Economic bubbles, including higher education, are self-perpetuating, until they are not

Reason Magazine has several analyses of what is wrong with American higher education, i.e. we need more liberal arts, less liberal arts, to treat it like an investment, to treat it like a consumption good. While higher education has gotten more expensive since the 1970s, it has gotten more expensive, faster, recently.  As Prof. Reynolds said, “At an annual growth rate of 7.45 percent, tuition has vastly outstripped both the consumer price index and health care inflation (see chart). The growth in home prices during the housing bubble looks like a mere bump in the road by comparison.”

Let’s say Fred is a high school senior, looking to matriculate as part of the class of 2017.  Fred is smart, savvy, and wants to determine if college will be worth the investment.  Fred decides to examine, inter alia, the income/debt ratio of graduates of the college he is considering (Podunk), and the default rate of Podunk’s graduates.

The most recent data available on income/debt is from the Class of 2011, who started college in 2007.   At a rate of increase of 7.45% per year, however, Fred’s first year at Podunk will cost 1.5 times as much as freshman paid in the 2007-2008 school year; his sophomore year, 1.5 times what the recent grad paid for sophomore year, etc. For every dollar that his 2011 grad year peer paid, Fred will pay $1.50.  That will render any serious income/debt or cost/income analysis entirely irrelevant, at best.

It gets worse if Fred were to consider default rates.  Students get a nine-month grace period, and then also get a few years of deferment and forbearance.  Podunk’s default rates are from students who graduated around 2009 and earlier.  That most recent crop of students matriculated circa 2005.  Again, using the 7.45% increase number, for every dollar that those 2005-2009 students paid, Fred and his family will pay approximately $1.80.

Due to the power of compound interest, and the fact that budgets can only be stretched so far, it is more than 1.8 times as hard to pay $180,000 as it is to pay $100,000. Yet diligent, risk-averse Fred, using the most recent data – entirely accurate data! – would be nevertheless using outdated  data – data that was obsolete before it was even published.  Exponentially-increasing costs cannot be analysed with data that is from a different part of the growth curve; however, due to the time delay between matriculation and loan payment, outdated data is the most current data that colleges have.

Homeowners had a lot of problems during the bubble, but, even with balloon payments and introductory rates, the market responded faster than the higher education market does. The same is true of health care costs – if you want a double-bypass surgery, you can find out what the hospital charged for one that it did yesterday; you wouldn’t be getting data on the heart surgeries performed back in 2001.  In higher education, however, you take out debt now and do not start paying for at least five years.

Even if the higher education bubble were to ‘pop’ tomorrow, in whatever sense that would happen, we would still not see the full extent of problems until sometime around 2020 – i.e. when today’s freshman have graduated, when their grace periods have expired, and when their lower initial payments are increased.  Our best tools to figure out what will happen to them are based on people who enrolled in 2005. If loan forgiveness were an option, those graduates would exercise that around 2038 – based on a law passed in 2010, using data from people who matriculated in the twentieth century.

Disclaimer: Yes, I know that increasing tuition does not map perfectly to increased debt, and I know that the sticker price at colleges is often more fictional than reality-based for many families.  But, unless costs and debt are constant for all but the super-wealthy, or are increasing linearly with respect to inflation, the point holds – all data is outdated data.

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Filed under Academia, Economics

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