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To Cut College Loan Default Costs, Reform For-profit Schools' Taxpayers Subsidies

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For-profit colleges enjoy the fruits of a business model to die for. It's not a new model. In fact, it's very similar to the one employed by subprime mortgage purveyors Washington Mutual and Countrywide Financial that helped put the entire global financial system at risk, pitching the U.S. into the worst financial panic since the Depression. As we confront a national student loan debt now over $1 trillion and counting, that holds back their "normal" investment in first-time housing, cars and the like, it would be wise to look closely at those similarities and see what we can do about them before its too late (again).

Actually, the for-profit colleges have gone the subprime mortgage peddlers one better: They have managed to get the U.S. taxpayer to pay for their high-pressure marketing programs. Even the infamous Angelo Mozzilo at Countrywide wasn't able to pull that off! But let's start with the basics first: the key parallel between subprime mortgage and subprime degrees is that the merchants of both products have been able to get the Federal government to front the money to enable consumers who couldn't afford to pay cash for their product. At the same time, the merchants take no financial responsibility for the quality of their product. This leaves the U.S. taxpayer with the bill when "customers" -- finding what they acquired to have much less value than expected -- default on their debts.

In both cases, the intended purpose of public policy behind these taxpayer subsidies was apparently high-minded and praiseworthy -- expanded home ownership was championed by leading politicians of both parties: George W. Bush and Barney Frank, to name just a couple of political opposites who made it a priority. Democrats liked mortgage-related subsidies because it gave the poor a boost up the social and economic mobility ladder. Republicans liked it because it might help the poor become -- well, Republicans, as they got higher on the ladder and liked the view. And even Alan Greenspan, of the Ayn Rand persuasion, chipped in with artificially low interest rates in order to spur economic recovery for everyone from the pains of the dot-com crash. In just a few short years, apparent housing wealth replaced $4 trillion of the $7 trillion in paper net worth destroyed when the dot-com bubble burst. And Greenspan told concerned naysayers not to worry about irrationally exuberant bubbles because nobody could spot them anyway until they burst on their own.

The educational subsidies sprung from a similarly broad-based bi-partisan agenda that viewed higher education as the ticket to at least middle class status, which both parties wanted to claim as their own "base" back in the day. Stretching from the Morrill Act of 1862 at jump-starting land-grant colleges in the Lincoln administration to the GI Bill of Rights and Pell grants and Stafford loans, taxpayer subsidized grants and loans to college students were justified as net benefits to today's taxpayer. They enabled all who were qualified to have a chance to graduate with middle-class job skills, becoming tomorrow's taxpayers, and taking care of current taxpayers' old-age subsidies. Neat.

Unfortunately, while the Feds were doling out these subsidies -- at least based on demonstrated financial need forms (we could have used something like that for subprime mortgages scooped up from the Countrywides and their bankers by Fannie Mae and Freddie Mac -you and I are still paying off those bills) -- the states were cutting off their subsidies for college costs in order to build more prisons. That middle class thing wasn't quite working out as planned. Many folks were priced out of low-cost education where even the Federal money wasn't enough to get in the door. Enter the for-profits and their magical college business model. We'll make universities actually efficient. And we'll therefore be able to scale the price to you precisely to what the government will put up each academic term!

The high-minded folks at the Department of Education and in Congress weren't entirely gullible. However, they did smell a mouse, if not a rat. They put in a rule that for-profit colleges would get no more than 75 percent (at first) and then 90 percent of their tuition dollars from the Feds -- but they exempted military benefits from the numerator (not the denominator), so in practice the limit is often de-facto exceeded.

Eventually some of the promised efficiencies failed to materialize. Yes, the schools ran all year, did no research, had no tenured contracts, used online prolifically and often quite intelligently. While accreditors praised the for-profits "innovations" in delivery, they went a little soft on educational outcome assessment -- with 3,000 for-profit school accreditation fees to collect, the similarities to the NCAA in terms of tight regulation comes to mind.

Meanwhile, a student loan default bubble has emerged plain for all to see in the for-profit sector. It accounts for a bit over 10 percent of all college students (University of Phoenix enrollment is exceeded only by the whole New York State University system), but only about 20 percent graduate within six years compared with 55 percent at public and 65 percent at private non-profit universities. The vast majority -- up to nearly the 90 percent limit in many cases -- of that underachievement is financed by Pell grants and federal loans. For-profits attract 25 percent of taxpayer-funded tuition subsidies, but account for over 40 percent of all student defaults. The Fed stepped in with threats to put for-profits out of business if their default rates exceed 30 percent of their students after three years, effective 2014. If those rules were in force in 2010, 85 percent of schools disqualified would have been for-profit entities. This remedy closes the barn after the horses have left.

The real scandal is the fact that many of the largest for-profit schools allocate almost as much, if not more, of their tuition dollars on high-pressure telemarketing and advertising campaigns (not unlike our friends at Countrywide and Washington Mutual), marketing rather than educational -- up to 25-30 percent in recent cases. Taxpayer-funded tuition dollars aren't just paying for teaching; they're paying -- in full -- the costs of attracting the gravy-train pipeline of student borrowers! Detroit's automakers would envy that advance form of bailout.

Two reforms, borrowed from the Affordable Care Act (AFC) and Dodd-Frank, can strike at the heart of this scandal. First, as AFC did with insurers' administrative costs, limit marketing allocations to 15 percent of taxpayer-funded tuition at for-profits. Second, make these colleges, like today's mortgage lenders; keep some "skin in the game' when they book a Federal student loan -- say 15 percent of the face value risk. This requirement would begin to align their economic interest in producing a high graduation rate and high quality learning with the public interest of their U.S. taxpayer business "partners!"