Extra credit could bankrupt students

September 4, 2009

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.

27 comments

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It’s not what you know, it’s what you do with it that matters.I have a lot of respect for people who truly are academics, but I believe the expectation in corporate America that you practically need an advanced degree before you even get your first job was a big reason for the recession in the first place. Companies got away from doing tangible things and instead were swarmed with MBAs who reinvented things that didn’t need reinventing in the first place (say, 30 year mortgages).Like I said, I have a lot of respect for academics, but advanced education is both overrated and overpriced.

Great article Rolfe. I pointed out the same thing on felix’s blog yesterday. We are in a very destructive cycle. Its ruining the country especially younger generations.

Posted by James | Report as abusive

[...] otherwise want to buy a college education will refuse as the costs race ahead of the benefits. Rolfe Winkler

It’s because people are desperate for jobs. We shipped off most manufacturing to China, and so you don’t have a choice. Move way up the education ladder or starve.Unfortunately, it is obvious as day that not everyone is suited for a professional job, and you can’t fit a square peg into a round hole.

Posted by Mikey | Report as abusive

Excellent comments–and they probably apply to healthcare as well, mutatis mutandis.The road to hell is paved with easy credit.

Posted by But What do I Know? | Report as abusive

Manufacturing jobs aren’t the only kind disappearing from the US. We are bleeding high tech jobs to the BRIC countries as well. These were jobs that paid 50-100K. Some management jobs at tech companies are going to India now. I’m not sure why we haven’t seen more about this in the media. Too scary, maybe?

Posted by lynn | Report as abusive

Wonder why nobody raises cain about the obscene salaries College presidents make. The president of Yale makes over $900K a year, has a college provided residence and a expense account over $21K a year. He’s typical, as most presidents of major universities are somewhere in that range. The professors may not make that much, but they are busy with their start-up biotech companies or busy consulting, converting tax-payer funded research into personal profits. I refuse to donate any money to my alma mater because I consider them all to be a bunch of parasites.

Posted by PossumLover | Report as abusive

Some really excellent points. Higher education institutions are becoming bloated bureaucracies continually adding services to boost marketing — but not the quality of education. They also feed on the anxieties of parents who not only want the best for their kids (and have no clue) and strive to appease helicopter parents (who also have no clue).The entire public higher education system is a mess and needs to be overhauled to lower cost, increase value and recognize that not every kid belongs in college.

Posted by Geoffrey Mehl | Report as abusive

I’m so tired of the statistic about those with college degrees earning more than those without. This doesn’t prove that those with college degrees are initially better qualified for the work they get, nor does it prove that higher education necessarily has anything to do with job performance. All it proves is that a college degree is a hurdle that must be jumped to get higher paying jobs.What I’d like to see is statistics that prove that what is learned in college actually make a person better at a particular job – i.e. that the college ed is truly needed for more than just a piece of paper.Years ago, a first class commercial radiotelephone license was required to work in broadcasting in the larger markets. Education mills were set up to crank out people who could pass the test. People who knew nothing about broadcast electronics were passing the test. Companies finally realized the license made no difference in the quality of those they hired and the requirement was dropped with no ill effects that I’ve heard of.Why don’t companies drop the college degree requirement in like manner? For many jobs an exam given by the company could quickly separate those who know from those who don’t know what is needed to do the job.Somehow, to the great benefit of colleges, we’ve accepted that a college degree is a great boon without having any idea why.

Posted by CB | Report as abusive

Check out a site called studentloanjustice.org. It’s worse than you think.PS–You sound like Peter Schiff, Rolfe–not that I disagree…

Who really provides more actual value to society – a high school grad who becomes a plumber or electrician, or an MBA?

Posted by StevenKs | Report as abusive

Maybe it’s time to reconsider our system. For those who truly seek knowledge college is no longer the only way to find it. Anyone, rich or poor, can educate himself on any subject instantly on the Net, discuss or debate any issue, or find help understanding nearly any problem, without spending upwards of $30,000 per year. I’m not saying college is unnecessary, but maybe it should be reserved for advanced learning since the basics can now be picked up so easily elsewhere.Just my random thoughts.

Posted by al coholic | Report as abusive

The three most overated comodities in the US today:1. Sex2. A College Education3. “Health Care”In that order.

Great article Rolfe, can’t agree with you enough. As a current college student studying business, I try to pass this on to as many fellow classmates and friends as possible.Keep up the great work.

Posted by Minh L. | Report as abusive

[...] to an article by Rolfe Winkler at Reuters How much more will you make if you go to college than if you don’t? Are those extra [...]

Excellent article!I assume it was written by an Austrian Economist?http://mises.org.

Posted by Rich | Report as abusive

Excellent article!! and should be an eye opener for many who are oblivious to such issues – in the making. We should make every effort to ensure our politicians (at all levels) do what ever they can to stop such programs or curtail them, at least, which will help many in the med to long term.

Posted by fzf | Report as abusive

Great article and i agree with it mostly, but my opinion still stands.Earning a degree nowadays has become more pressing,due to the fierce competition in the employment market for two reasons; first, the cyclical environment of businesses worldwide has not been coping well enough with the increasing amounts of graduates thatwant to enter the professional realm. Leading to a higher concentration of qualified unemployed graduates with no job prospects. Second, the image of earning an academic degree has been gaining wider acceptance by youngsters who believe it would land them a better job if they go to one of the top universities.However, as i have been in the workplace for a while now, i found out that no matter what degree you earn, it would only be your visa entry to the interview process, but afterall its your knowledge and transferrable skills that would get you the job.Therefore, placing too much weight on the added-value of your degree would be an imprudent behaviour. But in my opinion status-quo will always previal, universities will always exploit the higher demand of their education, and student will always think it is their VIP ticket to the highest-paying jobs in the market.

Posted by Middle-Eastern | Report as abusive

One huge thing you left out- you can’t declare bankruptcy on student loans. So, no, they won’t be driven into bankruptcy because there’s no relief for them there.Historically, this is without precedent- since the 1600′s ALL debtors had a chance of some description to wipe the slate clean and start afresh. That’s because society can’t afford to have large numbers of people permanently disabled from debt and not participating in the economy.The reality is, students will pay all their expendable income to Sallie Mae or whoever for the bulk of their working lives. If a student takes out 23k a year for four years and leaves college 92k in debt (a conservative estimate- ivy league schools are much more than that) they can say hello to 30 years of 600.00 a month payments or $1,100 a month for a decade – if they can stay employed for that long. If not, the fines and fees and interest charges can more than double that amount for failing to make timely payments.In Europe of course, education is free and students leave college with a degree and a clean financial slate. Here, we prefer to let the vultures start in on our young before they’re even out of the nest. There’s no enslavement like financial enslavement.I predict a mass exodus among college educated to countries OTA (Other Than America) once they realize that they’ll quite likely never, ever be able to pay off their loans and they can’t ever get a clean slate.We’ll give the coke snorting degenerate Wall Streeters not only financial forgiveness but also tax payer dollars for wrecking the economy while they were pumped up on amphetamines and hallucinating about what Masters of The Universe they were but a middle or lower income kid who just wanted to earn her way in life through hard work and playing by the rules gets saddled for life with unshirkable debt because these same banks that tanked our economy passed laws that forbid ordinary people from debt relief when they land the job those same banks shipped overseas.Student Debt Immigration. It’s coming, and that’s a good thing.

Posted by swv | Report as abusive

[...] houses circa 2006 –  very bubbly. And the reason is similar: There is too much credit.”  (Rolfe Winkler also Felix [...]

That is what happens when government gets involved in a free market. Prices get inflated cause the government had pledged to support whatever it is subsidizing (home buying, cash for clunkers, education, farmers….) Wait and see what will happen when they enter the healthcare industry…

great post; hits the nail on the head re. student loans. kids will be buried in debt and unable to pay or discharge the loans in bankrupcy.sallie mae is much the same thing as the role of fannie/freddie in the real estate market. what would home prices have been if they didn’t exist to”facilitate” home ownership.

Posted by Gregg | Report as abusive

Rolfe isn’t an Austrian economist. He’s said and linked to some pretty un-Austrian things. But that leads to an interesting question. What school of economics does he subscribe to? Or is he a fellow traveler among the schools? Anyways I pretty much agree with his post on education. As a college student myself, $25,000 tuition for a semester is completely ridiculous! Usually in a bubble, real estate development increases dramatically. Its no coincidence that during the recent bubble, schools were building condo style dorms or huge business department buildings.

Posted by Geoffrey | Report as abusive

There are a lot of assumed connections here, none of which are proven in the article. I’ll give the author the benefit of the doubt that the assumptions are there because of article length concerns. But I’d really like to have the following fleshed out or discarded from the article:-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.Well, no, actually. The reason the housing market burst is because the credit was being furnished by private banks. Lending from the government is fundamentally different from private lending (it is spelled out most clearly in the risk of T-bills vs private paper).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.Perhaps, but this article seems to imply that amounts are per-year numbers rather than over the course of 4 years. The $31,000 is for unsubsidized aggregate Stafford loans for dependent undergrads. No one has yet borrowed up to this amount because the limits were only for loans first dispersed 7.1.08.You can practically hear the slicing and dicing in the argument–taking a small slice of loans, blowing it up to cover everyone, then placing these loans amounts as the sole cause of increases in tuition without any research, it seems, into what the schools are saying their increases represent.This leaves students saddled with debt when they graduate.Absolutely. What isn’t mentioned is whether this is a problem, and if so, is this a problem which is rising or falling? Are student payback amounts falling? Are graduates putting aside taking on “adult” debt (houses, families, etc) because of their student debt? The article is silent on the point.Debt which is paid off, even if students are taking on more of it before paying it off, isn’t a problem. This is like someone using their credit card to overpay for an item in a specialty store, then paying off their card in full. What’s the point?Are prices of colleges too high? Probably–they rise faster than inflation, certainly. But the author provides no evidence this is so, except asserting that government loans (mostly, for those who can’t afford conventional educational loans) keeps colleges awash in cash which keeps them raising their prices. I would like to have seen more facts to back that up rather than a breathless mishmash of assumptions.

Posted by Fred | Report as abusive

My junior in college is living at home and commuting 45 miles one way. Two days a week 16 credits. Just over $4000. I did this myself 6 years ago and paid $130/credit. I don’t really make any more than I did before, but I am happy and confident. Prozac, if it worked could accomplish the same result. My worry is hthe hard sell at secondary schools and the inflated claims. Poly sci, Education, Fine Arts, Social services, and, I bet you can add to the list of degrees that do not produce great earning potential in and of themselves. As ususal, earnings in these arenas are predicated on individual’s entrepreneurial enthusiasm in an honest system, and yet … right here in America the true measure of what your income is relates more to who you know… Sounds a little bit feudal.If I had the money to send my kid to Ivy league I fear a silver spoon would choke him (probabbly not) but he works hard and is forming relationships.Now for the other end…He works nearly full time. Our family income allowed for a good grant package. He has worked himself out of grant eligability and lost them. He is on the road constantly to earn his min wage, and will ahve to borrow about half of his tuition. Can’t get ahead. Later…

Posted by DanO | Report as abusive

[...] Rolf Winkler (Reuters) mener, at der er tegn på en bobel i markedet for universitetsuddannelser i USA. Priserne stiger grundet kraftig udvidet lånemuligheder for statslån. Det medfører at fordelene ved at tage en universitetsuddannelse falder, og kan dermed føre til færre universitetsuddannet, samt færdiguddannet der aldrig kommer af med deres studielån. [...]

I never thought college was just about getting jobs. education guys, e-d-u-c-a-t-i-o-n! I’m 57 and can’t say enough how boring most people are because they never learned to think beyond buying a house, getting married -all the wonderful things in life except really thinking. Most state schools are education factories. Most public education is a repeat of learning the times tables over and over. A good private college education is invaluable to becoming a leader in any way shape or form, business leader, civic leader, anything. An out of box thinker, a 2+2 doesn’t necessarily equal 4 thinker.Yeah, all my kids have over $100,000 in debt. If they can pay it back, OK. If not – and this is the downside of bailing out banksters, renege on your debt. Work off-beat jobs, hide income, anything until the s__ hits the fan with college loans (and it will). The second crisis is a generation of kids who can’t afford to buy a house because of school loans. I have no sympathy for the institutions that made a fortune on lending and then made a second fortune on TARP.Educate yourself to the fullest and take your education to figure out how to disperse your loans. Have your cake and eat it to.

Posted by susan bookfield | Report as abusive

sorry, that last word should have been “too” !

Posted by susan bookfield | Report as abusive

[...] Winkler is an astute blogger, and he (along with many others) sees a parallel in the markets for housing and higher education.  We have students (homeowners) purchasing an education (housing) at ever increasing prices using [...]

I believe that an education by itself is worthless. It’s not what you know, it’s what you know AND can utilize in your particular environment that’s important.

Posted by Mikey | Report as abusive

[...] Rolfe Winkler » Blog Archive » Extra credit could bankrupt … [...]

[...] Rolfe Winkler » Blog Archive » Extra credit could bankrupt … [...]

[...] problem kosztów wyższego wykształcenia w USA zwraca uwagę Rolfe Winkler, który porównuje wyższą edukację do rynku nieruchomości. Twierdzi, że nieustanny wzrost [...]

That $121,000 number you cite is specifically described in the paper as too low:The estimates of benefits of attaining a college degree are significantly understated. Thepremium for earning the bachelor’s degree has been growing over time but our calculationshold it static. College graduates also experience lower rates of unemployment, are healthierand are more likely to receive employer-paid benefits. In addition, only those who earn college degrees are able to earn master’s, doctoral and professional degrees, the returns to which aresignificantly greater than those of the bachelor’s degree.

Posted by Noumenon | Report as abusive

Noumenon….thanks for the comment….that’s why I include this paragraph immediately after quoting that figure:”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.”I never argue that getting a college degree isn’t valuable, I argue it isn’t as valuable as most people think.

Posted by Rolfe Winkler | Report as abusive

[...] economics blogger Rolfe Winkler thinks the economics of higher education are already wildly distorted. He writes: The market for college [...]

[...] Indeed, college graduates have fared better in this recession than those without degrees and college graduates earn more over their lifetimes, But it costs a boatload of money to attend a four-year private or public school, leading some to [...]

[...] to an article by Rolfe Winkler at [...]

[...] vast majority of loans come from the government. It’s doing students more harm than good offering them. More debt on offer to pay for an asset — whether a house, a security, or a [...]

[...] vast majority of loans come from the government. It’s doing students more harm than good offering them. More debt on offer to pay for an asset — whether a house, a security, or a [...]