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.

Recently we learned that a flag university in the state of WI has offered a free-tuition for all first-year students starting in the Fall 2018. The only condition applicants have to do is to apply financial aids through FAFSA.

Here are several points that prospect students and their family need to think about before taking the baits.

1. While the whole higher ed budget in that state has been cut, even some of the faculty members were let go, will the offer too good to be true?
2. Read the fine line carefully, the offer applies to all first year students.  The relevant question one might have would be what happens after the freshman year.  This has been a classic example of the bait-and-switch strategies that some of higher ed institutions have done in the past.
3. Perhaps, this strategy is one of the many efforts for the school to increase first-year student enrollments. Therefore, the enrollment department will have a pretty good metrics, and the boss will look pretty successful, but with the expense of the continuing students.  Once students get trapped, there are no other easy and cheap ways to get out.  School transfers can be very costly.  Basically, once trapped, a student has to wait another 3 years to complete her or his program, and worse thing is without or less financial aids money.  There is almost impossible for an institution who has experienced a budget reduction will be able to subsidize the whole first year students.
4. NCES data show the average tuition and fees charged by the institution in 2016-17 academic year is $25,230.00.  The average of freshmen year class is 3162 (Fall 2016).  The author mentioned 800 eligible students. Assuming no major change has occurred, it is easy to show the total annual subsidy amount equivalent to $80, 534,160.00 or $80.5 millions.  Which is about 40.15%  or 31.11% (see point #5 below) from the total institution’s core revenue  (2015-16 NCES’ reported figures) or 15.60% (use the author’s 800 student counts) will be used to subsidize the first year students.
5. Note that the fall-to-fall overall retention rate is 55%.  Let us use this fact instead as a comparison. Then the total subsidy amount is $62.4 million., which is smaller for some 45% first-year students will not be able to make it, and they will not return in the following spring semester.
6. Including in the core revenue are (1). Tuition and fees, (2). State appropriations, (3). Local appropriations, (4). Government grants and contracts, (5). Private gifts, grants, and contracts, (6). Investment return and (7). Other core revenues.  Yep, pretty much major cash-inlow sources are counted.

Based on the published NCES numbers above, it is up-to the readers to make their final conclusion.

In economics theory, goods and services are priced by the market, i.e., supply and demand determine the outcome(s).  Let us use the Neoclassical economic theory to examine if this is the case in higher ed industry.  When the resources are abundant, there is no issue to pay whatever price asked by the service providers.  This sounds more like a non-market solution which may lead to inefficiency?  Are we correct?  But thing, is a bit different when most schools are experiencing budget cuts from the state, waning federal dollars, when donations are getting much smaller or even more challenging when total student enrollment drops.  Worse if these four elements occur at the same time.  How colleges and universities in the US are going to fund their activities and cover their expenses?

In the past weeks, there were several articles discussing college and university administrators salary.  For example, when NY governor planned to expand aids for in-state, it appears that the Bundy Aids, which supposed to help paying students’ tuition went somewhere else, such as to pay the administrators salary.  Another example comes from FL.  The lawmakers in that state have questioned Broward College president’s salary recently.  Similar kind of situation at MSU.  When she quits her post, the school pays pretty well chunk of money to president, according to some analysts.

The question that one might have is that, what appropriate methods or approaches to use, if any, to determine campus administrators salary?  Manufacturing industry follows the so-called product costing discussed in managerial or cost accounting college textbooks.  Basically, there are three elements that make up the total cost such as direct material, labor and overhead or indirect cost.  The product costing theory discusses further the issue of standard or full costing as the basis in product & pricing strategies.  A question that one might have is that, in service industry such as higher ed, what will be the appropriate way to price the administrators salary? They indirectly contribute to the students’ class room activities.  So, their salary can be classified as overhead cost. If there is no scientific method that can be applied/used to price their contribution, then their salary may have been determined, so far, using some sort of arbitrary methods or guidelines, which do not have any clear scientific justification.

Neoclassical economists such as Pareto hypothesized that the price paid to the last hired worker should not surpass his or her contributing productivity (example, if her or his contribution has a value of $10, then the max amount that they can be paid is $10).  The question will be, how can one measure an administrator (Example: a college president) productivity?

Plus the Neoclassical economic theory applies basically to for-profit organizations, which may not be appropriate for non-profit institutions such as colleges or universities?  Will then the non-market solution, such as bargaining is the best efficient solution? We invite the best brain in this country to think about this challenge.  If  this question can be answered, then what one needs is mathematical proofs to justify it.  Believe us, that this will be a significant contribution not only for this country, but also the academic world.

If there is a managerial accounting or a mathematical economist genius who happens to read this post, please share your opinion along with your logical (math) proofs.  Thanks!

Now that the big guys and respected Journals, News and Financial Rating agencies have finally voiced their opinion (added on 02/20/2018), concerns, and admitted that the US higher ed institutions are broken.  Thank you guys for finally confirming AAEA’s past research results & recent outlook published on January 1, 2018.  Historical data and the American public’s opinion never lie.  It reflects many facets of the same coin, even though the coin has only two sides.  When we first published our research results (reminder over, 1k pages pdf file) no one thinks seriously that they are important.  When AAEA introduced the new mindset (IRI Analytics) back in 2012 at North Carolina Community College Systems Conference and 2013 SAS Regional Meeting in Houston, TX on how to strategically anticipate, cope and minimize the negative effects, the decision makers not even look at it in one eye.  Which is not a surprise for us.

Now that we see the reality, what striking on all of this business is that only several, literally only a few organizations recognize and understand the implications for not doing so.  Institution such as Harvard has prepared and made necessary changes.  Others, still BAU.  Even the most respectful research institution denied that there is a serious problem with $1.4 trillion student loans and sky rocketed tuition which may lead to higher ed institutions owned-doom days.  But it is now in 2018, over 5 year later, after thorough & painstaking research efforts what we had concluded is happening and confirmed by other important players.

Four years ago, on January 26, 2014 to be exact, the Association has written an article which discussed and tried to understand US College administrators’ management behaviors, motivations, goals, styles or purpose.  Upon examining college’s mission or statement of purpose, we found out the following words or a collection of words become a standard that can be found at every US college statement of purpose.  Below are a couple of many examples:

• “…. combines high-tech educational facilities and state-of-the-art programs with a focus on teaching for student success”.
• “… we offer exceptional student support services and staff that are eager to help you realize your dreams”.
• “…fosters educational excellence and student success, prepares students for local and global citizenship….”.

The institutions always say, their main focus is the student success.  However, in the past ten years, the graduation rate is more likely to be flat/stagnant, while the tuition has increased faster than the country’s inflation rate; the student loans sky rocketed to about $1.4 trillion; but the administrators’ salary has never been decreased.  You can make a logical conclusion what do these observations and the data tell you.

Then what the State representative from FL has said is correct ” …..the change is necessary so that they (the colleges) are able to live up their mission. Therefore, the students can take the right courses, reduce their debts and graduate on time.

It is fascinating to learn that these college administrators even think that the effort to make improvements that will benefit the students are direct assaults to the students?  These people always use the students as a reason for any proposed changes that will affect their own interests (readers need to read the reactions/comments of this article).  The comments are the reflections of the public’s frustration with the whole and prolonged aren’t funny jokes with expensive price tag that higher ed institutions’ administrators have been showing the American public around for many years.  Wow…

Let us present the data, so that our discussion can be fruitful.  We are all agree that we have a bigger and more important goal for this country, and not just focus on one’s owned interest.  Readers can examine the following research results (over 1K pdf file)and make up your own mind.  What are the college administrators’ true motivation?