Higher Debt: Is the student loan industry headed for a meltdown?

Mike Riggs | Contributor

If, at the barely-legal age of 19, I had called my local bank and asked for $25,000 in order to study English at a third-tier private university; called again six months later and asked to borrow just enough to get my 1986 Audi GT Coupe out of the shop; then called one last time–really, the last time–a few months after that because a woman I did not know very well had asked me to spend a week with her in Paris, my account manager would have laughed me off the phone.

Because in considering whether to lend a 19-year-old many tens of thousands of dollars for his “education,” she would’ve had to inquire about my employment status (professional student), checked the number of times I’d overdrawn from my checking account (many), and taken stock of my collateral (none).

After establishing that I was unfit to borrow gas money, much less the annual salary of an entry-level white collar worker, my account manager would’ve thanked me for calling and encouraged me to come back when I was an adult.

But the institutions in charge of doling out tens and hundreds of thousands of dollars in student loans to unemployed high-school graduates don’t work like your average local bank. Private lenders like Wells Fargo don’t have to worry about a borrower defaulting or declaring bankruptcy, because student loan debt–like circumcision–is a lifelong commitment. The government doesn’t have to worry about default rates either, because money is no object when it comes to educating America’s youth, or making those youth return to Caesar what is Caesar’s.

With no disincentives for lenders, and no escape for the debtor but death (or for fewer and fewer borrowers, successful repayment), America’s collective student loan debt has grown to $829 billion, surpassing Americans’ credit card debt for the first time.

As a result, more Americans than ever before are going to college, and more colleges than ever before have rock-climbing walls, turn-down service, and heated pools.

The catch? America’s most sacrosanct bubble is damn near ready to burst. The experts are hardly of a mind on the details, but most of them can agree on one thing: It’s no longer a question of “if,” but “when” the prevalence of easy credit will bring higher education to its knees.

Here are three visions of American higher education after the bubble bursts.

Next: The cautious realist

View: The cautious realist

“You can’t flip an education.”

Mark Kantrowitz dismisses comparisons of the student loan bubble to the housing bubble with a wave of his hand.

“People were investing in houses because people were investing in houses. The value of the house was based on the house, not on the price of construction. You saw people buying and selling pre-construction. But you can’t flip an education. If diplomas aren’t worth anything, people vote with their feet.”

In his spare time, Kantrowitz makes origami models and restores antique toys. During the day, he runs FastWeb and FinAid, two of the most respected and longest running websites that guide students through the ins and outs of having someone else pay for their college education.

The collapse that his peers have been ranting about is at least two decades away, argues Kantrowitz. We won’t see the worst of it until college graduates who are currently signed up for 20- and 30-year repayment plans are tasked with sending their own kids to college. At which point, Kantrowitz expects cost sensitivity will drive low- and middle-income students–whose parents are too busy repaying their own loans to pay cash for their kids’ educations–out of the arms of private colleges and into publicly funded two- and four-year colleges.

“The higher the cost of the college, the higher the debt at graduation, the more families pay attention to out-of-pocket costs and the amount of debt they’re taking on. Eventually they will start walking away,” Kantrowitz says.

While these kids could probably still borrow for their educations, tomorrow’s parents will have a much different view of student loans than do baby boomers, many of whom borrowed little or nothing to attend college. It’ll be state schools and community colleges for these kids, if it’s a traditional education at all.

Private nonprofit colleges and universities will be the canary in the coalmine.

“There are a bunch of tuition-driven nonprofit colleges that have very high tuition rates. I believe that some of them are going to fail,” Kantrowitz says.

“Tuition-driven” means that a school’s operating costs are mostly derived from the amount it charges in fees and tuition every year. When enrollment numbers are lower than expected, the schools find themselves running up against budget deficits. Many tuition-driven colleges also have a large number of students who borrow to pay for their education. If those types of students were to shift to cheaper schools, or if private credit lines were to dry up, tuition-driven nonprofit colleges, like George Washington University, Boston University, and a slew of other schools that charge top-tier rates in exchange for second- and third-tier educations and job-placement rates, would have to cut back.

Kantrowitz says such institutional belt-tightening isn’t out of the question.

“We’ve seen some of this during the crisis, as in the case of furloughs, but it does have an impact on the quality. You will start seeing colleges that are having financial difficulty boost their enrollments in response. They will try to cut full-time faculty, perhaps in half; they will cut the service side, cut salaries, and double the student-teacher ratios. It will be a slow and painful process, and schools will bank on their former reputations.”

The exodus hasn’t started just yet, argues Kantrowitz. But as tuition increases continue to outpace inflation, thanks to easy credit and federal subsidies, so will the pressure points. Eventually, families that can’t afford to pay $10,000 or $20,000 a year to keep their children from taking on debt will have to ask themselves, Is it worth borrowing?

“The answer,” Kantrowitz says, “is going to increasingly be no.”

NEXT: The optimist

View: The optimist

A year ago, Howard Horton co-authored a piece in the Chronicle of Higher Education that sent shivers down the spines of that magazine’s academic readership: “Will Higher Education Be the Next Bubble to Burst?” In the piece Horton and Joseph Marr Cronin, both college administrators, wrote that “with tuitions, fees, and room and board at dozens of colleges now reaching $50,000 a year, the ability to sustain private higher education for all but the very well-heeled is questionable.”

A year later, Horton’s outlook is rosier.

“Looking at how schools have weathered this economic downturn, what I’ve noticed is how resilient they’ve been as an industry vertical,” he says.

“The demand is just there. The tuitions at private colleges have exceeded inflation. The state colleges are bursting at the seams. The need for training and retraining is getting people to go back to school. More people are seeing the college degree as a necessity.”

Horton thought that a recession would be the ultimate test of the higher education industry’s supply-dependent economy. “In the housing market you had less people out there buying. That’s not a parallel in higher education. More people are buying education.”

Horton is the president of the New England College of Business and Finance and an early proponent of online education. Like any other college administrator, he has a fondness for education subsidies, which have only increased during the economic crisis thanks to the efforts of congressional Democrats and President Obama.

“Colleges have found a way to be resilient. They’re still getting a lot of cash from students,” Horton says. “Maximum loan values are up. PLUS loans are up. For the bubble to break the supply of those kinds of dollars would have to diminish.”

This is where Horton deviates from his arguments of a year ago. Higher education isn’t the sub prime industry anymore. Now it’s Detroit. “These subsidies are kind of like propping up the auto industry with cash for clunkers, or the housing industry with cash for first-time buyers. We have this financial aid system that is keeping the system alive,” Horton says.

Horton isn’t moved by the data that says this life support is actually killing us. According to a report published by the Chronicle of Higher Education in July, “one in every five government loans that entered repayment in 1995 has gone into default. The default rate is higher for loans made to students from two-year colleges, and higher still, reaching 40 percent, for those who attended for-profit institutions.”

Defaults, as we saw in the mortgage crisis, are a sure sign that a good is overvalued. Unless, of course, you’re Horton. In which case, there’s a sunny explanation for the record high number of students defaulting on their loans.

“One thing that has to be remembered about the default rate is that it’s demographically sensitive. You’re always going to have a higher default rate at an inner city school than at an Ivy League school,” Horton says. “Does that mean the school isn’t run well? No, it means the student is more at-risk for defaulting but that’s because they’re coming from a more impoverished background. There’s a great need for people to acquire skill and education, and the obstacles associated with that shouldn’t be an automatic reflection on the school.”

Like many online educators, Horton says the easiest way to cut costs is to move away from brick-and-mortar institutions, or for the brick-and-mortar institutions to move online.

“That is a huge cost-savings,” Horton says. “You can accommodate a lot of growth because you don’t have to build infrastructure. That’s a technological way you can adapt.”

And the supply? It’s not going away, even if Gen Y is a little smaller than the previous generation.

“Education is becoming more lifelong. You’re going to see more people doing stuff online. You’re going to see changes in how the academy functions. There’s been talk of three-year degrees and of eliminating 12th grade,” he says.

Those changes wouldn’t mean just asking the academy to adapt to a changing economy, but also asking future students to alter their expectations of college.

“There are colleges that students are competing to get into, and there are colleges that are competing for students. If you’re at that level of the former, you’re going to be fine,” Horton says.  The others, he says, will have to move quickly towards a cheaper model to keep from going under.

“I don’t know that the bubble is going to burst. But definitely it’s going to morph,” Horton adds. “You’re going to see more changes in how colleges deliver their product.”

And little change in how it’s paid for.

NEXT: The Pessismist

View: The Pessimist

“If a thing can’t go on forever, it won’t.”

Glenn Reynolds did not come up with this maxim, but he repeats it with the fervor of a proud papa. The University of Tennessee law professor says that easy credit for higher education is just such a thing.

“What can’t go on forever is an increase of tuition at rates higher than household income,” Reynolds says. “The thing that can’t go on forever is students graduating more and more in debt.”

Because those things can’t go on forever, they won’t.

Reynolds, like Kantrowitz and Horton, sees expensive mid-list private schools getting the shaft first. But he doesn’t share their comparatively rosy outlooks. In June, he compared a decline in student loan borrowing to the housing market in 2007.

“Bubbles burst when people catch on, and there’s some evidence that people are beginning to catch on. Student loan demand, according to a recent report in the Washington Post, is going soft, and students are expressing a willingness to go to a cheaper school rather than run up debt. Things haven’t collapsed yet, but they’re looking shakier — kind of like the housing market looked in 2007,” Reynolds wrote in the Washington Examiner.

“A few things constant about bubbles are that nobody can predict when they’ll burst. Whatever causes a bubble to burst, it tends to be something small and hard to predict,” Reynolds told TheDC. “The other thing about bubbles is that people always tell you this one is different.”

And the Instapundit blogger wouldn’t roll back the tide even if he could.

“If [this kind of lending] were done by any other business, it would be regarded as predatory. Whether a university is organized as for profit or nonprofit, it’s a business like any other.”

While he’s not the first person to make this comparison, I asked Reynolds why more politicians aren’t critical of the student loan industry, and the government’s role in egging on a generation of indebted 18-year-olds.

“Education has really good PR in the U.S. We have the best university system in the world, but in 1965, we had the best automobile industry in the world, too. Don’t think that because it’s good, it’s unassailable. I think they need to be accurately informing students about how they’re going to afford these loans.”

Accurately? Many of them won’t be able to afford these loans, because they won’t be able to find jobs upon graduation. Or, at least not the jobs they were promised when they borrowed $50,000 for school, and which they have to begin paying back within six months of graduating college.

“The ramifications for defaulters go beyond higher ed,” Reynolds says. “People with student loan debt can’t afford to buy houses. They’ve already bought a house. They can’t afford a car, because they’ve already bought a car.”

Reynolds’ suggestion? “You want these borrowers to know what they’re getting into, and you want the institutions that loan money to get some skin in the game. They shouldn’t have to eat the entire loan in the case of a default or bankruptcy, but they should retain 10, 20, or 30 percent of the risk.”

“That oughtta make people less willing to write $200,000 checks to unemployed 18-year-olds.”

But even if his suggestion is ignored, Reynolds stands by his mantra: Things that can’t go on forever, won’t.

To an 18-year-old, student loans are like fairy dust. You’re not really sure where they came from, why you’re eligible to receive them, or how you’ll pay them back. Only that they are good and plentiful, and without them, you’d be forced to attend a school in your parents’ income bracket. Maybe a public university where you are “just a number.” Or a community college, where single moms go to brush up on their remedial math skills.

Student loans, the key to attending a school that will make you healthy, wealthy and wise, are also undermining the American economy and exposing millions of young Americans to a level of risk more befitting seasoned investors.

More than likely, more government subsidies won’t be the answer. As tuition hikes continue to outpace inflation in both private and public nonprofit schools, states will find it difficult to keep up their own financial aid contributions. That’s already the case for the public university systems in Florida, New Jersey, California, and Arizona, where skyrocketing attendance numbers means more people on an increasingly crowded dole.

And while encouraging a reality-based approach to post-secondary education might mean fewer trips to Paris for broke 19-year-olds, and maybe even fewer English majors, that’s a small price to pay for graduating solvent adults.

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