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A Dysfunctional System That Bankrupts A Generation

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

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Reader Comments (11)

What's the problem? The market clearing price hasn't been reached yet if people are still willing to pay the increases. The supply / demand informs us that we haven't hit the optimal price yet. You have to have people who opt out because of price before you'll have arrived at that point.

I agree, the system has artificial mechanisms like student loan programs which (temporarily) shield the effects of price from the consumer. Incidentally, the health care system functions similarly.

what is needed is for prices to get high enough that people opt out, and chose things like vo-tec school or apprenticeships.

Capitalism still works, we just don't really have it.

October 26, 2011 | Unregistered Commentercapitalist
The Australian system seems to have the best of both worlds. Students pay for tuition indirectly, the government pays initially, but charges repayments through a tax surcharge, that surcharge activated once the graduate's income has reached a threshhold, it's set at about the graduate entry level job level and scales up as income rises. In the meantime, the government pays the university an amount per student, the student debt is interest free, but adjusted for inflation (yes thats a cost to the taxpayer). It seems to work well, and harnesses market forces to balance the system and capturing 'public good' benefits while achieving the wider aims of society and students. I feel it's worth a closer look.
October 26, 2011 | Unregistered Commentermazewolf
You understand now why PIIGS states are so in debt: universities are payed by governments, not by students!
But in USA, with universities no more payed by government, roads no more fixed by government, water no more delivered by municipalities... All trillions $ taxes goes for extremely expensive wars and for transforming the corrupt billionaire politicians into multi-billionaires...
Should USA be neutral, as Switzerland?
October 27, 2011 | Unregistered CommenterJean-Francois Morf
"Should USA be neutral, as Switzerland? "

Do you think you can learn to speak Mandarin or Russian?
October 27, 2011 | Unregistered CommenterRich V
@Rich V: USA neutral was a joke!
Even Switzerland has an army! If we had no swiss army, (our swiss socialists wish no army!), Milosevic would have invaded Switzerland, taken all the Gold of Swiss National Bank and taken the many trillions assets from our Swiss banks! But USA could torture more terrorists dictators, and kill less moslem civilians...
October 27, 2011 | Unregistered CommenterJean-Francois Morf
Capitalist - Totally agree. "Capitalism still works, we just don't have it."

As you pointed out, that's also the problem with healthcare. Have you ever tried to do price comparisons on some surgery or other treatment before it starts. The industry will not give you prices up front. They treat first and then determine how much it cost. Hence, there is no way for the consumer to exert pressure on prices by shopping around. That's one of the fundamental flaws in our healthcare system.

These things aren't easy to fix, especially since the provider industry likes it the way it is. And the entities that pay a large part of it (insurance companies and governments) have become at least complicit, though I have to say that the Medicare administration does exert some pressure on providers to keep their prices down.
October 27, 2011 | Registered CommenterWolf Richter
Once again you are right on. The student loan problem is a national disaster. A lifetime of indentured servitude for kids who are not fortunate enough to have parents who can pay for their education. Most kids cannot make enough after-tax income to pay off these loans. Essentially we are bankrupting these kids by giving them worthless degrees and no real skills.

Great blog! On my daily read list.
October 27, 2011 | Unregistered CommenterZugersee
A dime a dozen degree like accounting, marketing, and other bs BS degrees are a waste. If you're going for one of htose now you'd might as well consider learning a trade to make a living.

You can't compete with experience workers and companies that would even hire unemployed experienced over new grads.
October 28, 2011 | Unregistered Commenteryellowsub
Government has always been the original problem. Go back to any civilization...Kings ruin countries, Presidents ruin nations, Congressions ruin hemispheres and Senators ruin the rest!!!! The most " civil " place you will find, is......out in the remote, peacefull country side! I have many munitions....I don't need Gov at all!!!!
October 28, 2011 | Unregistered CommenterBLY
Brian ... how is it only "{temporarily)" for the effects of all that Government distortion of the Education Industry ?? It looks to be what is driving all of the demand and the rising costs.
October 28, 2011 | Unregistered CommenterVBNTR
We are a in our current condition because we have no respect for a thinking person. We worship the loud and boastful who demonize anyone who does not think like them. We have deteriorated into a nation of adolescents.
October 30, 2011 | Unregistered CommenterXxxxxx

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