Tuesday, June 21, 2011

"Drowning in Debt: Financial Outcomes of Students at For Profit Colleges"

Last week, I blogged on the Cato Institute's report critizing nonprofit higher education's "profligate" spending which, according to the Institute, eats up federal subsidies of higher education and generally results in increased tuition costs as opposed to increased access.  In an effort to give equal time, I note that the U.S. Senate Committee on Health, Education, Labor & Pensions held a hearing (full video, plus witness statements) on student debt at for-profit colleges.  You can get the full text of the witness statements at the Committee's website.  All the witnesses pretty much beat up on for-profit higher education, mostly for encouraging vulnerable populations to borrow too much money to pay for increasingly worthless degrees.  One witness, though, gave a succinct description of the motivations distinguishing for-profit from nonprofit higher education.  I thought the discussion was particularly useful as it relates to the need for the nonprofit form (characterized by the nondistribution constraint) and the advisability of sharing public subsidies amongst both for profit and nonprofit higher education.  Of course, the statement neither addresses nor precludes the assertion that the nonprofit form too often acts very inefficiently.  Here is a large excerpt from that witness (Dr. Sandy Baum):

How is the For-Profit Sector Different from Other Postsecondary Sectors?

The prevalence of high debt levels and high default rates in the for-profit sector justifies a focus on this sector. Individual institutions and categories of students in other sectors who are in similar circumstances also merit particular attention. But it is worth thinking analytically about why so many problems are concentrated in for-profit institutions. Too much of the debate on this issue is tinged with ideology. Are critics of the sector opposed to market forces or to the idea of profits? Are owners, managers and supporters of the sector evil people who cannot see beyond their own pocketbooks?

The reality is that the fundamental purpose and structure of for-profit entities differs from that of public and nonprofit entities. If the outcomes of these structures could not be differentiated, proponents of the free market would not be such strong opponents of a larger role for government in the production of goods and services. The market works very well for our economy and our society in many cases. But it is not difficult to see that all market outcomes are not optimal. We have seen all too well in recent years the dangers of inadequate consumer protection, inadequate information, and inadequate regulation of financial markets. By definition, for-profit enterprises are run with the goal of maximizing profits. Managers have a fiduciary responsibility to make the interests of owners their primary focus.

When the for-profit sector was smaller, it consisted largely of small privately owned institutions. Some owners of for-profit colleges founded their institutions to provide specific opportunities to specific types of students and are deeply committed to the well-being of their students. But the sector is increasingly dominated by large, publicly held companies. Where it exists, good will and social consciousness on the part of the officers of these companies can only go a limited distance in determining how the firms operate. Comparison of compensation levels in the three major sectors of postsecondary education is instructive. Average compensation for the five highest-paid public university chief executives in 2009-10 was $860,000. The five highest-paid Ivy League presidents received an average of $1.3 million in 2008-09. The top five leaders of publicly traded for-profit postsecondary institutions received and average of $10.5 million in 2009.

Economic theory suggests that market forces lead to efficient outcomes if certain stringent conditions are met. These conditions include the absence of significant externalities – the costs and benefits of the product or activity must accrue to the direct participants without significant impact on others - and notably, perfect information. Consumers must have the information necessary to make sound judgments about which products and services will meet their demand. They must understand the characteristics of what they buy, how the products and services produced by different firms compare, and the prices they will pay. The rapid growth in enrollments in the for-profit sector is not just a reflection of increased demand. It’s not that so many students are suddenly making informed decisions about the best way to realize their educational dreams. A combination of aggressive recruiting and the growing funding and space constraints in the public sector have changed the way students perceive their options.

The market for higher education meets few of the requirements for perfect competition. Students can’t buy one, try it, and buy a different brand next time if they are unhappy with the outcome. There is little market incentive for producers to provide thorough and accurate information because they do not rely on repeat customers and once students make a choice, it is likely to take them a long time – and a lot of payments – before they learn the true properties of what they have purchased.

Well-designed consumer protection makes market forces work more effectively. It doesn’t make sense to have students give up large amounts of time, energy, and money to test for themselves whether institutions offer reasonable education and training. Postsecondary education is an investment that typically provides a high rate of return to both the students who participate and to society as a whole. But it can be a risky investment. If we subsidized only students who have a very high probability of succeeding and seeing their investment pay off handsomely, we would fail to provide opportunities to many individuals who cannot afford them on their own. We know some students will fail, either because they aren’t up to the task or because circumstances interfere with their success.

But we shouldn’t subsidize students to play the lottery. Students who enroll in institutions or programs that graduate fewer than 20% (or 15% or 30%) of their students or that succeed in placing only a small percentage of their students in remunerative positions in the fields for which they have been trained are playing the lottery. They are making a significant investment in an undertaking that has a stunningly low probability of success. Our political philosophies might lead us to debate whether or not we should prevent them from playing this lottery. But it is difficult to come up with sound principles of public policy that would support our subsidizing them to play this lottery. And unfortunately, even the best available information is unlikely to discourage the most vulnerable students from playing the lottery with a combination of taxpayer funds and funds they will only have to pay off in a vague and distant future.

Public Subsidies

There is nothing inherently wrong with people making profits from providing education. And no doubt there are some efficiencies in the for-profit sector that could, if applied in other sectors, both improve the learning experiences of students and reduce the cost of providing those experiences. But holding up this sector as an example of market forces at work is simply inaccurate. Many institutions in this sector receive close to 90% of their revenues from federal student aid. That number is actually higher if the federal funds that are excluded under the 90/10 regulations are considered. Very few students are actually paying with their own money to enroll in these institutions. Why is it that only independent students and dependent students from low-income families choose the for-profit sector? Don’t these particularly vulnerable students, who are most likely to be making their educational choices without the advice of college-educated parents or well-trained counselors deserve added consumer protection, rather than maximum opportunity to make decisions with a high probability of damaging their futures?

Surely there should be better regulation of an industry that is so heavily financed by taxpayers and that has such a dramatic influence on the lives of so many Americans – particularly vulnerable Americans.  Advocates of the sector frequently contend that restrictions on their institutions will deprive low-income students of educational opportunities. But if these opportunities lead to heavy debt burdens and questionable credentials, they are not opportunities in any meaningful sense of the word. Is it wrong to regulate payday lenders because it might deprive vulnerable individuals of the right to borrow money at extraordinary interest rates and generate debts they will never be able to repay? Is it wrong to regulate car dealers because we might deprive consumers of purchasing cars that have every likelihood of self-destructing on the road? Institutions in the for-profit sector that are serving their students well should be first in line arguing for protection against their colleagues whose drive for profits is exploiting students and undermining our ability to use market forces to the fullest to further our educational goals.

 dkj

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