Good for College Administrators, Bad for Students

Last week President Obama signed a bill lowering student interest rates. “Obama praised Democrats and Republicans alike for agreeing — finally — on what he called a sensible, reasonable approach to student loans even as he cautioned that ‘our job is not done.’”

Before we consider if this is really good news for college students and their families, let’s first consider the relationship between interest rates and price.

Most of us are familiar with the 0% free financing offers by big-box stores such as Best Buy and Home Depot. The purpose of the offers is to increased demand for their high-ticket products. Of course they are not being altruistic, increased demand means they are able to sell these products at a higher price. Their calculations are that the revenue they gain by selling the items at higher prices will more than make up for the revenue lost by the free financing. When you are shopping for electronics or appliances, a store that does not offer free financing will almost always be able to beat the price of a store that has free financing.

Do you know the one question, posed by a car salesman, which you should never answer when shopping for a car? “What monthly payment did you have in mind?” As soon as you answer that question the salesman has shifted the focus from the selling price of the car to the financing arrangements. The outcome is that you will pay more than if you simply negotiated over price.

By now most of us understand how low interest rates fed the housing bubble. Very low interest rates reduced monthly payments which increased demand for housing. The increased demand for housing dramatically pushed up the price of housing. The inevitable will happen and, one day, interest rates will rise. When they do, and increase of even a few percentage points will have a dramatic impact: housing prices will fall.

Years ago, when interest rates were higher, some builders offered subsidized interest rates as a way of increasing demand for, and thus the price of the homes they sold.

Back to our question, is subsidizing interest rates good news for students?  As with appliances, cars, and homes, lower interest rates mean increased demand which means increased tuition. Indeed, the cost of a college education in the United States has increased twelve fold over the past 30 years while the consumer price index has increased only three fold.

And what have colleges spent that increased money on?  Better classrooms? Better dormitories? Better food? Better faculty? Perhaps in part, but much of the money has gone to hiring more administrators. In a not so atypical example, the Wall Street Journal found that the University of Minnesota “added more than 1,000 administrators” over the past 12 years. “Their ranks grew 37%, more than twice as fast as the teaching corps and nearly twice as fast as the student body.”

Subsidizing interest rates has other unintended consequences. Students will be less mindful of education costs since someone else (the taxpayer) is paying part of the bill. Colleges will be less mindful of wasteful spending, and they’ll feel freer to increase tuition since lower interest rates will increase demand.

Whatever you subsidize, you get more of. In other words, individuals respond to incentives.

In the past few years there has been a healthy questioning of the value of a college degree. This questioning has caused some students to consider, for instance, should they go deeply into debt if their intent is to major in a subject for which job prospects are not strong. For example, is it a good deal to borrow a hundred thousand dollars to attend a private school and graduate with a degree in art history?  As more students consider questions such as this, there will be healthy adjustments in the subjects students choose as majors in college. With that adjustment, more students better prepare themselves for today’s jobs.

Some want to do more than subsidize interest rates; some in Congress have proposed student loan forgiveness.

If, for example, a hundred thousand dollars of debt can be wiped out by declaring bankruptcy, there will be an incentive to find yourself in circumstances under which you can declare bankruptcy. With loan forgiveness, the process of shifting demand toward majors for which there are stronger job prospects will slow down.

Someone has to pay for the college education of a student whose debt is subsidized or wiped out. That “someone” may be hard-working person who never had an opportunity to go to college. Consider, for instance, a bus driver. Is it fair that a bus driver pays taxes to subsidize college students?

Colleges are filled with students who are more interested in going to parties than in going to classes. Along with the expansion of administrative ranks, alcohol abuse is rampant on many campuses. Many schools are known for their weekly three-day drinking period which begins Thursday night and ends on Sunday night.  Again, subsidies warp decision-making.

Disruptive innovation is coming to higher education. Many of the coming innovations will surprise us. And as with housing, when the higher education bubble finally bursts, those who thought the party would go on forever will be deeply impacted.

One Response to Good for College Administrators, Bad for Students

  1. Sancy says:

    We still haven’t figured out that college education is not some nice treat for the “privileged” or those who have money and want to make more, have nice houses, etc. We mandated twelve years of fundamental education at taxpayers’ expense a long time ago, hopefully to ensure a reasonably prepared citizenry to deal with life and build better communities. Is it time to revisit that twelve-year benchmark, and fix that system, as well as consider how important well-educated populations are to better governance, inventiveness, creativity, world competitiveness, not to mention national security. Should the health of the country, economy, government be left to who happens to have enuf funds to learn?

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