The Higher Education Bubble

I was golfing with a college friend of mine the other day and he mentioned a fund-raising event he went to at our Alma Mater. There, the president of the school projected that tuition would continue to rise at a rate of 8.5% annually. Perhaps this doesn't sound too awful, but compounding the increases is a bitch...

2011-12 tuition: $40,000
12-13: $43,400
13-14: $47,089
14-15: $51,091
15-16: $55,434
16-17: $60,146
17-18: $65,259
18-19: $70,805
19-20: $76,824
20-21: $83,354
21-22: $90,439
22-23: $98,127
23-24: $106,467
24-25: $115,517
25-26: $125,336
26-27: $135,989
27-28: $147,548
28-29: $160,090

For a child born today, entering college at age 18:
29-30: $173,698
30-31: $188,462
31-32: $204,482
32-33: $221,863

Total: $788,805

Keep in mind that this is for tuition only and does not include living expenses or various other "fees" that colleges like to tack on to the bill.

My friend noted that he was trying to put together a savings plan for his one year-old son. To which I replied, "What's the point?" How much money do you reasonably have save each year to save for both college tuition and retirement? And is it at all responsible to pay for college over saving for retirement? And if you have multiple children, what percentage of people are going to have $1.5 million saved for their children's colleges? Finally, what entity (in the post-financial crisis world) would be crazy enough to lend a college student upwards of half a million dollars to get a bachelors degree?

Honestly, I tried answering these questions until I got dizzy and decided to consider the ramifications of home-schooling my future children through medical school.

Unless wages rise dramatically over the next decade (and there's little reason to believe that will happen), we can expect to see dramatic changes in the behavior of American students at some point in the next 15 years.

It is my belief (and a google search of "higher education bubble" will show I'm not alone in this belief) that America's higher education- colleges & grad schools- are a bubble that will eventually burst. I can't say when this will happen, but as the above tuition chart shows, it may come sooner rather than later.

Look at the parallels between higher education and the housing market bubble:

1. Belief that the item has an almost mythical value. (See: American dream of home-ownership vs. America's dream of a college education)
2. Irrational belief that the items value will always increase. (See: "Historically, housing has never gone down in value." vs. "College educations pay for themselves many times over in a lifetime")
3. Tax treatment that inflates the affordability of the item. (See: Deductible home loan interest payments vs. student loan interest deduction)
4. Easy credit to purchase the item. (See: Housing Loans of 2004-2007 vs. student loans backed up by the government, ability to defer interest until graduation, and availability of federal loans at a low fixed rate- which are admittedly not that low right now)
5. A rapid increase in cost that dramatically outpaces average incomes (See: Historical housing prices vs. 8.5% annual increases in tuition)

The housing bubble burst when banks became unable to sell the loans that were on their books and stopped offering refinancing on adjustable rate mortgages. Homeowners, who were relying on refinancing to avoid the increased payments, began defaulting on their mortgages. This threw into doubt the ideas that housing always goes up in value and that housing is a 100% safe investment. Suddenly, people who were overextended on their debts were no longer able to rely on the banks to prop them up. New home buyers couldn't get loans to buy homes, a glut of foreclosed homes and houses bought for investment flooded the market, and the deteriorating employment picture kept most other home buyers on the sidelines. Housing prices got crushed and are finally starting to stabilize after price drops of well over 50% in some areas.

This is the final major characteristic of all bubbles. Once they burst, things unravel very quickly.

I see two scenarios for the bursting of the higher education bubble. Let's tackle them like an episode of 'Mega-Disasters':

Scenario 1: The short wait-list.

It's a warm spring day in Chesterfieldtownport, Connecticut. The dean of admissions for a small liberal arts school is downloading the applications of candidates to start in the fall of 2018. The college has had a minor drop of in applications the previous two years, but nothing drastic. Tuition is $72k a year and the average salary for graduates is hovering about $41,000 a year with 55% finding work within 6 months of graduation.

Something seems off. There's only 2300 applicants for a class of 1850 students. She tries to redownload the applications. She calls her IT department. The IT department contacts the digital application hub. The number is correct. Only 48 paper applications are in-hand. The admissions board moves quickly through the applicants. Only 1100 students merit acceptance based on the prior year's standards. The entire wait list from early applications is accepted. After much argument, the standards are relaxed. 1500 are accepted under the new standards.

The application numbers are leaked to the press, becoming national news within hours. Other colleges are revealed to be suffering the same drop-off in applications. The public universities reap the windfall, as in-state applicants double across the country. The state schools (with in-state tuition about half that of private schools) become extremely competitive and become harder to get into than all but the most prestigious private universities.

The small liberal arts college takes a massive reputation hit. Only 950 students send in deposits for the 2018 school year. Many sophomores and juniors decide not to return to school. The school lays off staff and non-tenured professors. Classes jump in size, the school's ranking plummets. By 2022, the college is closed.

Scenario 2: Don't send us your poor.

It's the late summer of 2019. At the south's Big Private University, orientations are being planned, dorms painted and the basketball court polished. Over 3400 freshman are expected to arrive in the coming weeks.

Suddenly, the financial aid office's telephones start ringing. By the late afternoon, the office has left a voicemail message to contact them by e-mail. Over 5000 e-mails arrive that day. Sallie Mae, citing a huge number of student loan defaults, is suspending its loan program. The company is owed $9 billion in delinquent loan repayments and may need government intervention to continue operations. Citibank soon suspends their loan program, citing concerns about delinquencies and the need for an 'internal audit' to assess the risk they're taking on these loans.

All students receiving financial aid are notified that their loan money is not going to arrive in time for the fall semester. Big Private allows these students to withdraw for a semester without academic penalty due to financial hardship. Over 5500 students take this option. No one at the school will say it, but there's no guarantee this loan money will ever return.

Once the belief system of college as an American birthright and as an unrivaled investment ceases to hold consumers (and that's what college students are- consumers) captive, the entire system will need to be reanalyzed. Like with housing, college will again begin to be assessed like any other major purchase. Schools will need to focus on supplying value and on showing that to potential students.

After the bubble bursts, the gap in education may be filled by private companies, who cherry-pick the most talented students to start 'apprenticeships' at their companies. Likewise, on-line colleges will likely become more of a mainstream option and more accepted as a reasoned alternative to traditional colleges. Finally, colleges may start allowing for public service to count for school credit. In this way, students can gain life skills, help their community, and reduce the cost of tuition by replacing classroom work with service.