Thursday, July 9, 2015

Cheap Loans Lead to Inflated Prices

Easy student loan money lead directly to tuition rate hikes.  Sadly, college graduates can't figure this out.

The Federal Reserve Bank of New York has said what I have been saying all along:  Cheap student loans lead to massive price increases in tuition.

When students fund their education through loans, changes in student borrowing and tuition are interlinked. Higher tuition costs raise loan demand, but loan supply also affects equilibrium tuition costs—for example, by relaxing students’ funding constraints. To resolve this simultaneity problem, we exploit detailed student-level financial data and changes in federal student aid programs to identify the impact of increased student loan funding on tuition. We find that institutions more exposed to changes in the subsidized federal loan program increased their tuition disproportionately around these policy changes, with a sizable pass-through effect on tuition of about 65 percent. We also find that Pell Grant aid and the unsubsidized federal loan program have pass-through effects on tuition, although these are economically and statistically not as strong. The subsidized loan effect on tuition is most pronounced for expensive, private institutions that are somewhat, but not among the most, selective.

Even if you have the most rudimentary financial skills, you can understand why this is true.   For example, you go to buy a car, but loans are not easy to get (as in many other countries in the world).  So you have to pay cash for the car.   Since you don't have a lot of cash, you can't buy a lot of car - you look for the cheapest car you can find, that you can buy for cash.

But if you have financing available, well, it is a lot easier to buy a more expensive car.  The "LE Option Package" is only $52 more a month, not $5000 more on the sticker price.  In real terms, as well as emotional ones, you end up spending more, because money is more freely available.

We also see this in the housing market.   Loans for personal residences are subsidized in a number of ways as the government wants to encourage home ownership.  Interest is tax-deductible.  Loans are guaranteed by the government.  And so forth.  As a result, interest rates for home loans are far lower than they should be - compared to commercial rates, for example.  And yet arguably, home loans are far riskier, as the borrower is likely to be an amateur, and there are a host of laws making it difficult for banks to foreclose on a property.

When loans become ridiculously easy to obtain - and the interest rates are artificially slammed down using gimmicks, then prices skyrocket.   Suddenly, everyone qualifies to be a buyer, so they buy - and the market meltdowns of 1989 and 2009 occur.   The meltdown in 2009 was much larger - in direct proportion to how much more ridiculous the loan terms were.  3-2 buydowns of the 1980's pale in comparison to the "liar's loans" and "optional payment" loans of the 2000's.

With student loans, the same effect takes place.   Parents are desperate to "launch" their children and make them self-sufficient.  There is also a lot of emotional baggage tied up in keeping their kid in the middle class, having bragging rights to other residents of Foreclosure Mews Estates, and so forth.  Kids, brainwashed from birth that college is the ticket to high living and a high income, sign their life away at age 18.

In addition, many private loans are often obtained not for college expenses, but to enhance the lifestyle while in college.   College students are no longer starving, but in fact have nice cars, smart phones, designer clothes, and whatnot.   For some, it is rich parents picking up the tab.  For others, it is borrowed money - used to maintain the appearance of wealth, as many striving middle-class people tend to do.   These kids learned the lessons of their parents - go into hock over your head to keep up with the Joneses.

Colleges have huge overheads.  Alumni donate buildings, but not the electricity to heat and cool them - nor the funds to re-roof them and remodel them when needed.   Union janitors and maintenance workers outnumber faculty 2 to 1, if not more.   Administrative staff is bloated.  Everyone is a "Dean" of something, including the parking lot.   Oddly enough, one of their smallest expenses these days is the teaching staff.  Most are part-time "adjunct faculty" or graduate students, paid little or nothing and never offered tenure.  The school's new rock-climbing wall costs more to maintain.

And therein lies another aspect - college as entertainment.   Schools are vying with each other to attract and smaller and smaller number of high school graduates.   While the "Millennials" are starting to outnumber the Baby Boomers (because the latter are dying, and the definition of "Millennial" has been expanded to encompass a larger time frame) the number of high school graduates each year is declining.  The Boomers had higher birth rate numbers - numbers which have not been matched since 1960.

So the schools offer grandiose "student centers" and extracurricular activities to attract students.  College isn't all hard work and studying, it can be fun, right?   Well, unless you are in the Engineering curriculum.  Then it's pretty much all hard work and studying (and a job at the end of the pipeline).

Another aspect that baffles me is the idea that the cost of education doesn't matter.  I met a young high school graduate the other day, and they were considering several colleges.   They gave me their logic behind each selection - the location, the reputation, the courses, the professors, the available majors, etc.  Even the rock-climbing wall was mentioned.  However, tuition was not discussed, which I thought was odd, as the various schools on the list had radically different tuition rates, some as much as three times what others were.   A private college might cost three or four times what a State school costs.

When you shop for a car, the first thing you settle on is your price range - or at least you should.  You do not make up a shopping list of "Hyundai Accent, or Cadillac Escalate, or Bentley" as it would make no sense.  If you could afford the latter you would not consider the former, and if you couldn't afford the latter, the former is a foregone conclusion.

But kids for some reason have this "Well, Dad will pay for it" mentality, or figure they will just sign more student loan debt, and figure the more expensive degree will be "worth it" as they will make three times as much money.  This is, of course, not true.

And that is where student loans come in.  Some folks protest they have "$25,000 in student loans" which is a pathetic amount of debt to worry about, even if you are working slacker jobs.   The kids who signed up for $100,000 in student loan debt -  to get the same degree as the $25,000 guy - are the real issue.  When you read these stories, you ask yourself, "What prompted them to make these poor lifestyle choices?  Why didn't they go to a cheaper school?"

And the answer is, the funny-money student loan debt, which they did not cognitively realize at the time would have to be paid back someday, took pricing out of the equation - or at least dampened its effects.

The good news isn't student loan debt forgiveness.  In fact, that would be the worst thing.   I am sure there are students today, signing loan docs and saying, "no big deal, by the time I graduate, student loan reform will make it so I can duck out on the debt!" - and people really think that way, too!

No, the good news is that I am hearing more and more about students considering college costs and more aggressively shopping on price, rather than just picking schools willy-nilly.    If more students voted with their pocketbooks, colleges would be forced to lower costs - as the law of supply and demand dictates.

Plus, we are hearing more stories of expensive outmoded institutions (usually smaller liberal arts colleges) facing struggles as their high costs are unaffordable and their outmoded educations unmarketable.   And yes, some school are starting to re-think their pricing strategies - offering lower tuition and (gasp!) looking for ways to reduce costs.

But regardless of all these external forces at work, you as an individual, are free to make better choices, smarter choices, richer choices, in deciding which school to go to, and how to pay for it.   Personal decisions you make trump just about everything.  Cheap loans or not, you can't get into trouble with student loan debt if you don't take any out - or at least minimize your exposure.  And if you are going to college, think hard about what you want to major in.  What sounds like "fun" is probably least likely to lead to a job when you graduate.