Do We Face a Catastrophic Education Bubble?

Antony Davies, writing in US News, argues that when it hits the education bubble will be worse than the housing bubble.

Davies analyses the housing crisis thus: The net effect of Fannie Mae and Freddie Mac was to make lending an essentially risk free business for private banks that could simply pass the risk down the line to government and ultimately the taxpayers. As each loan equals profit, without risk there is no reason to deny loans even to subprime clients without the means or inclination to repay them. This influx of cheap money caused housing prices to soar.

Similar arguments have been made several times recently (such as the Bennett hypothesis and its modern iterations) about the education market and how subsidized loans in many cases just allow colleges to ramp up tuition costs.

Davies argues that the creation of Sallie Mae in 1972 was equally misguided social engineering which has only been made worse recently by the Affordable Care Act of 2010 which allows the government to provide loans direct to students and the Taxpayer Relief Act which provided student loan borrowers with tax breaks.

And the price of a college education soared—just as one would expect from a market flooded with cheap money. By law, lenders cannot even deny Stafford and Perkins loans (types of federal student loans) based on the borrower’s credit or employment status. What other reason is there to deny a loan? And just as home buyers took out loans to speculate on houses they could never hope to afford, students are taking out loans to cover educations they often cannot complete and which often do not hold value in the market even when completed. Government meddling has again separated profit from risk. Universities get to keep the tuition profits while taxpayers are forced to shoulder the risk of students not paying back their loans.

The crux of Davies’ argument that the education bubble will be worse is the nature of the good involved. A house owner can sell back their house to free themselves of the debt. It’s difficult to return one’s education to the store. Also, bankruptcy clears mortgage debt, but not student loan debt. Graduates don’t even have that last resort option. There is also the figures:

From 1976 to 2010, the prices of all commodities rose 280 percent. The price of homes rose 400 percent. Private education? A whopping 1,000 percent.

Subprime loans to enable low-income earners to become homeowners and education loans to people unlikely to repay them are similar situations. In both the government engineered a situation whereby loans where granted that would not have been made by choice. Davies’ solution is simple. If we wish to avoid further bubbles then all the government has to do is not interfere.

06 15, 2012
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