Would New Financing Models Produce Useful Higher Education Reforms?

Problems with rapidly increasing student loans, a poor job market for recent graduates and new for-profit competition for the education dollar are generating interesting ideas for educational reform.  Is coming of age through a higher educational experience worth a huge debt burden that will stay with you even after bankruptcy?  Recent news reports of those with unpayable student debts will be giving some second thoughts about maxing out their student loans and living it up on the leftover “refund” checks after they pay their university bills.   Like home ownership, for some, college education may not even be necessary to achieve the American Dream.  From a financial standpoint, a university diploma will be well worth the cost for many students.  Others with college degrees will work lifetimes in dead-end jobs and have little to show for the time and money invested in education.  Results will depend on the effort put forth, the quality of the institution, and the demand for the skills obtained.  Default rates are much higher at for-profit institutions than others.  Those who default damage their credit and lose many potential job opportunities.  For the 20% who eventually default on student loans, the price of a college education may well be too high.

Unfortunately, at 17, many are not in a position to assess the costs and opaque benefits of higher education.  They depend on institutional representatives for help.  In many cases, especially at the for-profits, there are substantial government-backed incentives for selling services that might not be in the best interests of the student.  Could financing education with claims on future earnings instead of debt help align the college’s incentives with the student’s best interests?  Adam Levitin and Yves Smith have recently suggested such an approach.  With an equity stake, colleges would accept a percentage of enhanced future earnings for a set number of years rather than proceeds from student loans as payments.  This could reduce the institutional incentive to enroll students unlikely to benefit financially from education and reduce the number now saddled with difficult to repay student loans.

Over 50 million U.S. student loan balances averaging $17,000 total roughly one trillion dollars.   This student loan debt now exceeds the total credit card debt of the nation.  The distribution of loan amounts is highly skewed with a median amount of just $12,000.   These are current balances on the debts and many have paid the balances down over several years.  Over 25% of the 1.6 million Bachelor’s degree recipients from 2008 borrowed over $30,000 and 15% (240,000) borrowed over $40,000.   Payments are roughly 1% of the original loan balance each month for 10 years.   Therefore, each year, 400,000 graduates will owe over $300 on student loans each month for 10 years.  That’s more than a car payment, but without the car.   If the rates double in 2013 from 3.4% to 6.8% as suggested in the President’s proposed budget, the payments would increase by 17%.

Presumably, the problem loans have the highest values.  While it’s hard to get good student loan statistics, a large chunk of the 22-35 year olds in the US must be struggling with this debt because 9% of U.S. student loans are currently in default, 20% eventually default and 63% will get behind on payments at some point.  Default rates vary widely by schools with by far the worst rates coming from the for-profit sector.

Equity Financing

While equity financing seems like a reasonable way to align institutional incentives and to reduce the debt burden, it would drive massive changes in education with consequences that might not be in the best interest of society.  With equity financing, we would expect the greatest educational benefits to flow to students most likely to succeed financially rather than to those who succeed academically.  Institutions would push vulnerable students into programs where they would produce the highest income.  Programs that couldn’t attract or produce high earners would be defunded and eventually die.  Directly rewarding universities based on their ability to attract high earners would radically redistribute funding toward top-tier schools.  Those catering to the low-earners wouldn’t get resources and would eventually “reform” by changing their target audience or die as well.

What’s wrong with that?  A lot.  Many youth already define their worth by the size of their paychecks.  We don’t need additional institutional pressure in this direction.  They get enough from their peers.  Doling out education to those most likely to be able to generate high paychecks will increase the already too wide income and wealth gaps.  Most of the programs that generate high-income graduates benefit from government-enforced licensure and other market distorting influences.  Equity financing would provide one more distortion benefiting those permitted to run such programs.  It seems unlikely that equity-financed students would be able to choose a field independent of their ability to repay the costs.  There would be too many incentives for institutions to move easily influenced students toward more profitable programs and restrict or eliminate others.

Still, fraud and other problems associated with government-backed student debt are very similar to those associated with government-supported housing loans several years ago.  We’re in the middle of an “education debt bubble.” If it continues to grow the inevitable crash will affect society and the education sector in much the same way the 2007 bursting of the housing bubble devastated the housing sector and created economic difficulties for much of society.  Continuing to finance higher education with almost unlimited government-supported student debt is not an option.

Short-term Approaches to Student Debt

In the short-term, we should consider measures to share the risks of loan default between lenders, students, and educational institutions.  Everyone needs to have “skin” in the game; otherwise, the incentives for predatory lending, “deadbeat” students, and sham educational institutions will erode trust in the entire system.  This will reduce total educational funding substantially.  There seem to be few realistic alternatives at this point.

Schools with the highest student loan default rates should absorb the bulk of the funding reductions.  Much of the for-profit education sector would disappear if government-supported student loans carried reasonable restrictions and shared penalties for default.  Others with high default rates would feel the pain as well.  To the extent that it affects institutions providing legitimate services to those who might otherwise create a burden on society, states might replace some lost funding with tax revenues.

Despite my concerns about an all-encompassing equity-funding model, we might experiment with it in specialized licensure programs with rigorous admission standards that produce high earners.  This wouldn’t have much impact beyond the students in such programs.  Limiting equity financing to specialized fields seems unlikely to redistribute money to programs and schools that attract high earners.  It seems fair to trade a piece of a medical other licensed professional income stream for state-enforced laws prohibiting competitors without licenses.  This is especially true when the supply of licensed professionals is restricted so much that salaries become grossly inflated.  Health care is a good example.  The American Medical Association and accreditation councils strictly control the supply of physicians and other health care professionals.  The lack of competition allows physicians and medical specialists to charge higher prices.  Since medical education is very expensive, equity financing would eliminate some of the largest and potentially problematic student loan balances in the system.

Long-term Educational Reforms

In the longer-term, we need to undertake root and branch educational reform at all levels.  To some extent, reform being forced upon us with alternative educational delivery and certification models.  For those of us mired in the past, we’re still designing educational programs that we hope will meet societal needs then recruit students into these programs.  Too often, these students are unprepared for the programs, the institutions don’t remediate, and students either fail or lack basic skills that their credential suggests that they have.

Potential students need good honest advice about how they can help society with the skill sets they possess and can develop.    High school guidance counselors, parents and teachers are relatively independent but generally don’t know enough to give useful career advice.  University counselors, professors and administrators are more knowledgeable but have incentives that often conflict with the interests of the student.  Most students end up driven into mass-produced education and careers by their fears.

Mass Customization of Education

If we moved from a mass production model of education to a mass customization model, then we would focus on the needs of each student and not institutional programs, credentials and ratings.    I’d like to flesh out such a model in a future post.

For now, I think one key to mass customization in education and career planning is advising.  Starting in adolescence, we need to give people frequent, meaningful individualized feedback on skillsets they have, how these skills relate to potential career choices and interests, and how to develop the knowledge and abilities needed to pursue those interests.  Accessible educational options are also needed for mass customization success.  A large chunk of the population would have to provide these options.  I’m thinking broadly of apprenticeships, mentoring, writing seminars, and other skill-building activities available to relatively few students today.  Most communities don’t facilitate this type of interaction.  Christopher Alexander’s thoughts on community building would be a step in the right direction.

I would appreciate any ideas or useful references related to mass customization in education.  My thoughts are sketchy but I’d like to try to post on the topic.

Update 1:  May 18, 2012.  Provided more definitive student loan statistics from the Progressive Policy Institute and finaid.org.

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