William Jessup University. People graduating from William Jessup are less likely to pay back their loans than those graduating from Yale. She’s a risk they’re no longer willing to take - and rightfully so.
Ultimately, one would like to see college be affordable enough so that Ms. McClain can attend a two-year college without taking out loans. This will only happen if credit continues to evaporate, thus forcing colleges to cut back and compete in a market where tuitions are continually declining. The days where our parents could work their way through school must be allowed to return.
Instead, the Department of Education has set out to socialize student lending.
With scores of lenders unable to come up with money to provide student loans, the Department of Education is preparing to exercise broad new powers in the coming weeks that could fundamentally recast how millions of students pay for college.
This initiative could transform the federal government from a guarantor of student loans into the dominant provider, replacing the outside lenders to whom students and their families have long turned.
. . .
Some leading Democrats in Congress have urged the government to take responsibility for providing all federally guaranteed loans. Sens. Hillary Rodham Clinton (D-N.Y.) and Barack Obama (D-Ill.) have both said that, as president, they would hand the entire market to the Department of Education.
The quickest impact of this governmental intervention will be to continue the drive up in price of college tuition.
The other unintended consequence is that, after every college student needs loans to attend school, there will be unprecedented control over colleges - whether private or public. The U.S. Congress will have different reservations about extending loans to a Bob Jones U. student than would Bank of America. There will be conditions to a college qualifying for federal lending, much as there are now, except that the federal government will be the only lender.
Can we please get around to eliminating the Department of Education . . . if for no other reason than it violates the 10th Amendment to the Constitution?
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Thank you for this information. I had never thought of the rocketing education costs as a bubble, and I had hope until you got to the part about government interference…
Good to hear from you again Joshua,
I sometimes wonder what the government’s ultimate goal is each time it intervenes to prop up a bubble. People were living easy with the values of their houses far outstripping inflation . . . what is the result of perpetuating this trend indefinitely? We would live in a world where houses cost billions in today’s dollars, and the only people who can afford them already have them! Obviously the market will never allow such a thing, no matter how much the government wants it to.
I believe, given the current trends, that the term “Educational-Industrial Complex” will soon be coined, and it will cost more than ever to attend college (given that tuition will come from the government and not from the marketplace). But at some point one of 3 things will happen at the hands of the market. Either the government won’t be able to afford it, students won’t be able to afford the debt even with the government paying the interest, or people will just start entering the workplace out of high school because the quality of education will be so low and the costs so high, . . . or even a fourth option where students go out of country to attend college. India perhaps?