Since a college education is expensive, many students would be unable to receive a higher education unless they got help with the financing. Some students are lucky to receive the needed resources from their parents, but many others in the United States and elsewhere have to borrow in order to attend college. The vast majority of loan programs available to students are highly subsidized by governments, either through direct government loans with generous interest rates and other terms, or through government insurance of loans from private banks combined with restrictions on the interest rates banks can charge students.
Even though student loans cannot be discharged through personal bankruptcy, default rates have been high. The average rate of default in 2007 was high, about 7%, but still much below the over 20% rate in 1990. In addition, many borrowers with lower incomes work out terms that involve slow and usually only partial repayments of the amounts borrowed. As Posner indicates, for-profits have a high default rate of close to 25% on their student loans. There is a clear hierarchy in default rates by type of school: For-profits have the highest default rates, followed by public and non-profit junior colleges, then by graduates of four year colleges, and graduates of medical and law schools, and other high earning professionals have the lowest default rates.
Since student loans are heavily dependent on government financing, governments have a legitimate and important interest in these default rates. Consequently, it is proper for governments to impose limits to colleges on both the fraction of their students who can default, and also on the fraction of students at a school who can receive government loans. However, the present default limits of 25% for profit-making institutions are too generous. Banks would be forced out of business if the default rates on their commercial loans were so high. The maximum allowable default rates should be cut to 15% %, or so. That itself, without any other changes, would give for-profit and other colleges much stronger incentives to police better who they accept as students since they would not want to exceed such more stringent ceiling on default rates.
A lowering of the permitted default rate is a far superior approach to reducing defaults than is the proposed limit on the amount of loans available to students who are expected to have low incomes. For it is hard in most cases to know in advance how much a student borrower will eventually earn. Students entering well-paying fields may turn out to do badly, whereas those entering poorly paying fields might do extremely well. Colleges have a strong incentive to police their default rates in order to remain eligible for student loans, but one can hardly expect government officials to be able to predict with any accuracy the eventual earnings of students applying for loans.
Unfortunately, various proposals to restrict loans to low earning students partly reflect the federal government's desire to bash for-profit colleges. Yet these colleges play a significant role in the portfolio of college choices available to students. For-profit colleges appeal to older and fulltime working students who never received a college education. To be sure, the quality of the courses offered by for-profit colleges are generally are not so high. But many public colleges, such as Loop College in Chicago, or Santa Monica Junior College, also offer courses at the low end of the quality spectrum, and also have high loan default rates. That for-profit colleges can compete against highly subsidized public and private non-profit schools indicates that the for-profits are offering an education valued by certain students that is not available to them at other schools.
In addition, comparison of default rates between for-profit colleges and public colleges is not the right measure of how much government subsidies they receive. All public colleges and most private ones receive large direct subsidies from various governments that enable them to offer much lower tuition levels than are offered by for-private colleges. Many students in public colleges, especially the lower quality ones, also drop out without finishing, and also receive low earnings, after having been generously subsidized by governments. The right comparison between for-profit and public schools might be the increase in earnings of students per dollar of government subsidy, no matter what form these subsidies take. The for-profits may still look worse on this measure than do the public colleges they compete against, but the difference would be much smaller than the differences in default rates.
Some argue that for-profits can only compete by misleading students into believing they will benefit much more from such an education than they will actually benefit. Clearly, some of that does occur. However, even some of the best colleges and universities are quite misleading in their advertising and other attempts to attract students. For example, very few philosophy, French, or English Lit departments warn incoming students that jobs in their fields are scarce, and that most entering students may never get a decent job using their specialized training. To be sure, for-profits tend to be more flagrant in their efforts to attract students, but it is a difference in degree.
So my conclusion is that while stiffer default rules on government subsidized student loans are needed, for-profits should not be discriminated against in these rules since they offer valuable forms of education. Moreover, public colleges receive substantial direct government subsidies that for-profit colleges do not receive. With lower allowable default rates, for-profit (and other colleges) would cut back on the number of students accepted whom they expect to eventually default on their student loans.