What Is Driving the College Tuition Bubble?

It’s not a failure of monetary policy, but fiscal policy.

Over at The Quantum Pontiff, ScienceBlogling Dave Bacon asks if college tuition is a bubble:

But what I find interesting, and what I’ve never been able to figure out, is the larger trend (ignore the last two years, please). Why are tuition prices increasing at such a fast rate for four year colleges? For example, see slide 5 of this presentation where one sees that over the last three decades, the inflation adjusted price of college has more than tripled at public four year universities and gone up nearly as much a private four year universities….
My own theory is that we are in the middle of a leverage driven bubble. Okay, yeah, its a stretch, but its fun to look at the numbers.

I think Dave is right that the continuation of the ludicrous increases in college tuition is due to funny money–just as the final stages of the ridiculous run up in housing prices was due to ‘ninja loans’*. To explain what I mean, let’s first think about what putting two kids through private college entails (and remember that rising private college tuitions allow public institutions to raise tuitions and still seem like a bargain).

If a family with two kids born two years apart sends both children to private colleges, that family will spend ~$400,000 over a six year period. This is in a country where the annual median income is ~$50,000. So when you hear well-endowed universities congratulating themselves that sixty percent of their students receive financial aid, keep in mind what that really means: forty percent of families could afford to pay what is essentially a second mortgage cash on the barrel head.

Now consider this figure from Les Leopold’s The Looting of America (and derived from U.S. Census data):
What is driving the incredible rate of increase of college tuition is that there are enough families that can pay those tuitions with cash. Sure, they would rather pay less (less is always better than more), but they can pay more. That drives prices up. The start of the boom in tuition was the explosion in income inequality.

So how does increasing leverage factor in? Well, if that leverage weren’t available, universities would have a revolt on their hands: families in the ‘second tenth’ would have a hard time paying the bills–never mind the other eighty percent. Yes, flooding the educational market with funny money kept the boom going. But this is what happens when rising income inequality meets an inelastic good.

The way we lower tuitions is two fold:

1) Increase funding to quality public schools so they can lower their tuitions. At some point, they will drive private prices down, or at least retard their growth.
2) Reduce income inequality so there is a smaller pool of people who can spend so much on tuition.

And if this sounds anything like a rehash of Keynes vs. Bernanke-Friedman, well….

*No Income, No Job, Approved.

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7 Responses to What Is Driving the College Tuition Bubble?

  1. Eric Lund says:

    forty percent of families could afford to pay what is essentially a second mortgage cash on the barrel head
    And of course that’s 40% of the families whose children are attending Top Dollar U. I’m guessing that few students from the left hand side of the income distribution bother applying to Top Dollar U. unless they have some confidence in their ability to win a scholarship (whether athletic or academic). A few of the better endowed private universities still claim to do need-blind admissions, but many of them either can’t afford it anymore or depend heavily on the availability of student loans. Meanwhile, marginal students from the upper 5% are more likely to go to Top Dollar U., either because it was Daddy’s or Mommy’s alma mater or out of a sense of entitlement.
    More importantly, there was never any evidence that college tuition is an efficient market. Everybody complains about high tuition costs, but there is no effective means to push back against tuition increases, at least as long as the loan money flows. Same deal with real estate: as long as people were able and willing to borrow money to cover the outrageously high costs, there was no real way to prevent those costs from becoming even more outrageous.
    Small nitpick on the NINJA loans: I thought that stood for “No Income, No Job or Assets”. If you have a big enough bundle of money stashed away, and the loan is a recourse loan (not always true of mortgages, depending on state law), lending to you is not as risky as somebody in an otherwise similar situation who does not have a stash of extra cash. Though I would want to ask you why you didn’t want to spend more of that stash instead of taking on the loan.

  2. A says:

    I always thought that the tuition charged by American Universities is a method of economic segregation: the high price is to keep the riff-raff out. Having an expensive diploma is a signal to employers that you are ‘part of the club’ (no matter what your grades, see G.W. Bush.). Middle-class parents have recognized that a high-priced diploma is the entry ticket to upper-class jobs and upward social mobility, and therefore are willing to sacrifice.
    And state universities could get away with raising tuition (as second-best alternative), and were systematically defunded (here, in California, since Regan was governor). I suspect, with the entrenched ‘no-tax’ mentality among politicians, public colleges will not do better anytime soon.
    The income inequality is even worse than what the graph suggests: From Paul Krugman’s March 13, 2006, blog:
    (I suspect that in the last few years, it got still worse)
    “….leaving the impression that everyone in the top 10 percent was a big winner. In fact, there was hardly any rise in the share of income going to people between the 90th and 95th percentiles: almost all the gain went to the top 5 percent. And most of the gain went to a very small elite. The income share of the top 1 percent went from 9.6 to 17.5 percent, accounting for more than 70 percent of the top decile‚Äôs gain. The income share of the top 0.25 percent went from 4.9 to 10.5, accounting for a bit more than half the total gain.”
    (With adjustment for inflation, the lower 80% lost, and the upper 90-99% probably just stayed even)
    And income inequality is apparently not something our Mainstream Media like to report on, as Krugman says “..my editors at the Post tried to pressure me into taking the income distribution chapter out,.. ”
    Oh well, the US now shows the least economic mobility (with the UK) compared to other developed countries. (http://www2.lse.ac.uk/ERD/pressAndInformationOffice/newsAndEvents/archives/2005/LSE_SuttonTrust_report.aspx)
    High tuitions keep it that way.

  3. A says:

    “The way we lower tuitions is two fold:
    1) Increase funding to quality public schools so they can lower their tuitions. At some point, they will drive private prices down, or at least retard their growth.
    2) Reduce income inequality so there is a smaller pool of people who can spend so much on tuition. ”
    That sounds like a tax increase! Indeed, a tax increase on the upper 0.5 income percentile would address both points; more state income to fund public colleges and universities, and reduce to a small degree the income inequality. (I would be more forgiving of the excesses of Wall Street if I had known that 50% + of the ill-gotten gains had flown into the public treasuries, but I know that my marginal tax rate is the same as that of billionaires (Bill Gates once pointed out, that his secretary paid more taxes as percentage of income than he did), and more than that of hedge-fund managers (who apparently get away with 15% [all income is capital gains]). But good luck with getting a politician on board! Tax increases are class war! (Even the democrats could not get the tax code changed to have hedge fund managers income taxed as salary).
    Oh well. The Roman Empire declined too, when its richest citizens could avoid taxation.
    The other thing is that, indeed, as the other poster pointed out, the real price of tuition is not clearly advertised. The higher-priced colleges all claim scholarship programs to assuage their conscience, but the extent of those is often unclear. All parents of [high-priced university students] I ever met told me that their son or daughter gets a scholarship; but when I ask for detail, I often find that the actual financing is a mix of loans (big), family contribution (big), some tuition rebate (insignificant), and for lower-class people, work-study [often a bad deal, considering the little income as percentage of tuition you get, better study for better grades; a good deal only if you can work in some lab or office related to your major, so you can sell it as work experience on your resume], and a scholarship/grant you’d get even if you’d go to any other school (Pell and similar state programs). But that their child gets a ‘Scholarship'[no matter if it is really insignificant dollar-wise] makes parents more willing to come up with the remaining cash for tuition.

  4. D. C. Sessions says:

    Scholarships? Maybe. However, in order to get a scholarship you have to be admitted and you have to apply for them. To be admitted, you have to pay for the admission process — which, for a kid who isn’t already well-financed, is a hardship in itself. To apply for a scholarship, you have to know that the scholarship is there.
    For anyone who isn’t an all-State athlete, it’s far from obvious that the scholarships even exist — unless you can afford to hire people who make a business of finding scholarships for their clients.
    The bottom line is that, academic qualifications equal, scholarship money still tends to favor the well-funded. From personal experience, even being a National Merit finalist isn’t going to help you if you don’t have enough money to paper the world with college applications and don’t have a guide to the scholarship search.

  5. scrabcake says:

    My parents paid a mint for me to go to a good school, and my education cost as much as a small house. They had been saving since I was a kid. My family’s income was just above the cutoff for financial aid. I got some one year, but it was really just enough to pay for books. Less than half of a month’s tuition. I know people who did grad school who are going to be paying off the student loan debt until a decade before retirement. I think that a lot of my parents’ lifestyle choices made this possible…I don’t know if they could have afforded to pay in full had they lived in California instead of the midwest, or if my dad had not chosen to work overseas for half the year.
    Anyway, what I’m trying to say is that it’s not simply an issue of rich kids vs poor kids, but an issue of priorities and how much debt you are willing to undertake. It is unfair, and believe me, my parents would have loved it had it been cheaper. Universities do this because they can. People want the best education for their kids and will make it work even if they can’t afford it, so universities CAN charge pretty much what they want.

  6. David says:

    I’m paying cash for my older son’s tuition at a prominent private college. The school proudly announces that almost 2/3 of the undergraduates receive need-based aid and the average tuition package is over 1/2 the cost of tuition, room and board. So pretty clearly, the people in the low 3 quintiles aren’t exposed to the full cost of tuition. There is a feedback cycle between increases in tuition and increases in financial aid.
    I agree that increased funding to high-quality public schools is the most direct approach to cost reduction. Tuition assistance to individual students makes the cost bearable to the individual but contributes to increased costs for the group.
    great post.

  7. Edward says:

    Two kids two years apart here, and the oldest is applying to college now. Several of the colleges my oldest is applying to say they will meet 100% of “demonstrated need.” These schools have also typically adopted a “no loan” policy – it’s all grants and possibly a bit of work study. I remember hearing that all families that make under 200k generally qualify for some type of financial aid. That suggests that you have to be in the top 5% before you don’t qualify. That doesn’t quite jive with the figures I can find on % of students getting aid and the supposedly “need blind” admission system. However, it’s also the case that stuff like private music lessons, attending exclusive schools and doing well there, enrolling in expensive summer programs, etc. can help you get into exclusive colleges. In other words, while financial need may not be a factor in deciding who gets admitted, other factors that are strongly correlated with financial need ARE considered. Also, it tends to be only the very most exclusive private schools and state schools that don’t consider financial need in the admission process. Many private schools, including a number of exclusive ones, do consider need.
    Ideally, I’d like to see a system where any kid could afford to attend any school to which they could get admission – without any loans involved.
    (Disclaimers – I attended a school with “need blind” admissions and do alum interviews of applicants. However, under COI rules, I’m not doing any this year since my son is an applicant).

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