Bubble Update: More Helium, Part 1

Peter Wood

The bubble in American higher education is inflating rapidly. Ironically this is happening just at the moment when large numbers of Americans are noticing that there is indeed a higher-ed bubble—that colleges and universities are enrolling too many students at too high a price; that the market for college graduates is saturated and oversupplied; and that there is a serious disparity between the costs and the rewards of the typical college-degree program.

One might think that parents who have some sense of this situation would think twice before spending tens of thousands of dollars (or more) on college, and encouraging their sons and daughters to go deeply in debt. But that hasn’t happened yet, at least not in substantial numbers. The psychology, as well as the finances, of this market differ from some classic bubbles. College degrees aren’t tulip bulbs, or overpriced condos. It’s complicated.

Not that the idea itself is complicated. As George Will describes it, the bubble is what happens “when parents and the children they send to college are paying rapidly rising prices for something of declining quality.” The point at which parents cease to be willing to pay those rising prices is when the bubble bursts. When that happens, the financial assumptions on which American higher education has been based for many decades will come crashing down.

There are, however, two highly unpredictable elements in the current situation. One is the willingness of the Obama administration to sustain the bubble by encouraging more and more students to attend college and by using student loans to support this expansion. The other is the bubble-deflating power of online education.

I want to say something about the interesting riptide of these two developments, but it is helpful first to survey the larger situation.


To make sense of the situation, we need some distinctions. It simplifies things a bit but doesn’t over-simplify them to think of four triplets:

Types of college: public colleges and universities, ordinary private colleges and universities, and elite colleges and universities. The dividing lines among these are not as rigid as they may sound. Public colleges and universities receive only a small fraction of their income from tax revenues and private colleges and universities are also dependent on public subsidies of various sorts. And the dividing line between ordinary and elite private colleges and universities is ambiguous. But that said, these three categories of institution play strikingly different roles in the bubble. The bubble also affects graduate education in ways that are distinct from undergraduate education.

Motivations: Americans pursue college degrees for many reasons but the three most common are credentialing for the workforce; prestige and connection; and actual education. Of course an individual student who is primarily motivated by one factor may benefit from the other two as well. College blends these motivations together by addressing all three with much the same package, but the differences in students’ primary motivations still bear deeply on their choices of where to attend college, how much to spend, and what to do with the opportunities at hand.

Destinations: The bubble is not just a reflex of parents overpaying to send their kids to mediocre colleges. It also has to do with how they see their children’s lives unfolding. If you fully expect your son or daughter to go to medical school, you think one way about college; if you expect your child to get a decent job in retail sales after four years, you think another way. Destinations can be usefully divided into three categories: a bachelor’s degree necessary and sufficient; a bachelor’s degree necessary but not quite sufficient—additional certification needed; a bachelor’s degree merely preliminary and valuable only as a stepping stone to advanced professional training.

Family Finance: As far as the bubble goes, we should distinguish between families whose means are limited to state college tuitions unless their children land large athletic or academic scholarships; families of whose means are so large that they have no real price considerations in choosing a college; and families in between—high earners who are nonetheless price sensitive. The first category consists of families whose combined income is under $100,000; the second category has family incomes over $250,000; the middle category earns $100,000 to $250,000 and have their own marketing shorthand. They are “HENRYs” for High Earners who are Not Rich Yet.

The Sun That Always Rises, Never Sets

The higher-education bubble affects everyone but one part of it is especially unstable. That’s the part that involves ordinary private colleges and universities; parents and students who are primarily motivated by prestige; destinations for which a college degree is preliminary and mainly of use for getting into top-ranked graduate programs; and HENRYs. These are the families that have been willing to pay more and more money for education of lower and lower quality, so long as it delivers access to graduate programs in law, medicine, business, or academic fields. It is unstable because those HENRYs are in a perilous financial position and relatively small shifts in family finances, such as tax increases, can have precipitous consequences. An affluent family that suddenly has to tighten its belt is very likely to take another look at its commitment to Ov’r Priced College and their daughter’s exploration of Post-Colonial Identity Studies.

At the moment, families in this category tend to see the alternatives to expensive four-year undergraduate colleges as too risky. If the goal is to set Alex or Katie up for life, a four-year degree from a prestigious liberal-arts college or major university still seems the best “investment.”

That word, however, requires special attention. A college degree is metaphorically an “investment.” It is much more plainly a consumer expense. Confusing consumption with investment is often what gets us into financial bubbles. A consumer good such as a house in the suburbs can look like an investment if the market has been driving up home resale prices, but few houses accrue value just as houses. They grow older, need repairs, have out-of-date wiring and plumbing, lack the latest amenities, etc. Their intrinsic value, on the whole, declines with the years, other things being equal. Of course “intrinsic value” is hard to measure. Normally we let the laws of supply and demand determine the price point for things, and those laws don’t preclude dizzying run-ups in price when people come to believe that resale prices are bound to rise still further.

The equivalent of this when it comes to college tuition has been the idea that the college graduate is bound to find a better job and make a lot more money than the non-graduate. And—so the theory goes—the addition of a graduate or professional degree on top of the college degree is bound to increase that margin a great deal more.

The advocates of this form of predestination are relentless. And while there is much disagreement on the size of the average college-degree lifetime earnings premium (from $279,893 to $1-million), there is no serious dispute that it exists. But that’s hardly the end of the story. Averages are one thing. Real-life experience is something else. The real life side of this includes:

  • Large percentages of graduates who end up working in positions for which the college degree is not required. By Richard Vedder’s account in 2010, we already have 17 million Americans with college degrees working in jobs for which a college degree is not needed—and not included in the employer’s calculation of what he should pay.
  • Graduates burdened with student-loan debt at a level that limits life decisions such as buying a house, getting married, and starting a family.
  • Prolonged unemployment and/or marginal employment, often resulting in setbacks in earning that can never be erased.
  • College attendees who fail to finish their degrees but end up still having to service large student-loan debts.

When we keep these facts in mind, it is easier to see the costs of college as essentially a form of consumption that incidentally and only in favorable circumstances can also function as an investment. But that, in turn, means that selling college as an investment is fundamentally dishonest. A trip to the casino is not an investment.

By focusing on the segment of private-college-attending, prestige-minded, graduate-degree-destined sons and daughters of HENRYs, I don’t mean to suggest that these are the only students driving the higher-education bubble. There are plenty of not-so-affluent families who feel they have no choice but to send their children to colleges that cost more than can afford and that teach less than the students need to know. They are caught in the cold grip of guilt. “If we don’t do this, we are shortchanging our child.” And that may be true in some cases, though the most reliable figures suggest that only a third of college students gain much intellectually from the experience. The other two thirds could well have benefited more by taking a different path—one unencumbered by exorbitant costs and large debt.

The bubble also bids to swallow some of the rich. The line I drew between those earning more than $250,000 and those earning less isn’t my own invention. President Obama is using the same line as his cut-off for families to be eligible for the continuation of the Bush tax cuts, and the figure is fairly standard in marketing. But many of those earning above $250,000 populate the elite private colleges and universities and pay something like the full freight. These affluent families have, by and large, been able to ride out the recession, but their net worth has fallen significantly and with large tax increases in the offing their willingness to keep writing checks to Priceless U may also erode. The behavior of this segment of the college-consumer market has been a source of great comfort to college administrators for a long time. That also could change.

Hot-Buttered Nonsense

Another layer of complication is that differences among colleges exert an outsized influence on the results. The bubble isn’t inflated to the same degree in every sector. The price of state universities is also rapidly escalating as state governments retreat from the public subsidies they used to offer and the universities respond with tuition increases. The rising price of state tuitions creates a price floor for private colleges and universities that generally can command a nominal price at least twice what the public sector changes.

This two-tier pricing is built on the perception—often false—that the private institutions offer a substantially better education—or at least a better “experience,” since what parents expect their college tuition dollars to buy doesn’t typically form a very close match to the official curriculum. Tuition-paying parents are buying prestige, atmosphere, identification with a community, and a conception of what it means to be an alumnus of a particular college more than they are buying what the college actually teaches. That’s why so many colleges get away with teaching hot-buttered nonsense for $40,000 or $50,000 a year.

The bubble could not exist without a substantial number of parents willing to buy high-priced prestige and daydreams about the future in lieu of actual education. Count that as one of the necessary but not sufficient conditions.

Discounts, Scholarships, Selection

Nominal tuitions, of course, are for chumps. Most colleges discount their tuitions in the form of scholarships for students, and they do so on the basis of opaque criteria that amount to their own calculations about the price point that will secure a family’s willingness to commit to paying the rest of the bill. The family plays this game at a steep disadvantage. The college demands to know everything about the family’s finances, but the family learns next to nothing about the college’s negotiating position.

Rachel Louise Ensign and Melissa Korn writing in the Wall Street Journal draw from a new study released by Sallie Mae this week (How America Pays for College) to report that “On average, U.S. undergraduates received $6,077 in grants and scholarships in the 2011-2012 academic year.”

The discounted tuition is still typically too large for a family to pay outright, which means the parents or the student will also have to secure student loans. The college originates some of these, which gives it further control over which students it will strive hardest to lock in and for how long.

Loan burdens are rapidly increasing as colleges retreat from scholarships. That $6,077 average scholarship for 2011-2012 is down from $7,124 in 2010-2011. That’s not because “need” decreased. It is because colleges calculated that they could successfully shift more of the burden to students by making them borrow still more. As grants fell, loans rose—up from a national average of $4,753 per student in 2010-2011 to $5,551 in 2011-2012, a 17 percent increase. (The averages include students who didn’t borrow, so the actual borrowed amounts are much higher. ) Four years ago (2008-2009), a quarter of all students took federal loans. That’s now up to 34 percent.

The news of the moment is that as discount rates fall, returning students are often finding that their scholarships are being reduced or eliminated. This might be a sign that the bubble is beginning to deflate in some sectors: colleges cannot afford to play the financial-aid game at the level they are used to and are willing to risk losing some students. But it might alternatively be a sign that the private colleges are confident they can capture even more income from parents without much risk. A cut in the discount rate is, effectively, a price increase. But it is a price increase that never need call itself that and that can fly safely under the radar of President Obama’s stern warnings about the need for colleges and universities to keep their increases in tuition to a minimum.

How the Game Is Played

All of this, however, is context for the real battle. President Obama has pursued policies that are meant to keep the bubble growing. Technological innovation is pushing in the opposite direction. Which of these countervailing forces will prevail? That’s for part 2.

This article originally appeared in the Chronicle of Higher Education's Innovations blog on July 20, 2012.

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