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The College Credit Bubble

The latest bubble forming on the horizon isn’t in real estate or stocks. It’s the cost of a college education, up four times the rate of inflation since 1985—twice as much as health care costs.

What’s driving this stratospheric rise? Just like the housing crisis, easy credit and poor government policy.

For decades governments have championed making a college education affordable for all, just as they did home ownership. Since some segments of society couldn’t afford an education or a house, the answer was to encourage lenders to make loans they wouldn’t normally have made. This was done by guaranteeing lenders that if the loans went bad, the government would take them over.

There were two results of this seemingly noble policy. First, with easy credit available, almost any jobless teenager could borrow up to $250,000 for a college degree without a worry in the world of paying it back until graduation.

Easy credit drives up prices, as the increased demand exceeds supply. Colleges increased tuition at a dizzying rate, simply because they could easily fill classes with students who could easily pay the tuition by painless borrowing. Normal market forces were thwarted, and prices rose exponentially and consistently. Four years of tuition that cost $50,000 in 1985 costs $200,000 today.

The second result is a replay of the housing crisis. According to an article by Malcolm Harris in the September/October 2011 issue of Utne Reader, students now owe more than $800 billion in outstanding student debt, of which only 40% is in active repayment. The majority of student loans are in default or deferment. Since these debts are guaranteed to the lenders, U.S. taxpayers are on the hook for them.

The government’s artificially gaming markets to give credit to those the market would normally deny, while well intended, causes unintended consequences. The distortions create a new set of problems, sometimes as bad as or worse than those that inspired the attempted fix in the first place. More often than not, most of the parties to the transaction ultimately lose.

Among the losers are the students themselves. Few take the time to calculate the overt cost of obtaining their education with the corresponding salary it prepares them to earn. But Laurence Kotikoff, professor of economics at Boston University, describes the hidden costs in the September 2, 2011, InvestmentNews. These include the time spent learning rather than earning, plus the progressive income tax which taxes annual earnings rather than lifetime earnings. According to a recent study by economists Stacy Dale and Alan Krueger, going to more selective colleges and universities makes little difference to future income.

Kotikoff compares two students, neither of whom borrow for their education. One becomes a doctor and the other a plumber. The doctor spends 11 years of her life in school in order to earn $185,895 annually. The plumber spends two years and earns $71,685. The bottom line is that the plumber’s sustainable spending is equal to the doctor’s.

If the government stopped guaranteeing college loans, the initial result would be significantly less demand for a college education. Tuition rates would plummet, eventually becoming affordable once again as the source of easy credit dries up.

Without easy borrowing as an option, parents and students would be encouraged to begin college saving early. Students would have new incentive to earn money for college and also do well in high school to qualify for scholarships. The result would be more students graduating without debt and feeling less pressure to take the first job available.

Then, the money that today’s grads apply to student loans could instead be invested in retirement plans.

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4 Responses to The College Credit Bubble

  1. Jerry October 17, 2011 at 7:55 am #

    That’s a “eye-opener”. Any other “good-ship-lollipops” out there since the Nanny State mentality took over in the ’60’s that drove national debt and unfunded obligations to sore to $76 TRILLON ?

  2. Dowell October 17, 2011 at 11:50 am #

    The increase in tuition is more a result of cost shifting. What was once paid for by state governments has been dramatically shifted to tuition. The forces you mention may play a secondary role but the strategy to shift costs from taxpayers to users is the fundamental cause of the rise in tuition.

  3. Mike Haubrich October 18, 2011 at 7:21 am #

    Read “Real Education” by Charles Murray for an eye opener on this current bubble that is bursting — Higher education scam.

    We are selling our youth a bag of garbage on how a college degree is the answer to their futures without informing them that half of what they learn in the first two years of college will be irrelevant by graduation. That is assuming Johnny (or most likely Jill) are actually majoring in a useful subject (English history probably won’t do it). Instead of teaching life-long learning skills, higher education is lowering standards for grades and meaningful degrees to keep the flow of customers/victims coming through their turnstiles –many who really do not belong in college.

    And this scam is being financed by well-meaning parents and grandparents with the ultimate bag-holder — the US taxpayers.

  4. Jason February 16, 2012 at 11:12 pm #

    I agree with the above commemorator. More and more the cost of a college education is being shifted to the consumer. Student loan debt is piling up and schools are receiving less and less funding. To some extent I feel a lot of what students learn in school is irrelevant but… many good habits can be established.

    Best of luck!