Education, the next bubble to pop?

One of the fundamental premises of Austrian economy theory is that markets must be free to allocate capital quickly and efficiently.  When governments or central banks instead try to control or influence the allocation of money, no matter how noble a pursuit, results in larger, more complex and completely unforeseen problems.  Call it the law of unintended consequences.

The problem with central planning, is that it generally indeed has the most noble of goals.  Some recent examples of the last 50 years include:

This video, while a little dramatic, does a great job of highlighting these unintended consequences:

The general methods for central planning are financial incentives, or regulations.  Focusing on financial methods, the government will either give you money to do something, give you money not to do something or penalize you for doing something. This can be found in the form of rebates, tax deductions, fees, penalties, criminalization, etc.

For this conversation, lets focus on the most common: giving or loaning you money to do something.  One of the most common and obvious side effects of government influencing the public to do something is an increase in prices related to that service.

Here is an example we are all now familiar with: housing.

Over the years, the government did a lot to promote housing.  This was undoubtedly done for both noble reasons (The American Dream, affordable shelter, supporting family structure, etc) and some more shady reasons (help builders, mortgage brokers and banks make a bundle in the process).  Regardless of the reasons, the government did what it does best – it threw money at the problem, either via tax credits or subsidized loans:

  • Mortgage interest tax deduction
  • Property tax deduction
  • Home sale capital gains exception
  • Fannie Mae and Freddie Mac
  • Federal Housing Administration (FHA)
  • US Department of Housing and Urban Developer (HUD)
  • Cheap mortgage rates
  • Tax rebates and credits (these were fortunately short lived)
  • Incentives to banks to lend to home buyers
  • Hyperbole and other rhetoric (Ugh – “The ownership society” is a great example)
  • Countless others…

The result of all these incentives were obvious: as more and more people had more and more access to larger and larger sums of money via loans, etc., the price of homes increased.  This is the basic law of supply and demand.

Education is no different. Just like housing, the government is encouraging and enabling the spending of money on education.  Through various programs such as guaranteed loans through Sally Mae, grants, scholarships and more there are ever-increasing amounts of people who can spend ever-increasing amounts of money on education.  The result is that prices rise.

It’s a vicious cycle:

  • Education is too expensive
  • Government provides loans so people attend school
  • The price of school increases as attendance grows
  • Education becomes too expensive
  • The government offers larger loans
  • The cycle continues…

The result: the cost of education rises faster than wages (people’s ability to pay) — and just about everything else for that matter.  Because the price continues to increase, and the government and society continue to demand (and subsidize) affordability, the government creates an ever-increasing array of payment options.  Including:

  • ESAs / Coverdell Education Savings Accounts – Like an IRA for education.
  • Education tax credits and deductions – If you spend more on education you can spend less on your taxes.
  • 529 Plans – Because you can’t borrow enough, you should also be encouraged to save for college in a tax advantaged account.
  • Various Federal grants and financial aid programs – Loans aren’t enough, we can just give you some money.
  • Pre-paid Tuition and Guaranteed Education Tuition Programs – Lock in today’s prices by pre-paying for tuition.  This is based on the premise that your state will make up the difference in the future.

Each one of these options all seem like a good thing.  After all, who doesn’t want to promote education and helping people achieve their potential? But… take a look at what has happened to the price of education as all of these incentives influence pricing.  The problem with incentives is that they focus only on enabling people to pay the rising prices, instead of asking why prices are rising in the first place.  This madness is one of the reasons, I do not plan on “taking advantage of” my states GET or other 529 plans.

Here is a graph of the cost of a 4-Year college tuition, when compared to median household income and the Consumer Price Index (CPI):

Comparing CPI, Median Income and the cost of education in US

As  you can see, since 1977, the median US household income has increased by almost 3.6x, while the cost of education has increased more than 10X, thus the rate of “education inflation” is several times that of regular inflation.   To enable this: government loans have filled the gap!

I think the fix to rising education costs and unaffordable education is for the government to simply stop “helping”, or at least help less.  The easiest way to do this would be get rid of Sally Mae, or perhaps alter the way it works.  The fact that Sally Mae backed loans (effectively all student loans in the US are Sally Mae backed loans), are 100% guaranteed and can never be defaulted on or discharged in bankruptcy is pure insanity.  Essentially, student loans have zero risk to the agencies and banks that provide them and 100% risk to the students that take them out and the tax payers that fund them. Thus banks have no incentive to give student loans only to credit worthy borrowers, or at least borrowers whose education plan make sense (spending $150k to get a job making $35k for example does not make sense, especially if you could get a job making $30K without the education.  You’ve just spent 150K before interest to earn an extra $5K per year).

Does this sound familiar?  Do mortgage-backed securities, NINJA loans, To Big To Fail and the housing bubble ring any bells?  Without risk, sanity is thrown to the wind.  If risk was slowly and surely re-introduced to the student loan market the supply of new money would decrease, the demand for education would decrease and the prices would decrease, thus allowing more people to afford the education they want without the need for debt.  And without an unlimited supply of applicants, colleges would have to become more competitive to command high education prices.

Much like the housing bubble, the education bubble is also plagued with consumers that have bought into the idea that education is worth the cost, no matter how high.  And like the housing bubble, the risk of default is theoretically solely on the borrow — although waves of defaults would still wind up hurting the taxpayer.  Many who borrow don’t know what it will cost to repay the loan, or even what their monthly payments will be, until the borrowing is already done.  And without requirements to provide Truth In Lending disclosures, it’s incumbent on the borrower to figure it out — the lender doesn’t have to tell you.

On a final note, check out the following infographic that has been making its rounds on various PF blogs.  It tells the history of students loans in the US, and might make you rethink the value of taking one out:

Why student loans suck Infographic

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3 Responses to “Education, the next bubble to pop?”

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