23 Nov 2015

What do university fees represent?

Feri writes*

In this blog, I will explain the possibility of an impending student debt crisis in the United States and its similarities to the 2008 mortgage crisis. Furthermore, I believe that plans to ease student debt and make universities tuition free that have been adopted by democratic candidates for president Hillary Clinton and Bernie Sanders could be very harmful.

The general idea is to make the top 1% wealthiest Americans pay for everybody else's education. This plan is badly researched as the math doesn’t simply does not add up. This is largely due to the common misconception that there is this source of taxable money that is being hoarded by the wealthiest of Americans and that once it is taxed it would create a stream of new income for the government. This notion has been disproved by the Laffer Curve.

Tackling the $1.2 trillion student debt crisis and the 7 million debtors in default in the US is essential. The idea to forgive the debt and to provide low-interest government-insured loans is only going to benefit private universities. This easy money will cause a wave of big borrowing and a resulting inflation of tuitions that will quickly swallow up the money these government programs would require. I believe the student debt bubble that has already been formed could burst if either of these popular plans are implemented.

In the 2008 housing bubble, we saw similar policies which proved to be very harmful. The government provided easy money leading up to the bubble: people who otherwise wouldn’t have been eligible for a mortgage were given the cheap debt they desired. Soon, housing prices rose due to an increase in demand. The bubble burst when it became clear people were not able to repay their debt and many defaulted and the debt became worthless. Exactly this could repeat itself with the student crisis.

What the "New College Compact," idea assumes is that by making it easy to go to university and burden students with a lower cost they will eventually get a high paying job and it will be easy for them to pay the loans back. What is not taken into account is that this will also lead to oversaturation of college graduates and the government has exhausted businesses with new taxes and regulations, as a result companies stops creating more high paying jobs. Meaning those graduates will get low paying jobs and won’t be able to pay back, leaving us with $1.2 trillion written off,  $350 million spent on this new plan plus the new loans that will not be paid. What is the possible outcome of this?

Boom. The bubble bursts.

We can still prevent this problem of the tuition bubble growing and bursting with, for example, a $15,000 voucher plan that will create competition between universities, which would not be able to  raise the price of education because the voucher would be valid in any state. This way universities will not waste money but will try to increase the quality of education. Students would graduate with little or no debt. This will allow for university graduates to have a purchasing power much sooner than before and help the economy grow (the money, for example, you need to move from home or create startups).

Competition will also get rid of only for-profit universities who have very low standards. This will also make great community colleges much more desired and appreciated. This idea is supported by numerous people such as economist Milton Friedman and Mark Cuban.

Bottom Line: Making tuition easy to afford, community colleges free and forgive past student loans may sound great and beneficial for students their parents and eventually the economy, but in reality, it will be much more beneficial for universities that will raise tuition while producing more graduates chasing lower paying jobs with more debt. Instead of making it easier to spend money on something and reduce completion, create more competition to improve quality at lower prices.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.