Default Rates and For-Profit Colleges- Becker

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.

 

 

Comments

[Dan Cooper]

I need to learn more about the idea of "human capital," but people can wonder if (along the lines of questioning the efficiency of asset markets) schools really do what people presume they do.

Shiller's THE NEW FINANCIAL ORDER has some arguments in favor of better information systems for credit rating purposes, but one could also apply many of the same ideas to measuring the lifetime learning of citizens. One could randomly administer SAT-style multiple choice tests (similar to the entrance exam for Harvard Medical School) that minimize sampling error and tend to assess what people know "six months after class." There will always be problems with defining what should be measured and preventing people from gaming things, but then that's life. The Great Books program, libraries, etc., have long been around to disseminate information. While there's a case to be made for pooling resources for things like science labs, it's not entirely clear why schools even exist. One may need some travel agent capacity, but it doesn't seem that many miss the demise of travel agencies on every street corner. Some people claim that IQs are rising, but Derek Bok had a book a few years ago that brought up some interesting research -- a claim that the average college graduate of today knows what the average high school graduate knew about fifty years ago.

[Dan Cooper]

Forgot. As with prisons, there may be many (sometimes conflicting) goals to education. One role may be, like a credit rating agency, to discriminate on the basis of merit (rather than some more Rawlsian approach).

The point is that one should expect the cost of education to be decreasing, quality increasing.

[msgnet]

Has anyone ever studied the effect of government subsidies on tuition rates? I tend to think that as the government provides more money to students to finance their education, colleges will respond by increasing their tuition rates in kind.

[Kyle]

What exactly are for-profit colleges? Are they private institutions or are they institutions like University of Phoenix and other online universities?

[William Bell]

Becker's recommendation sounds right, but how would a college's administrators control the default rate on loans to students who went there, if not by relying on the sort of assumptions that Becker decries?

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[Miguel Villarreal]

Professor Becker - a lot of your assumptions don't seem to be supported by some of the empirical and anectdotal data shown by Eisman, et al.

Your reasoning is a bit circular, you seem to assume that for-profit colleges, since they have been able to recruit students and compete against non-profit colleges, must be offering a valuable service or product. I say that this is simply a function of superior marketing/advertising, which makes up the single largest budget expenditure for most for-profit colleges and dwarfs that of most non-profits in the same market space.

You acknowledge that "some of this does occur" - I think it's a lot more than just some. Let's presume that a student is a rational actor. I can't think of a great many instances in which a rational actor would opt for course credits from a for-profit university, which is generally not subject to the same accreditation standard adn thus not transferrable, at four times the cost, of credits from the local community college.

Further I don't think your analogy to the lack of employment prospects for holders of an English degree really makes a lot of sense in this context. Sure, a Harvard senior thesis on Iambic Pentameter doesn't seem to have much immediate application to the labor force at the present day, but a four-year degree (regardless of major) serves its biggest purpose as an indicator to a potential employer of the likely merit of the prospective employee, rather than as something that endows practical skills. A degree from a for-profit school (for the small fraction of students who actually graduate) in many instances has the opposite effect. For example, Eisman et al have presented evidence of certain employers who have a formal policy against hiring for profit grads for certain positions.

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