A few weeks ago, the Association has written an article to examine the behaviors and motivations of the College administrators.  The conclusions of our analyses point to several interesting results and one of them is that “their interests may not necessarily be inline/consistent to those of the public’s, students’ and their family members’ objectives”.

Recently, there are clear evidences show that lawmakers in each state finally saw (after so many years) the need to listen to their constituents’ outcries.   For example, FL has started to overhaul the whole higher ed system in that state, followed by WI, OK, CT, MO. Today we learned that the state of Arizona has taken similar steps, or even more comprehensive measures to change the course.

The past school board system, and the way how the members are selected have proved to be failed, big time.  It is, in fact, important contributors to the whole mess.  The Association has raised the question in its BLOG, about six years ago.  It is the pat-on-the-back culture or system.  They, members of the board are selected, not because they are concerned for the country’s competitiveness or have the idea to apply the NDEA.  Rather, they are either have the money, or have the connection to those who will be the big donors or a yes man, and who will support the administrators, regardless, period.  Are they concerned about the graduation rate improvement or making the institution where they are serving to be more cost-efficient? Please click the following link for the answers of that question.  These findings will tell it all.  Readers have to make their own judgment, after reading the research results.  For sure, they also played important role on increasing US student loans which have reached $1.4 trillion?

We are glad to see, that our independent analyses have positive impacts on shaping-up the US higher education public policy for the better.  We always show the data in our study and share the unbiased and honest conclusions to the public.  We have no interest than to see the country increases its competitive edge in the global arena, as stated in the NDEA.

In 2012 we wrote an article of three possible scenarios if US colleges and universities do not adapt to the new competitive environments where they are operating.  Today we learned that our third prediction has happened.

If the readers read the article critically, they will be amazed to learn the AAUP’s (American Association of University Professors) comments.  Even, under the financial stress, AAUP thinks that financial restructuring efforts such as reducing cost strategy is not good ideas.  The institution is lucky to be bought out.  A couple of years from now, its value may be lower than it is now, and no one will take it over.

If this represents the whole picture of AAUP and the US college culture, then one can conclude that improving operational efficiency is not the top priority in the US.  If that is the case, then one will see of more direct investments and college buyouts in the future.

So, what is the spirit of the student loans and why the US Congress enacted the law in 1958?  And how the Act has evolved over time, what kind of changes have happened and if the changes have positive or negative impacts to the American public?

The purpose of NDEA is quoted below:

As stated above, the initial purpose of enacting the law is to increase the US ability to compete in the global arena.  Commemorating its 60 years, let us analyze if the purpose has been achieved?  The answer is definitely YES and it is still progressing!  Many evidences have shown the US has made important innovations in both science and technology.  However, at the same time these fine achievements have been tainted by (1). Decreasing cost effectiveness as a result of increasing college education cost, and (2). The progressing rate or growth may have been slowed down.  One may ask the question, why?

Possible answers would be:

1. Mismanagement.  DOE is supposed to manage all the student loans, but desperately failed.  Over the time, as the American population grew, more family have sent their children to college.  It seems that the DOE as the loans’ manager overwhelmed which created many problems in collecting the repayment.  Employees have not been trained properly.  It is just a mess.
2. Because of point#1, then DOE contracted to the third parties to collect the students loans.  Some of these third parties are for-profit institutions with their stock publicly traded at Wall Street.  Therefore, the soul of NDEA begin to be corrupted.
3. The third party came into play such as for-profit higher ed, where their stock also traded publicly, but a failed business model.  DOE as the public executor tries to get cleaned, but the students suffer from their (DOE) policy.

Now that the current regulator is confused what needs to be doing, flip-and-flopping from one ideas to the others, inconsistency and show no interest to deal with it.  Solving the problem cannot be done by (1). One person and (2). Scrapping, deleting, amending, changing, revising and putting new policies on top of the others.  Policy changes need to be done after intensive studies to see the impacts on the whole society and if the NDEA objective is attainable.  NDEA is the moral guidance for every policy makers, lawmakers, colleges and universities decision makers and any other makers in Wall Street, Main Street or any other Streets.  Away from the moral guidance, there would be no (any) equilibrium or peace., i.e., satisfy the American public needs.

The motivation of investors to buy, and hold the share from a publicly traded company is the return from their investment, in this case profit.  If the company makes profit, the Wall Street will (1). Reward them by buying or holding their share which will increase the value/price of their stock and (2).  Reward the CEO with higher salary, bonus and other perks, but the reverse is also true.  Dumping and selling their holding of the company’s shares, if return on investment is less than the interest rate. Therefore, it is only logical for the for-profit higher ed to make bigger return/profit as it possibly can, i.e., by all means.  The graphs show that in 2004, the COCO’s (parent company for Corinthian College) stock price reached its peak, but since then it has declined.  The same pattern also found with APOL’s (parent company of the Univ of Phoenix).  This is clearly examples of DOE’s mismanagement and subpar policy to let for-profit organizations get into the higher ed business.

We start seeing the pattern that once the investors get involved, thing will get murkier.  The next logical question that one ordinary person will ask is that why the lawmakers fail to see the pattern.  They perfectly see it, but they also need the contributions and financial support from the Wall Street, and big corporations for the campaign fund.  Therefore, they, the lawmakers may be reluctant to work against the corporate America, in the expense of the general population (GP).  What they need from the GP is their votes, but individual contribution will not as big of those of corporation. So, many are their empty promises during the campaign seasons.

Here are several points that the readers can take and think about:

1. Who your representatives that you put in the office are actually working for?
2. Will Uncle Sam ever solve the $1.4 trillion (with 9 zeros) student loans problem?
3. Will education cost ever stop to increase under the current reward system?
4. Has anyone realized that DOE (determine by the US Congress) charges higher interest rate for some of the loans than the commercial banks’ or the Fed’s prime rate?
5. Is this an example how the US current state of economy has declined, compared to that of 60 years ago?

This article is written to find the viable solutions for the US student loans, through scientific and honest analyses based on past publicly available data, published facts and information by other parties such as the Brookings Institute (previously has denied that Uncle Sam is facing a student loans problem) or Wall Street publications.  The purpose of writing this article is not against anyone, any group in the society, or any company, but to remind the readers that the final outcome of stretching too far a rubber band will, at one point, to break it.  About a week ago, the Association has written an article on the wealth transfers designed by tampering or meddling the purpose of the (NDEA) student loans.  Indeed, an article has shown us all, how one company made their way to profit out-of the misery of the students.  Needless to say, that this company is a public entity.  That means, the investors who own its stock are also enjoy such a profit.  Perhaps, this is a clear example that shows why many people may love to see the education cost keeps going up.  The higher the price tag, the more people will take loans, which, in turn, will help to fulfil their interest such as making profit.

It is truly amazing to see how the economic system has developed since Adam Smith wrote the Theory of Moral Sentiments.  This loan servicing company own about $25 billion student loans, and it collects interest out of those loans.  Suppose the interest rate per year is 1%; then it potentially will make $250 millions per year.  We have never seen the interest rate charged to any loan is 1%.  If, 5% then it will make $1.25 billion interest revenue per year.  According to the article, in 2016 this company net profit was $200 million.  In the future, however, the company said, it is going to manage $397 billion loans with 13.4 million borrowers.  With 5% interest rate, each borrower will transfer about $1,500.00 per year from their wealth to the company for paying the interest only.

The report above presented data, which again confirm the hypothesis that the student loans (NDEA) which first created for a noble goal has become the means to make the borrowers worse-off.  Sure, one may argue that the society also receives the benefit through owning the company’s stock.  The question is, which segment of the society enjoys such a benefit?  How many of the working class has extra money which they can invest in the stock market, while most of them live from paycheck-to-paycheck.  Little left for buying any kind of company stocks.

How many of the readers are still thinking that taking student loans nowadays is such a great ideas?

A couple days ago, we have discussed and shared the idea of college drop-out insurance (CI), as our response and contribution to reduce the negative impacts that may cause to the economy as a result of a never-declining growth of US student loans.  When more people taking the loans, then the probability that some of them will be defaulted will also increase.  Recent study shows that the rate of student loan defaults have shown a trend that makes some of the economics actors to equate it as the “Housing Bubble”.  Scary?, may be so.  AAEA has predicted this is going to happen not last year, or two years ago, but longer than that.  Based on the actual data, the Association has makes a prediction, that if the source of tuition increase does not get controlled then consequently something could happen.  To read the article, please click here.

So, what is the viable solutions, among many possible ways that policy makers or market players can do?  Some in Wall Street will bet either way, right?  The student loans bubble (SLB),  may have devastating impacts in the market considering that the Bull has run about ten years, because of the money supply and low interest rate policy.  SLB may or may not happen, depending on:

1. If majority of the loans are issued by the government, instead of the private lenders.
2. How strong the labor market is?  If it keeps absorbing the new batch of graduates, then pay-back streams may not get disrupted.
3. What is the composition of those graduates in hard and soft science?
4. If inflation rate picks up, it may affect borrowers’ ability to make repayment.

However, if SLB happens, it may trigger chain reactions in the market, and the accumulation of the multiplier effects due to market corrections will be significant enough to repeat the housing bubble?

Uncle Sam can easily add a provision on the loan agreement where the Institutions or/and the borrowers have to buy an insurance to cover the possible events when the students drop-out school.  Of course this will increase the burden to the students.  Perhaps, a better idea is to shift part of the burden to Title IV institutions, colleges or universities where the students are enrolling to cover unfortunate events which may cause the student to drop-out school.  This will motivate them, the institutions, to manage such a chronic problem facing Uncle Sam.  It has a good chance that the school drop-out rate can be reduced, either by real efforts, or by lowering or watering down the courses passing requirements.

The concept of hedging is originated in the commodity market (CBOT).  Just a simple illustration, a farmer named Joe grows corn in the spring, but the harvest may not come till first week in October.  During the planting, growing and harvesting time, he may get exposed to different source of risks or many uncertainties, such as weather (flood, or dry) which will definitely affect the selling (spot) price at the harvest time.  However, he can minimize selling the corn at a loss (low price), by locking at current, and possibly hedge his crop through futures markets mechanism.  Example, he can hedge his corn at the beginning of the planting season to a certain price (possibly higher than the price 3 months later), with the hope that if something bad happens, he still gets his locked guaranteed price.  Usually, but not always, when supply of corn is higher around the harvest season, then the cash/spot price will also be lower, citeris paribus.

The same situation can be applied to a student who takes loans to get his or her college degree.  Four years, to earn an undergrad degree or 2 years for an Associate degree, surely longer than what famer Joe has to wait before harvesting.  Technically speaking, students are facing greater risk than farmers do.  yet, there is no market mechanism to shift some of the risks.

When students and their co-signer agree and sign the student loans application or agreement, they basically assume that her/his future income will be higher to pay back the loans and cover her/his living expenses after graduation.  In such a case, she or he bears all the possible adverse events which may affect her or his ability to finish school.  In other words, students and their family are going to absorb all risks, without having a chance to shift part of it to others for there is no market mechanism for that.

Let us put some simple numbers here.  Supposed James, the son of farmer Joe after graduation net monthly earning (after tax) is $2K.  If he needs to pay back his loan equal to $1K per month then 50% of his net income will be gone.  So, a monthly payment is directly affected by the amount of loans that he needs to take.  Generally speaking, the higher the tuition that James is charged by the school, the higher the pay-back amount.

The old Joe can hedge his risk of getting lower price or crop failure through the futures markets.  He, the famer, even can buy crop insurance to cover the possible loss of his crop.  But his son James does not have such a luxury, because there is no insurance or market for James to hedge his possible risk associated with (1).  School drop-out without a degree or (2). Get a job with salary that can pay back the loan.  James is lucky that he is able to finish his undergrad degree and get a job, but some of the other students may have to face different outcomes.  Two possible worse scenarios that could happen to anyone after signing the student loans agreement.

1. Drop-out of school with non-zero student loan debts or
2. Receiving income which is less than or equal to loan payback amount.

Option one are commonly found in the US higher ed.  Graduation rate at the national level is less or on average around 40%.  Meaning 60% of students who attended colleges will not graduate, but have to repay their loans, plus interest.  This is the main reason why the Association thinks it is important for the American public, students, school administrators and both state and federal lawmakers to realize how serious this country is facing with the rising education cost due to moral hazard.

Unlike his father, James and million other young Americans have to bear the whole risk on their shoulder.  It will be a total nightmare, If they cannot find employers who will pay them at a price where they can pay back the loan plus its interest and living expenses.  Some of them may end up working at places which do not need a college degree, such as fast-food chain.  There have to be a market mechanism which can be used by the young generation to hedge the risk to go under or if things do not work out as planned.  Or there should be some types of insurance to cover such risks. The Association shares this idea to the Wall Street or the federal or state government to create a product or financial instruments which the students and their family can buy this “College Drop-out Insurance (simply CI)” to cover student loans balance in the event of school drop-out occurs.  CI innovative idea is purely originated by AAEA.  For courtesy, please cite appropriately.

Until this happens, the regulator needs to step-up its control professionally, literally to police that higher ed institutions do not take advantages of the innocent little guys and let them to bear the total risk on their own shoulder.  If any of the lawmakers happen to read this blog, can you guys do a real contribution to the American public or your constituents who have put you in office?  So, do something meaningful!  Something similar as the Crop Insurance.

You may not be trained as an economist or a math whiz, so we are going to explain it real easy–bare with us.  If you have a chance to look at Figure I, presented also on the Home page, you will notice different lines intersect or cross to one another.  You can read the story behind it here.  For now, let us pay attention on rectangle T1 T2 D B, which indicates the total aids that Uncle Sam has poured-out in the higher ed industry.  This amount then will be used by the US colleges and universities to finance their (efficient and inefficient) operation.  In such a case, the Uncle Sam’s role is equivalent as the loan-guarantor.  What unfortunate implications this system can bring as the by product of this policy?  If the institutions operate based on profit motive or if morale, as suggested by the founding father of the capitalism idea/concept is not in the equation when strategic decisions are made, it creates a lot of loopholes that can be taken advantages by any entities.  For example, higher ed institutions may increase its tuition and fees constantly.

Data showed that the spirit of 1958, when the first Act was enacted was faded away over-time.  Higher ed institutions forgot the sole purpose of the National Defense Education Act (NDEA).  Which is to make the country to be more competitive.  In facts, the Act was created after the US was shocked, because another country has successfully launched its first-ever satellite, Sputnik.  However, over time, some “smarts” people have different ideas and they look at the NDEA as opportunities to satisfy their own ego, such as making profit or to increase their materialistic well-being from the society to their own pocket(s).

Let us analyze this whole situation academically and set aside the politics, using Figure 1 as the starting point. Though, this graph shows the analyses are in a static equilibrium notion, but it actually is a dynamic game with incomplete information (assume a two-period game for simplicity).  In period one, before the students graduated, the total amount of taken student loans are paid to the Universities and Colleges by Uncle Sam.  In such a case, from the borrowers point of view, signing the student loans contract can be seen as a binding promise to willingly share or partially giving up her or his future-income to the third parties such as school, private lenders, banks or any financial borrowing institutions.  Of course, this is the most profitable business, because in one side, they have the government as the regulator, and it has the power to garnish students’ future income if the loans got defaulted.  Therefore, it minimizes the issue moral hazard on the loan borrowers side, but not on the lenders.  Are there any rules which will punish those institutions charge higher tuition above normal or the lenders that charge late fees, higher interest rate, etc (Please click here for Yale University’s Lecture)?

In the other side, the whole system has been set-up such that diploma, or any college degree is a signal of competency to the employers.  Unfortunately, these employers not only, are in fact, the financial institutions who partially own the companies (through NYSE, the stock market) or the lenders of other businesses in manufacturing, services and others.  Think about the practice to appoint the schools’ or colleges’ or universities’ Board of Directors?  How many of them have ties to financial institutions or companies as such?  These clearly will affect the school when making strategic decision., i.e potential source of moral hazard.

So, in period one, taken student loans can be seen as the advanced transferred of future wealth or income from the small guys (students) to the big guys (higher ed institutions and lenders). Regulator works as the loan-guarantor, a middleman or the financial institution itself.  For its effort, it receives the interest income and other related loan origination fees and late fee penalties.

In period two, after student graduated, either the guarantor or other financial institutions and private lenders will start taking back their money, plus interest.  In such a case, higher ed and others involved in the whole process are the biggest winners, while the borrowers and their family or the general public, especially the working bees (class) are the real losers.  Did the readers see this dichotomy imitates something?

The student loan borrowers or the whole society need to start asking critical questions such as (1). Why they may need to borrow their own money and (2) Pay the interest; (3). Why as an alum, you should support your school?

Exactly a month from today, AAEA will celebrate its fifth anniversary.  Starting with our humble motivation to help the average American families to get through college with minimal debts, the Association has become the source of inspirations and a place for researchers, grad students to get new research ideas, for companies to create new business and for other to innovate.

We are surprise that in the past, so little scholars have put their fine mind, talent and time to analyze such a huge problem facing the society.  It is AAEA, an independent non-profit, self-funded organization that started to utilized and applied widely available NCES public data to study this important, but neglected sector for so long.  From knowing a little, we know more how most higher ed institutions have been managed, and honestly, we are stunned.  Our research results show this sector, among others is one of the worse contribution of the financial nightmare to most family in the US in recent years.

None of the researchers has tried to measure the “Dead-weight Loss” cause by public policy and other players in the market.  This is our first attempt to put this mystery unveil, at least in the scientific way.  Starting in 1958, when the country tried to promote science and technical education which led to the creation of National Defense Education Act.  According to this Act, the loan dollars come directly from the Uncle Sam.  This noble plan worked fine at the beginning, where moral is the motivation to participate in the effort.  However, as time lapsed, group and self-interest and profit motive replace the moral, the bad dreams turn to nightmares.

Since the beginning of 2006, students loans has increase tremendously as shown in the following graph. During the same period of time, the average of college tuition and fees has also increased tremendously.  In spite of this phenomenal tuition increase,  demand for higher education also experience upticks due to technology change where higher institution offering online classes.  Continue to Part II.