Two college sports foster madness in American households come late March: basketball and mailbox-watching. Yes, 'tis the season when millions of high school seniors and their parents find out their college options, from where the applicants have been accepted to what kind of financial aid they'll receive. But with all the PhDs, MBAs, and other lettered luminaries produced by the American educational system, why haven't we come up with a better way to pay for college educations?
No matter how you slice the numbers, the payoff from a college degree is high. For instance, over the past four decades, the median family income of adults aged 30 to 39 with a four-year college degree rose by 46%, according to data compiled by the Economic Mobility Project.
In sharp contrast, incomes for their peers with a high school degree gained 7% and high school dropouts suffered a 6% decline. Despite the employment and earnings trauma of the Great Recession, the long-term trend is toward employers valuing college-educated workers.
Problem is, many of those students and parents wonder how they'll pay for that education. For it's also true that no matter how you cut the numbers, the cost of a college sheepskin is steep. For more than three decades, students and their parents have funded a college-tuition bubble with borrowed money. An ample supply of loans allowed colleges to raise the cost of attending their institutions at four times the rate of inflation over the past two decades.
The credit-fueled spike in tuition costs has hit loan recipients hard. The number of borrowers maxing out on student loans has surged from 57% to almost three-quarters. The default rate on those loans is at ominous levels, too. For instance, studies reaching back into the 1990s and following students over the subsequent decade show that students with loans totaling $15,000 or more had nearly triple the default rate of those with $5,000 or less—19% vs. 7%. For African American students, the default rate was almost 40%.
The college enrollment gap between children from well-heeled families and those from low-income ones is wide—80% vs. 34%. Fear of taking on large debt burdens is a barrier to enrollment among less well-off families.
To top it off, the college pricing and application system is Byzantine and opaque. For instance, the basic financial aid form—the notorious Fafsa—is so complicated researchers have documented that it discourages applications from low-income students. (Consider that subprime mortgages, typically involving far larger amounts of money and far greater danger to the financial system, involved much less paperwork.) And when it's time to make good on the loans, borrowers are faced with a mind-numbing variety of loan repayment schemes.
The Obama Administration and its allies in Congress are currently embroiled in a battle to end subsidies to private banks that make student loans and instead rely solely on direct federal lending. (The savings would go toward shoring up Pell Grants to low-income students.) But when looking for a bigger solution to a mess like this, it always pays to consult the late economist Milton Friedman, Nobel laureate at the University of Chicago. He had a genuine knack for devising simple yet powerful solutions for knotty financial problems. In a 1955 article, "The Role of Government in Education," Friedman noted that loans weren't a good way to finance higher education and professional training. "Such an investment necessarily involves much risk," he wrote. "The average expected return may be high, but there is wide variation about the average."
Any small business entrepreneur will tell you Friedman was right. Debt is too risky for startups, whether a small business or a college freshman.
"The device adopted to meet the corresponding problem for other risky investments is equity investment plus limited liability on the part of shareholders," he wrote.
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