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College Tuition and the Credit Crisis

Cornell's indispensable professor of economics, Robert Frank, has an intriguing article in the Washington Post today, suggesting that America's current housing crisis and credit crunch can partially attributed to the quest for educational excellence. It's a provoking thesis:

Even in the 1950s, one of the highest priorities of most parents was to send their children to the best possible schools. Because the labor market has grown more competitive, this goal now looms even larger. It is no surprise that two-income families would choose to spend much of their extra income on better education. And because the best schools are in the most expensive neighborhoods, the imperative was clear: To gain access to the best possible public school, you had to purchase the most expensive house you could afford.

But what works for any individual family does not work for society as a whole. The problem is that a "good" school is a relative concept: It is one that is better than other schools in the same area. When we all bid for houses in better school districts, we merely bid up the prices of those houses...

Yet millions of families got into financial trouble simply because they understood that life is graded on the curve. The best jobs go to graduates from the best colleges, and because only the best-prepared students are accepted to those colleges, it is quixotic to expect parents to bypass an opportunity to send their children to the best elementary and secondary schools they can. The financial deregulation that enabled them to bid ever larger amounts for houses in the best school districts essentially guaranteed a housing bubble that would leave millions of families dangerously overextended.

I think the phenomena actually extends beyond the competition for the best public elementary and secondary schools. At the peak of the credit bubble, many families were taking out second mortgages on their home equity to help finance an education at a private college for their children. And as housing prices continue to decline -- and current trends show no signs of abating -- more families will find themselves owing more on their house than it is actually worth. To add insult to injury, if the debt for the high priced educations was supposed to be justified by a higher earning potential, the current recession and weakened job market will only serve to make times even more dear for families and recent grads.

The icing on the cake is the student loan industry. I think it's fair to say that most college's wouldn't be able to keep on raising tuition the way they have been if it were not for the easy availability of credit through student loan programs. The cruel irony is that the leftist academics who deride the ill-gotten gains of the financial services industry and Guilded Age excesses of today's America are largely benefiting from the enormous credit bubble that the industry has spawned over the last decade. After all, their salary is paid in part by the debt of the American middle class -- as reflected in the over-leveraged home equity lines and the mounting piles of student debt.

Thankfully, it seems like the era of cheap credit is over. Liar loans are a thing of the past, and banks are running out of the student loan industry faster than a philosophy major can say, "Would you like fries with that?" after graduating. But we'll see how well the universities weather the storm -- in both their endowments and in their sources of tuition revenue.

The missing link is the public role of financing higher education. Thirty years ago, public funds financed a much larger share of higher education's expenditures. Today, as Pell Grant and federal research funding stagnates, even ostensibly public universities are funding a much larger share of their activities through private sources. Look no further to see how much tuition has shot up at Cornell's contract colleges over the last decade to see these changes in action.

The final twist is that the public -- taxpayers like you and me -- may end up paying for our fair share of higher education after all. As the major financial institutions see the writing on the wall -- that the second mortgages and student loans that they underwrote to finance the goal of higher education may not be as sound as an investment as they thought it was -- there will be increasing political pressure for the U.S. government to assume these liabilities. Privatize the reward but socialize the risk. Don't think it will happen? Well, the Federal Reserve already agreed to eat the majority of the billions of dollars in bad bets that Bear Stearns made. Why couldn't it happen to Sallie Mae as well?

It kind of makes you wonder why we didn't just have greater public support for higher education in the first place. But then again, Citigroup founder Sandy Weill might not have been able to donate all the money that he has to Cornell.

N.B. MetaEzra interviewed Robert Frank last year. You can read the interview here.

Matthew Nagowski | Posted on April 29, 2008 (#)

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