Extra credit could bankrupt students
The market for college education looks a lot like the market for houses circa 2006 — very bubbly. And the reason is similar: There is too much credit.
Colleges can keep raising prices, despite the recession, because the government keeps lending students more money to pay them.
According to a report cited by Anne Marie Chaker in the Wall Street Journal on Thursday, the government will lend students $75.1 billion to pay for college this year, up a spectacular 25 percent compared with last year.
But the extra credit isn’t benefiting students. It’s just inflating the price of their education, burying them under a bigger pile of debt despite stagnant wage growth and poorer employment prospects.
This is eerily reminiscent of the housing bubble, when too easy credit inflated the price of houses well beyond their fundamental value.
What is the fundamental value of a house? Roughly speaking, it is what a buyer can pay for it, some portion of his income plus what he can borrow.
Historically, the increase in house prices has tracked income growth. But excessively easy credit disrupted this relationship over the past several years.
A similar dynamic is playing out in the market for college education.
A college degree can be valued by the incremental earning power that it can provide over a working lifetime.
In other words, how much more will you make if you go to college than if you don’t? Are those extra earnings enough to pay back your loans with interest, along with the opportunity cost of forgoing full-time wages while you’re a student?
A common misconception is that a college degree is worth a million dollars over the average working lifetime. But a paper published late last year by the National Association of State Universities and Land Grant Colleges pegs the value at close to a tenth of that, $121,539.
This is a very rough figure. There are big differences depending on the type of school, the time it takes a student to finish their degree and other factors. In any case, the present value of going to college is positive, but not nearly as high as most think.
And surely, during a recession, colleges wouldn’t be able to keep raising prices. Not only are job and wage prospects down, more parents are struggling to make ends meet, and lower house prices mean that the home equity ATM has stopped spitting out cash. But this year, the price of tuition is expected to rise 12 percent.
Indeed, since 1979, according to the Bureau of Labor Statistics, tuition has outpaced inflation every single year, and by greater than two times most years.
Where is the money coming from to increase prices? The government. According to Dr. Richard Vedder, Director of the Center for College Affordability and Productivity, federal loan programs are responsible for the dramatic rise in tuition costs. First made widely available with the Higher Education Act of 1965, federal loans went from near zero to $75 billion this year.
This leaves students saddled with debt when they graduate. In a CCAP paper published in April 2008, Andrew Gillen says that in 2006, the average student graduated with debt equal to 50 percent of his median income, up from less than 35 percent in 1999.
A big reason colleges will be able to raise tuition prices this year is because dependent undergrads can now borrow $31,000 from the federal Stafford loan program, up from $23,000 just last year.
The government, we’re led to believe, is acting heroically to “save” the economy by providing credit where the private market won’t.
In reality, it’s sustaining an asset bubble, and not just in college educations. Those who are asset rich — homeowners, banks, stock and bond investors — are benefiting at the expense of everyone else as the government props up the value of their holdings.
In the long run this will be very destructive for the economy. Those who need to buy assets are being forced to pay prices that are artificially inflated because the government is providing too much credit to finance the purchase. The price isn’t being allowed to fall, so buyers who don’t have oodles of cash lying around are forced to pile on the debt.
The government should get out of the way and let the price of college fall. If it doesn’t, many who would otherwise want to buy a college education will refuse as the costs race ahead of the benefits.