Blowing The Bubble On Student Loan Debt Crisis

by: David J. Waldron

Following years of scrutiny directed primarily at for-profit, post-secondary institutions, the ever-expanding student loan debt crisis is now bringing all U.S. higher education into its growing bubble.

As widely reported, the amount of student loans awarded last year crossed $100 billion for the first time and total loans outstanding will exceed $1 trillion for the first time this year. Americans now owe more on student loans than credit cards.

First enacted by Congress in 1965, The Higher Education Authorization Act (the Act) was last reauthorized by Congress in 2008 as the Higher Education Opportunity Act. It includes the programs under Title IV that are the primary source of federal student financial aid. The Secretary of the United States Department of Education (USDOE) is charged with administering regulations on behalf of the Congressional reauthorizations of the Act.

Lower Interest Rates and Income Based Repayment

In advance of the next reauthorization, the current one expires at the end of this year, Congress is mulling both the lowering of interest rates on student loans, set to double to 6.8% on July 1, as well as implementing an automatic income-based repayment program.

With past due student loan payments also at an all-time high, it is clear some federal action is warranted. As a post-secondary education veteran, I have witnessed first-hand unintended disparities between student loan awards and job income prospects. Members of Congress and student loan reformers advocating the automatic income-based repayment plan must certainly be aware of the existing voluntary program. It allows eligible students to pay back loans at 15% of discretionary income.

Conceivably, opposing opinions may ask why not simply remind students of the automatic plan that already exists. It appears revamping the student loan program by forcing all borrowers into a structured income-based repayment may not go far enough. A delinquent payer's challenge may persist if the student has borrowed an amount that does not compliment the income potential of their chosen career. Alternatively, proponents may scrutinize the front end of the student financing process and recommend enhanced methods to control the amount of initial loan awards.

For example, my general rule of thumb, cultivated based on observations as a former campus administrator, is limit total student tuition commitment so not to exceed average potential first year income of the chosen field of study. This assumes the student is relying primarily on their career for income as opposed to an affluent household or trust fund. Granted, privileged students will survive this crisis [read SA contributor Robert Kuttner's relevant article: Higher Education: The Coming Shakeout.]

Return On Student Tuition Investment (ROSTI)

For most students, ultimately graduating and securing gainful employment will remain paramount to their ability to pay back student loans used to finance their education. A hypothetical case in point: a student of relatively modest means studying to be a web designer in an area of the country that pays on average $39,000 a year to start in the field. This student should avoid training costing more than $39k to fund (both out-of-pocket and loans). To illustrate, Education Management Corporation charges a web design student at its Art Institute campus in Pittsburgh approximately $22k for a diploma, $44k for an associates degree, and $88k for a bachelor's degree.

Web Designer: Initial Return on Tuition Investment

In this simplified example, the diploma would potentially generate a positive short-term return on student tuition investment, i.e., $22k invested for a first year income of $39k; the associates degree would require a medium term ROSTI, or $44k invested for first year income of $39k; while the bachelor's degree commands longer term tenure to potentially recognize the student's return on investment ($88k for first year $39k.)

Of course, there is substantial evidence that degreed workers surpass non-degreed in salary over the long term, but the chart demonstrates short-term return opportunities during the time frame when student loans first enter payback. This is the period when defaults are most susceptible. Nonetheless, the risk/reward proposition appears to favor reward in the shorter training while escalating risk in the longer, more expensive programs.

Gainful Employment

To be sure, the above rule of thumb is based on experience and observations, and is not currently a regulatory requirement. However, the USDOE allegedly remains committed to formulating gainful employment regulations that will hold up in court.

The Department's goal has been to effectively tie graduate employment and income (ROSTI) to a for-profit school's continued eligibility in administering Title IV federal aid in any approved program of study. Naturally, when Main Street returns to an economic boom cycle, the risk of higher cost degree programs will lessen. But obviously this cycle remains elusive considering today's stagnant economic climate. Continued slow growth on Main Street would potentially mitigate further congressional legislative action in response to the student loan crisis.

Although previously defeated in the courts, any renewed gainful employment rules from the USDOE are expected to remain directed at for-profit institutions. If enacted, the negotiated regs should apply to every higher education institution which ties its academic programs to career attainment, regardless of profit motive or tax status. This would essentially link student loan awards to income potential for all career seeking students. Frankly, this sea change would encompass a vast majority of the post-secondary education universe.

Education Industrial Complex

The student loan debt crisis is ultimately a macro issue that encompasses the so-called Education Industrial Complex. In higher education this would include the benefactors of traditional public or private non-profit institutions such as administrators, faculty, high net-worth donors, notable alumni, athletic boosters, mainstream media, and elected politicians. Unlike the principally student-centered for-profits, students often take a back seat at the patron-centered traditional institutions.

Until recently, the student loan crisis was a micro issue targeted by the Complex at the now vilified for-profit education sector. Not an orchestrated conspiracy, mind you, simply a self-interest protection of the embedded tax-free Complex. But it came at the expense of the tax generating, yet vulnerable for-profit sector and its blindsided investors.

Effective "Defaults" on Grants Lacks Coverage it Deserves

A correlated education funding dilemma rarely addressed by the Education Industrial Complex is the amounts of free federal Pell Grants, often awarded to low-income students at community colleges (and for-profit schools) that effectively go into "default" when the student drops out without transferring to a four year college. High drop-out/non-transfer rates at community colleges are prevalent, yet not universally documented.

How many Pell Grants, funded by the taxpayers, are rendered non-productive when as many as 70% of public community college students drop out or do not transfer? And because Pell Grants are not student loans, there is no payback liability. Both the student and the college are essentially off-the-hook.

Yet the taxpayers remain accountable for having invested in a student who did not follow through as intended, which is to graduate, get a job or transfer to a four-year college, thereby contributing to society in a meaningful way. It is undeniable the for-profits are emphatically over reliant on government grants and student loans. But I would challenge any investor or taxpayer in general, to look beyond the for-profits and also question the traditionals. Institutions invariably protected by the Complex, which in its own right patronages taxpayer dependence.

There are significant numbers of tuition driven public and private non-profit colleges and universities that might perish without state/local taxpayer subsidies and federal student loans or grants. And with the exception of payroll taxes and voluntary contributions to local police and fire departments serving their campuses, relatively little is directly returned to the tax coffers by traditional institutions.

Consequently, it may be too narrow a focus to limit the student loan discussion to for-profits only, when all higher education (sans the heavily endowed institutions) is in a proverbial bubble bursting at its seams.

Opportunity Beckons the For-Profit Education Sector

My recent article, A Renewed Value Proposition for U.S. Education Companies, presented the for-profit, post-secondary education industry as basically an investment "hold" pending the consequences of the student loan debt crisis and any final gainful employment rulings directed discriminately toward them. The fifteen publicly-traded U.S. education companies relying on federal student aid programs to a varying extent are: EDMC, WPO, APOL, DV, LOPE, APEI, BPI, STRA, ESI, CPLA, UTI, COCO, CECO, LINC, and NAUH.

As the for-profits fix their well-publicized woes, it will be critical to continue their lobby to hold all higher education institutions accountable to their respective students and the taxpayers who fund them. A universal expectation for generating a return on investment in the form of genuine career opportunities that justify the tuition paid.

But the for-profits will invariably be forced to set the example, collectively or in a shakeout of their own. If or when this occurs, investors in U.S. post-secondary education companies may benefit from a resumption of consistent growth and profitability, albeit reinforced by quality academic delivery and strong regulatory compliance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.