The current market for college education mirrors that of the housing bubble in the early 2000’s. Both markets experienced similar government interventions to assist lower income individuals in buying homes and affording college. Despite the best intentions of the government, these policies were a failure in the housing market and will eventually fail the college education market if deregulation does not occur.
Initially enacted by congress in 1977, the Community Reinvestment Act was intended to encourage depository institutions to “meet the credit needs of the communities in which they operate, including low and moderate-income neighborhoods”. Eliminating discrimination in lending was the initial goal of the bill; however, legislative changes in the 1990’s made compliance with the CRA less about a fair process and more about results. In order for a bank to change business operations, such as a merger or expansion to new markets, the bank needed to prove to regulators that it made sufficient loans to low income individuals and minorities. Regulations on mortgage underwriting streamlined the process. Banks could now make loans without traditional credit criteria, thus contributing to an increase in subprime lending. In a 2007 speech about the CRA, Ben Bernanke stated “Securitization of affordable housing loans expanded, as did the secondary market for these loans, in part reflecting a 1992 law that required the government sponsored enterprises, Fannie Mae and Freddie Mac, to devote a large part of their activities to meeting affordable housing goals” . High returns in the stock market during the tech bubble of the late 1990’s kept the MBS market relatively small.
After the bubble burst, the Federal Reserve lowered its target rate from 6.5% in late 2000 to 1.75% in late 2001, and then left the rate at 1% from 2003-2004. Investors around the globe were also seeking new opportunities at this time. Seeking to capture a share of this market, banks, thanks to the CRA enabled streamlined mortgage underwriting process, began lending out “bad mortgages” at a rate unlike any other time period. Refinance loans increased from approximately 2.5 million in 2000 to over 15 million in 2003. The national median home price was about 2.9 times the median household income. By 2004 the ratio rose to 4.0 times. Household debt as a percentage of annual disposable income rose from about 90% in 2000 to about 120% in 2004. Pressure to comply with CRA standards, in conjunction with easy credit conditions and demand for alternative investments was responsible for the subprime mortgage backed securities boom and subsequent bust.
Initially enacted by congress in 1965, the Higher Education Act was intended to provide financial assistance for higher education through the Federal Family Education Loan (FFEL) program. Under this program, private lenders made federally guaranteed student loans. Amendments were made in 1978 and 1986, and loan volume ballooned in response. The most notable legislation was the Student Loan Reform Act of 1993 which greatly expanded the federal loan program. Total Federal Aid increased from roughly 22 billion in 1990 to around 160 billion 2015 dollars. Since then, college tuition has increased by nearly double on average for private institutions (17,430 to 33,480 in 2016 dollars) and has roughly tripled for public institutions (3,720 to 9,560 in 2016 dollars). Consider the federal loan program a subsidy for higher education. Demand for a college degree has certainly increased, driving up prices. The price increase would normally be constrained by individuals’ ability and willingness to pay, but the increase in subsidy has effectively increased their budget constraint. The tuition increase is a reflection of colleges attempting to maximize their gains due to the new higher budget constraint.
By isolating aid for lower income students, the government has disproportionately hurt students from middle income and higher income families. The share of debtors owing 40,000 and up has increased from 22% in 2003 to 47% in 2011 – 2012. The tuition increase described above leads one to think: Where does the additional money go? The answer: administrators. Before the loan program expansion, almost 80% of professors were full time and today about 50% are lower-paid part-time employees. Most of the additional money is funneled into administrative positions. Data from the Department of Education, shows a 60% increase in administrative jobs between 1993 (Student Loan Reform Act Enacted) and 2009. During this same period, growth of tenured professor positions rose only 6%.
Poorly implemented government initiatives created the conditions for the housing and subprime mortgage backed securities boom in the early 2000s. The market for a college education is currently on the same path. As tuition prices continue on a bullish trend and wages and output growth remain relatively stagnant, defaults on student loans will increase. In addition to the proposed forgiveness plan already in place, the government should eliminate any further regulation of colleges and allow market forces to drive tuition prices back down to sustainable levels. If history is any indicator, the state of higher education in the United States could be damaged for years to come if government intervention continues.
This piece was written in December. Refer to the post about fabricated loan repayment information. I was right all along about the default rates!