By Andrew Gillen
This is the second in a four part series that will explore the similarities between the housing bubble and rapidly increasing tuition. A study that explores these issues in greater detail will be available at the conclusion of the series. Part 1 is available here.
Similarities in Higher Education
Part 1 of this series explored how lax lending standards and artificially low interest rates contributed to the housing bubble. This part is concerned with how they may be doing the same thing to tuition rates.
For many students, the only way to pay for rapidly increasing tuition is to take out student loans, primarily through government programs run by their schools' financial aid office, but increasingly through private lenders as well. The Federal government encourages this by providing guarantees for a large number of these student loans. This essentially means that lenders don't need to worry about default, since the government will pick up any slack. And it is clear that lenders have almost nonexistent lending standards when it comes to student loans Choy and Li (2006) analyzed the default rates of the 1992-1993 cohort of graduates, and found that 20% of those who borrowed more than $15,000 had defaulted on their loans.
The interest rate on student loans secured through government programs is also much lower than would otherwise be the case. Student loans are essentially loans with no collateral to people with uncertain repayment prospects. As such, we would expect for the interest rates to be high, a reflection of the riskiness of the loan for the lender. But interest rates on loans secured through government programs are reasonable, even downright low. This is entirely due to the government guarantees. To be sure, lower rates are typically a condition that the government requires for the loans it guarantees, but even without that requirement, interest rates would be lower because there is less risk involved for the lender. The impact of the guarantees on interest rates is huge. Currently, the rate for government backed loans is 6.8%, while for private loans, which don't have a guarantee, the rate can be as high as 18%.
While lax lending standards and low interest rates for the housing market were caused by securitizaiton and the Fed respectively, they are both caused by government guarantees for student loans when it comes to higher education. Unfortunately, while these would appear at first to improve access to college by increasing the ability of students to afford college, their main effect is to make it easier for colleges to increase their tuition rates. Part 3 in the series will explore the reasons for this.
Coming Friday: Part 3: How these parallels play out in higher education