Wednesday, June 23, 2010

Another Big Short?

I came across a quote attributed to Steve Eisman. Eisman was one of the main characters in the book The Big Short by Michael Lewis. He was one of those who made a financial killing by investing short against the subprime loan mess in the housing market. Having just read that book it was of interest to find out what Eisman is up to now. The quote is:
"I thought that there would never again be an opportunity to be involved with an industry as socially destructive and morally bankrupt as the subprime mortgage industry. I was wrong. The for-profit education industry has proven equal to the task."I saw the quote in the June 7-June 13 issue of Bloomberg Businessweek. There was no story to go with it. The quote apparently was from a speech Eisman gave at a conference in May of this year. The title of the speech was "Subprime Goes to College." The presentation was referred to on Mother Jones.

Eisman believes that the for-profit schools for higher education, such as ITT, Phoenix, and others that are heavily advertised, have been excessively profitable and are now headed for a fall. These schools are heavily dependent on taxpayer funds provided to students either in the form of grants or guaranteed student loans. Some are approaching the legal limit of having 90% of their funds coming from government sources.

There are a number of analogies to the subprime mortgage market. Deregulation during Bush years allowed these schools to be more aggressive in marketing themselves and more efficient in gaining access to federal funds. A good reference is an article in Businessweek entitled "Hardselling the Homeless" These schools have gone so far as to visit homeless shelters in order to recruit students—analogous to talking poor people into taking out mortgages they could not afford—these schools descend on the most vulnerable of our citizens and encourage them to take out student loans in order to cover their exorbitant tuitions. As one might expect, the dropout rate is enormous and the taxpayer ends up footing the bill. Federal aid to students at these for-profit schools was $4.6B in 2000 and $26.5B in 2009. Here are some quotes from the Businessweek article.
"The privately held Drake College of Business, which trains people to be medical and dental assistants, relied on taxpayers for 87% of its revenue in 2007. Almost 5% of the student body at its Newark (NJ) branch is homeless.....Late in 2008, it began offering a$350 biweekly stipend to students who show up for 80% of classes and maintain a ‘C’ average.....’Its basically known in the community: if you’re homeless and you need some money, go to Drake’ says Carmella Hutson, a case manager at the Goodwill Rescue Mission in Newark.....Operating margins averaged 21% in 2009; schools typically charge $10,000 to $20,000 a year, well above comparable programs at community colleges....The industry is now fully mainstream. Goldman Sachs owns 38% of the for-profit Education Management Corp."These abuses have been noticed. Eisman believes that new government regulations are forthcoming that will severely limit the profitability of these outfits and drive their stock prices way down. In other words, he is shorting them. It will be interesting to see how this all plays out.

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