Monday, August 6, 2012

What Universities Do With Their Money: Another Debt Bubble?

There was an intriguing article in The Economist discussing a possible debt-driven bubble in our higher education system. What was so interesting is that the article focused not on the exploding student debt, but on the exploding university debt. The article was titled The college-cost calamity. It provided this lede;
"Many American universities are in financial trouble"

The indicated source of the financial problems is an overinvestment in flashy goodies.

"Universities have been spending like students in a bar who think a Rockefeller will pick up the tab. In the past two years the University of Chicago has built a spiffy new library (where the books are cleverly retrieved by robots), a new arts centre and a ten-storey hospital building. It has also opened a new campus in Beijing."

The motivation for this spending is not necessarily associated with providing better education for their students.

"Universities hope that vast investments will help them attract the best staff and students, draw in research grants and donations, and ultimately boost their ranking in league tables, drawing in yet more talent and money."

This chart puts university debt in perspective.

"Long-term debt at not-for-profit universities in America has been growing at 12% a year, estimate Bain & Company, a consultancy, and Sterling Partners, a private-equity firm."

To suggest that school income is spent on things other than educating students, this chart of administrative and non-educational student services costs is included.

This is not unexpected. Administering classrooms is simple; administering research centers is complex.

This claim is then made:

"To pay for all this, universities have been enrolling more students and jacking up their fees. The average cost of college per student has risen by three times the rate of inflation since 1983. The cost of tuition alone has soared from 23% of median annual earnings in 2001 to 38% in 2010. Such increases plainly cannot continue."

And how might a bursting bubble occur?

"Glenn Reynolds, the author of "The Higher Education Bubble", predicts that the bubble will burst ‘messily’. People have long believed that "whatever the cost, a college education is a necessary ticket to future prosperity." Easy credit has allowed them to pay ever more, and colleges have raised fees to absorb the extra cash. However, this cannot go on forever, says Mr Reynolds, especially when people start asking whether a degree in religious and women’s studies is worth the $100,000 debt incurred to pay for it."

This sounds like scary stuff, but is it really something to worry about?

The author used the University of Chicago as an example. This type of large, research-oriented university is probably better thought of as a conglomerate than as a school. The business of higher education was discussed in So Why Is College So Expensive? Revenue figures for Stanford University in the 2009-2010 academic year indicated that only 17% of their income came from student tuition and fees. This compared with 30% that came from sponsored research, 22% from endowment income, 13% from medical services provided (running a medical center), and 12% from other sources of income. The students barely beat out the "other" category. On top of this, the revenue from donors slightly exceeded that from students. This data for Stanford is not unique. Harvard’s budget provides almost an identical breakdown.

I was moved to make this comment:

"There is no market for a university education because income from students is not a driver in the operation of the institution. A cynic might say that the students, at least the undergraduates, are merely props to allow the school to pursue its money-making endeavors like sponsored research and investment income. What is the greatest contribution a student can make to his school? He can become a happy and nostalgic alumnus who will give and give for the rest of his life. How do you make happy and nostalgic alumni? You let them cross paths with famous people every once in a while. You provide them with spectacles in the form of sporting events. You give them the impression that they are going first class and they will leave proud of how much their education cost."

Mr. Reynolds seems to conclude that the university bubble will burst because students will rebel and refuse to go into debt to pay for this increasingly expensive educational product. This is stated as an obvious conclusion, but no evidence is provided that anything like this is occurring, at least not at major private universities. In fact, a university like Harvard or Stanford has enough income to shield their students from having to acquire large debts even though the nominal tuition is high.

The author might have made a case by providing an example from a lower-tier university where student tuition will be a greater fraction of income. However, one suspects that that this is also the type of institution that is less likely to go overboard on borrowing to obtain expensive facilities. A student revolt will be felt first at the lesser schools—but where is the data?

The argument that a college education is worth the investment still holds in terms of lifetime earnings. Going to college may have become more of a financial gamble, but it is still the only reliable path towards a healthy income. Until an alternative is available, our youth will continue to pay the price—even if it is an unreasonable one.

If there is going to be a debt bubble it will be of a traditional financial nature, because universities are really just another form of a corporation. Bad investments lead to bad results. No evidence is provided to indicate that these corporations are making bad investments—just large ones.

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