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Make colleges pay loans if their graduates can’t

When the U.S. Education Department shut down ITT Technical Institute at the beginning of the fall semester, some people saw it as just desserts for the for-profit college. Given ITT’s relatively low graduation rates, alleged use of deceptive job placement figures in its recruiting efforts, and high numbers of loan defaults and delinquencies, the government may have seemed justified in refusing to fund more loans to ITT students.

Yet, now, 35,000 students are suddenly without a school and 8,000 faculty and staff are unemployed, and the entire episode shows that the government remains fixated on problems in the for-profit sector while virtually ignoring that all of U.S. higher education has long been guilty of what, in another business, might be called price gouging.

It will come as no surprise to most Americans that college tuition has been rising at about twice the rate of inflation for a quarter century. This has left student borrowers with increasingly heavy debt burdens, which in turn have led to rising delinquency and default rates. The fundamental problem is that a large portion of any college’s operating funds come from federal student loans, on which taxpayers take the loss if students fail to repay. Universities themselves have no skin in this game.

The solution is to require that colleges absorb some of the loss on delinquencies and defaults by their graduates and dropouts: say, the first 5 percent of losses. And 1 percent to 2 percent of loan amount should be deposited with the Education Department at origination, as collateral.

Only colleges can control tuition, and the cost of room and board and other student expenses. Only they can assess which students are likely to gain the benefits that college should provide. Only they can design their curriculums to prepare students to be productive members of society and to make a living sufficient to repay their loans. We should hold colleges accountable so they do all these things far better than in recent decades.

What would colleges do once they had skin in the game? For starters, they might trim their bloated administrations, where non-teaching staffs have ballooned by 60 percent between 1993 and 2009.

There would also be new pressure on admissions, forcing most institutions to focus on applicants with greater promise — or at least less likelihood of defaulting. Overall enrollment might slow or decline moderately, after having notched a stunning increase of about 40 percent over the last 20 years.

While almost all Americans see more and more kids going to college as a good thing, increasing numbers of graduates are taking jobs that don’t require a college degree — as many as half of them, according to a study by McKinsey. So, for the less-qualified applicants, college may not be the best choice. While colleges are not responsible for declining quality and availability of jobs in the U.S. economy, they must react to this reality.

We could also expect colleges to view their curriculums with greater realism. With tightened admissions requirements weeding out the least-qualified students, remedial courses would be first to feel the pinch. Beyond that, coursework would become more utilitarian. No more majoring in 13th-century Mongolian poetry. Taxpayers should not be forced, nor would colleges themselves want, to backstop losses on loans to students who choose abstruse subject matter, particularly in graduate schools, where debts can pile well up into six figures.

Placing a greater emphasis on career prospects may lead some colleges into deeper collaborations with companies. They could more explicitly tailor their curriculums to meet employers’ needs, in return for those companies committing to work-study opportunities for undergraduates and to hiring goals for graduates. 

Under this new system, we would also see big change in the for-profit sector. These schools have most exploited the free-money aspect of federal student loan funding. According to a recent study from the Brookings Institution, 77 percent of their students have federal loans — compared with 62 percent at four-year private colleges, 50 percent at four-year public universities, and 27 percent at two-year community colleges. Yet the for-profit students default more often — about 47 percent fail to repay loans after five years, twice the rate at which students from even non-exclusive public and private schools default.

If they had skin in the game, for-profits would have incentive to reduce their dropout rates, better align tuitions with average pay in the career tracks they target, and improve their job placement efforts. For-profits also might double up their current emphasis on online learning, which carves away the room-and-board cost of traditional college, and focus even more on career training. Properly designed and implemented, these would be positive developments.

One cannot underestimate the stakes in resolving the federal student loan crisis. A stunning $1.26 trillion in debt is outstanding today, double the amount in 2009. Moreover, expected losses are mounting from rising defaults, loan discharges and loan modifications under income-based relief programs.

The trends cannot continue. But Draconian actions such as the abrupt shuttering of 50-year old ITT, which will trigger as much as $490 million in taxpayer losses on loan discharges, are not the answer. Nor is making college free, as Bernie Sanders has proposed, or “debt-free” in Hillary Clinton’s craftily worded proposal. There is no such thing as “free” — someone always pays.

That’s why student loans should no longer be free to the colleges that use them to fund their operations. Introduce a cost to them for access to that money, and they will spend it more wisely. They are the ones who should know where funding should be cut and where to reallocate it. But until they have something to lose, they will have no incentive to do so.

As appeared in Bloomberg on Oct. 6, 2016.


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