Root of All Evil

By Richard Vedder

The papers are full of stories the past couple of days about the growing student financial aid scandal in American higher education. Financial aid officers at some schools (including ones as prestigious as Columbia) have had large stock investments in companies that are on the "preferred list" for student loans. Students are encouraged to borrow from companies in which the person doing the encouraging has a direct financial interest, or at least that is what New York Attorney General Andrew Cuomo and others say is happening. If true, this is truly a scandal of monumental importance, particularly if more than a few isolated cases are involved.

It is not surprising. We have a system almost designed to promote corruption. Kickbacks to schools are of a highly dubious ethical nature, while stock options and other devices to reward individuals are, if not outwardly criminal, at least very unethical. Greed trumps integrity, as it so often does in an era where all values are relative, where many think there are no moral absolutes, where most colleges cannot even agree on what good citizens should know in common about life and our world -- if anything.

The problem would not exist if there were not an unholy alliance between the provision of higher education and its funding. These are distinctly different functions, and should be provided by separate individuals. In the 1930s we separated investment banking from commercial banking because of possible conflicts of interest (however, this legislation has been largely reversed in the past decade or so), and maybe in the 2000s we should separate the provision of higher education from its funding, at least for institutions receiving government monies (nearly all of them).

It is my hunch that colleges use inside information to tailor their own financial aid to fit their institutional objectives, not the best interests of individual students. The colleges know that Student A has a $3000 Pell Grant, a $5000 Stafford Loan, a $1000 scholarship from a small local foundation, etc., and it tailors the price it charges the student (the rebate from sticker price) to meet this inside information. Thus the positive impact of the Pell Grant on the student's access may be completely offset by a $3000 reduction in institutional financial support. The student is no better off than she would have been without the Pell Grant, and the school uses the $3000 it saved from insider information to reward someone else, perhaps a rich kid who is also smart, but for whom public policy would not approve favoring with financial aid. Before this scandal erupted big, I argued for moving towards separating the financing functions from the educational ones. I have argued for the federal government getting out of the loan business, and for universities getting out of the business of loan provision completely, excepting institutional loans financed out of school endowments.

This scandal could have a positive or a negative conclusion, depending on what is done. If Congress passes heavy handed regulation that merely raises the costs of doing business, it will be a failure. However, there are some sensible things that can be done. Short term, it seems to me that financial aid officials should not have investments in financial service companies if the institution serves in an active role of a financial intermediary, bringing together students with lenders. Pell Grants should be given directly by the government to students in the form of vouchers usable at any accredited institution, with zero institutional involvement. No "preferred lender" lists should be made available to students, as that implies some form of institutional endorsement. Longer term, we should probably promote complete separation of the provision of academic services from the funding of them, except for the use of institutional funds themselves. Universities should be prohibited from asking students about non-institutional grants and loans provided. I suspect that institutions use their inside information to raise, not lower, the net tuition charge paid by students.