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The Student Loan Bubble

By Jim Chen et al.

Andrew Gillen of the Center for College Affordability and Productivity thinks the next US financial crisis will be the popping of the student loan bubble. In a recent report, Gillen draws parallels between the conditions leading up to the current housing crisis and those in the market for higher ed.

Here's his argument: To expand access to higher education, government has expanded students' access to financial aid, particularly through subsidized loans. Consumer subsidies expand demand. Profit maximizing suppliers normally expand production to respond to increased demand. In the case of higher ed, subsidies do not work that way.

Universities are not profit maximizers. Rather they maximize prestige. Expanding production and supply (adding more students) actually decreases prestige. Rather than add more students, universities hold enrollment constant, raise tuition, and use additional tuition revenue (care of federal subsidy) to build prestige. Consumers can benefit even if output does not increase if product quality increases. But, more prestige for a university is not necessarily coincident with a better education for students. Gillen asserts that universities are not using expanded revenue to improve the education they deliver to students. They can charge higher tuition without rendering a higher quality because students cannot analyze tuition cost against benefit. They tend to equate high tuition with high educational value, a correlation that is, according to Gillen, dubious.

Gillen's analogy to the housing bubble is compelling: Low interest rates and innovation in capital markets may have fueled increase in demand for housing, rising home prices, and the spread of subprime mortgage products. The federal government's tuition subsidy programs seem to have spawned the "sub-prime" student loan extended to students whose want a prestigious education, but sport prospects for graduation and loan repayment as shaky as their home mortgage counterparts. The market seems to be correcting for the student loan bubble. But, just as private lenders are closing their 'sub-prime' tuition loan shops, the federal government is considering legislation to take up the slack.

Perhaps government intervention is better directed at stimulating greater accountability for colleges and universities on the facts that matter to students' cost benefit analysis. Consumers armed with comparative information about the quality of education a university offers, including the impact of a particular degree on students' financial prospects, may provide the discipline universities currently lack. Critical Massand Inside Higher Ed ran stories on this idea yesterday.

Cross posted on Red Lion Reports.

Full post as published by MoneyLaw on May 02, 2008 (boomark / email).