A Real Education Market

From the October 20, 2014, issue of NR

In mid June, the Department of Education put for-profit Corinthian Colleges out of business. Citing the company’s failure to respond to claims it had fudged job-placement data and falsified attendance records, the department placed a 21-day hold on any additional federal loan and grant money due the institution. Corinthian’s 107 colleges — serving 72,000 students under the Heald, Everest, and Wyotech brands — draw 83 percent of their revenue from federal sources, and the firm was already reeling from two years of declining enrollment and a dozen state-level investigations. Despite Corinthian’s $1.6 billion in revenues in 2013, the department’s hold left it without enough cash to pay the bills. In early July, the firm agreed to sell most of its campuses and close the rest.

The announcement sent a shock through the for-profit sector. The Obama administration’s bloodlust for such schools had put the industry on its heels since 2009. But before June, none of them had been effectively forced out of business by the government. Education Department officials themselves must have realized that they had overstepped, and feigned ignorance that the hold would be the final nail in Corinthian’s coffin.

Many conservatives were understandably outraged by the administration’s coup de grâce. The Wall Street Journal editorial page called it an “extraordinary violation of due process . . . akin to a judge issuing the death penalty while a case is in discovery.” Economist Richard Vedder called it an “ideological victory at the expense of many poor younger Americans.” A longtime Wells Fargo analyst of the sector called it a “chilling and aggressive new level of oversight.”

These critics are right to question the administration’s ideological campaign — more witch hunt than reform effort — against private enterprise in education. Still, it is also hard to ignore the incongruity here: Since when are conservatives the staunchest defenders of a company that takes nearly all of its revenue from taxpayers, let alone one that is known to charge substantial sums for a shoddy product? As of 2012, nearly 30 percent of Corinthian students defaulted on their federal loans within three years of entering repayment, and a 2013 investigation found that campuses had boosted job placement numbers by paying temp agencies $2,000 to hire their graduates for short stints.

Two things can be true simultaneously: First, the department’s execution of Corinthian was an ideologically motivated and inappropriate use of federal power. Second, any rational market would have driven many of Corinthian’s programs out of business long ago. Indeed, perhaps the most telling aspect of the Corinthian saga is that it takes unprecedented federal overreach to drive a poorly performing college out of business.

The bigger problem is that for every Corinthian College there are literally hundreds more — public, nonprofit, and for-profit alike — that fail students and taxpayers but operate just below the radar. Thousands more charge far too much for a mediocre product, saddling students with debt that outweighs the value of what they were taught.

It’s time to ask why we subsidize so much failure in American higher education, and what we can do about it. Our goal should be to change the incentives that allow colleges — and not just the for-profit ones, but all of them — to survive and even thrive regardless of whether they deliver anything of value.

From the outside, federal higher-education policy looks like a conservative Shangri-La: Aid is given out as a voucher, and students can choose any college they want, including private institutions. Private accreditation agencies are tasked with ensuring academic quality, keeping government regulators at arm’s length. Ideally, market forces should reward good colleges and force the bad ones out of business, with accreditation agencies setting minimal standards: a model of market-based social policy.

But this market has been less successful in reality. Colleges have capitalized on goodwill, federal largesse, and hands-off regulation by doing whatever they please. That has included charging ever-higher tuition to finance ever-larger campuses while paying little attention to how their students fare once they enroll.

Unfortunately, the students aren’t faring particularly well. Evidence suggests that college students spend ten fewer hours studying per week today than they did in the 1960s. When two researchers tracked student learning at four-year colleges, they found that more than one-third made no perceptible gains in critical thinking between their freshman and senior years.

Nationally, just over half of all students who start a degree or certificate program finish a credential within six years, and those with some college but no degree now earn about as much as their high-school-educated peers. While those who graduate are better off, they are often unprepared for the world of work. The New York Fed found that 44 percent of recent college graduates were working jobs that did not require a college diploma in 2012, a fraction that has been on the rise since 2000.

All of this failure costs a whole lot more than it used to. Tuition prices at public four-year colleges have nearly quadrupled since the early 1980s, and the federal government now hands out $170 billion a year in grants, loans, and tax credits. Students are borrowing more than ever to finance college, but earnings have not kept pace. The effective delinquency rate on student loans is now as high as it was on subprime mortgages at the height of the housing crisi

If you ask progressives, many will tell you that for-profits are to blame for these troubling trends. For instance, in a recent New York Times op-ed, Cornell professor Suzanne Mettler argued that “tougher regulations of the for-profits, long overdue, are the quickest way to help the poorest Americans who seek college degrees.”

But the notion that problems are limited to a particular tax status — and one covering schools that enroll only about 12 percent of higher-ed students — is nonsense. According to the latest federal data, borrowers from 488 of the colleges eligible for federal student aid had three-year default rates of 25 percent or higher. True, the majority of those schools were for-profit, but 166 were public institutions and 40 were private nonprofits. When it comes to graduation rates at two- and four-year colleges, there is no shortage of embarrassing results. In 2012, 681 public colleges had graduation rates of less than 25 percent, a mark matched by 165 for-profits.

No, the problem is much deeper and more insidious than tax status alone. It’s a function of colleges’ self-interest and the flawed federal policies that indulge them. Democrats argue that for-profit colleges’ interest in maximizing revenue encourages bad behavior. What they fail to realize is that all colleges operate according to self-interest. Public and nonprofit institutions may not be out to maximize revenue per se, but they work instead to maximize prestige and influence. These colleges operate under what economist (and former president of the University of Iowa) Howard Bowen called the “revenue theory of costs”: They raise all the money they can and spend all the money they raise. And because the quest for prestige is open-ended, public and nonprofit colleges will tend to seek never-ending increases in spending, financed by never-ending fundraising and never-ending increases in tuition.

But maximizing prestige may have little to do with the quality of the education students receive. In fact, since measures of student learning don’t factor into popular rankings or public-funding formulas, there’s little reason to invest in great teaching. University of Michigan economist Brian Jacob and his colleagues have found that outside of the highest achievers, students tend to choose campuses that spend the most on amenities, not the ones that spend the most on instruction. Of course, the same problem applies to the for-profits: Building the best recruiting and marketing departments will attract students and revenue, but it won’t help them learn anything.

Higher-education policy could try to change these incentives. But the federal student-aid system seems tailor-made to serve the interests of colleges. The problem is threefold.

First, federal aid programs encourage any high-school graduate to enroll in any accredited institution at any price. With no underwriting of any kind, federal loans provide no signal as to the expected value of a given program. A generous federal loan program for parents, which allows borrowing up to the cost of attendance, helps ensure that students will have the money to pay tuition bills. And access to easy credit gives colleges every incentive to enroll students. Whether they succeed or not, colleges are paid in full.

Second, prospective consumers have difficulty judging the quality of different options. Some of this is unavoidable; college is hard to evaluate until it is actually experienced. But some of these blind spots are self-inflicted. Basic pieces of information needed to make a sound investment — out-of-pocket costs, the proportion of students who graduate on time, the share who earn enough to pay back their loans after graduation — are either incomplete or nonexistent. That’s due, in part, to a 2008 law that prohibited the federal government from collecting data on all college students. Championed by the private-college lobby and congressional Republicans, the ban keeps useful (and potentially embarrassing) information — things like graduation rates, debt, and post-college earnings — out of the public eye. As a result, prospective students typically have no idea whether a given program will be worth their while and are easily wooed by flashy amenities, high tuition prices, and promises of a high salary.

Information gaps would be less problematic if we could count on the accreditation agencies that serve as gatekeepers for federal aid programs to hold colleges accountable. Therein lies the third problem: Rather than protecting consumers, accreditation actually keeps poor-performing colleges in business. Accreditation is a process of peer review. Faculty from other campuses evaluate peer institutions, and accreditation agencies finance their operation with dues from the colleges they accredit. It is also a binary variable — you are either accredited or you’re not. Because federal aid is the lifeblood of colleges, the consequences of revoking accreditation are incredibly severe, with the result that accreditors are reluctant to go that far.

Together, these three structural problems have created a system in which poorly performing colleges that would never pass muster in a functioning market are rarely stripped of their access to federal aid. That aid, in turn, encourages consumers to buy substandard products they would otherwise avoid.

#page#Conservatives typically respond to these problems with familiar calls to do away with federal aid entirely. But without any federal aid, we’d face the under-provision problem we started with: Many low-income students who would benefit from post-high-school education could not afford it. Phasing out federal aid would certainly lead to a drop in prices, but it’s not clear that the market alone would ensure equal opportunity for all qualified students.

In the absence of serious efforts to change the incentives for colleges, Republicans have ceded this ground to Democrats. As the existing system continues to deteriorate, progressive proposals to create an elaborate system of federal college ratings or a federally funded “public option” will get serious consideration. Conservatives who want to maintain and improve the market-based system must present their own set of solutions. Two ideas stand out.

The most direct way to align the interests of colleges with those of students and taxpayers is to give colleges “skin in the game” when it comes to student loans. Currently, colleges can enroll any high-school graduate with a pulse because they bear almost none of the risk that the student will fail. They’re held harmless unless and until more than 40 percent of their borrowers default on federal loans within three years. Default rates are easily gamed, though, and if students default after three years, the college gets off scot-free. Last month, the Department of Education went so far as to “adjust” some schools’ default rates at the eleventh hour in order to save them from losing aid eligibility.

As my American Enterprise Institute colleague Alex Pollock has argued, when mortgage lenders operated under a similar set of incentives — handing out risky loans, bundling them up, and then selling them to investors, thereby shedding the risk — the result was the subprime-mortgage crisis. “A principal lesson from mortgages, nearly universally agreed upon, is that those who create the mortgages should retain a material part of the credit risk,” Pollock wrote in 2012. It is a lesson that he argues we should extend to higher education.

The simplest approach would be to make colleges responsible for paying back a fixed percentage of the loans their students default on. A clear, objective risk-sharing policy would hit colleges where it hurts — their budget — and would not be all-or-nothing like current default-rate regulations or the accreditation system.

Democratic senators Jack Reed, Dick Durbin, and Elizabeth Warren have introduced legislation that would force colleges with high default rates to pay back a share of defaulted loans. But here again, Democrats would rather play favorites than hold all colleges to account. The bill includes exemptions for historically black colleges and universities and for community colleges, schools that have default rates higher than the national average. And the proposal would cover only campuses where more than 25 percent of students take out loans. In other words, Democrats believe that only a subset of colleges should have skin in the game.

Excluding groups of colleges from risk sharing would be akin to exempting some mortgage lenders from regulation because they lend to subprime clients. We know how such lenders behaved when they had no skin in the game, and it wasn’t pretty. A better way to avoid unintended consequences would be to couple risk sharing with rewards for serving low-income students well. For instance, the feds could provide colleges with a cash bonus for every Pell Grant recipient they graduate, providing schools with an incentive to lift students out of poverty.

The second way to align the interests of colleges, students, and taxpayers is to provide consumers of higher education with the information they need to make informed decisions. In K–12 education, Republicans have been the party of transparency and accountability. The No Child Left Behind Act failed on many fronts, but it did compel states to collect and publish valuable information on the performance of public schools. When it comes to higher education, though, many congressional Republicans have stood in the way of similar ideas, not only rejecting the Bush administration’s recommendation to collect better federal data but banning such collection outright. This policy has left consumers in the dark when it comes to basic facts about their options, leading to bad investments and stunted market discipline.

Not all Republicans have toed the line. Senator Marco Rubio (Fla.) teamed up with Democrat Ron Wyden of Oregon to propose the Know before You Go Act, which would require the federal government to collect data on graduation rates, debt, and post-college earnings and publish that information for each program a college offers. Without support from other conservatives, however, these efforts to empower and protect consumers will go nowhere.

Some might argue that skin-in-the-game and transparency reforms represent an expansion of federal power. Conservatives should strenuously disagree. Skin in the game is not an expansion of the federal role, but a way to ensure that federal investments don’t go to waste. This sort of arrangement is standard in other policy areas. In the food-stamp program, for example, if local agencies dole out too many benefits in error, states must pay financial penalties to the federal government. Since that policy was instituted, food-stamp error rates have plummeted.

Likewise, the federal government is the only entity that can systematically track and publish information on post-college earnings and debt. Some states have tried admirably, but they can’t follow graduates across their borders. Put simply, better consumer information is a public good without which the market will continue to fail.

Rather than micromanaging colleges from Washington, these reforms would compel them to consider taxpayers and students’ interests as well as their own. Conservatives should welcome such a change.

– Andrew P. Kelly is a resident scholar at the American Enterprise Institute, whose Center on Higher Education Reform he directs. This article originally appeared in the October 20, 2014 issue of National Review.

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