CT Blue

Apparently, according to standard economic theory, the source of money used to purchase something, or invest in something, should not affect the price of that something. That is, over time, the cost of a given item or service should not rise just because most of the funds used to purchase that item or service comes from borrowed funds rather than ready cash. Why is it that it is no surprise to find that at least in the case of student loans, standard economic theory is dead wrong?

Sometimes you hear something that sounds so much like common sense that you end up missing how it overturns everything you were actually thinking, and points in a far more interesting and disturbing direction. That’s how I’m feeling about the coverage of a recent paper on student loans and college tuition coming out of the New York Federal Reserve, “Credit Supply and the Rise in College Tuition: Evidence from the Expansion in Federal Student Aid Programs,” by David Lucca, Taylor Nadauld, and Karen Shen.

They find that “institutions more exposed to changes in the subsidized federal loan program increased their tuition,” or for every dollar in increased student loan availability colleges increased the sticker price of their tuition 65 cents. Crucially, they find that the effect is stronger for subsidized student loans than for Pell Grants. When they go further and control for additional variables, Pell Grants lose their significance in the study, while student loans become more important.

via Next New Deal

The blogger (Mike Konczal) at Next New Deal explains the economic theory, and has his own ideas about why they don’t appear to apply to the student loan situation:

This derives from something called the Modigliani-Miller Theorem (MM), the frustrating staple of corporate finance 101 courses. A quick way of understanding MM is that how much you value an asset or investment, be it a factory or higher education, should be independent of how you finance it. Whether you pay cash, a loan, your future equity, a complicated financial product, or some other means that doesn’t even exist yet, you ultimately value the asset by how profitable and productive it is. In this story, which requires abstract and complete markets, expanding credit supply won’t drive tuition higher.

Now what would change your valuation, according to this theorem, is getting subsidies, say in the form of Pell Grants. This would make you willing to buy more and pay a higher price. This is one of the reasons why so much of the economics research focuses on Pell Grants instead of student loans: the story about what is happening is clearer. But, again, extensions of the credit supply, not subsidies, are doing the work here.

So the actual practice stands things on their theoretical heads. Outright subsidies have little effect on the price of education, while access to relatively easy loans is what is driving increasing tuition costs. The effect is greatest at private colleges, including non-profits, but of course as the cost of private education goes up, increasingly underfunded public universities have more and more room to increase their tuition, given that almost nowhere in the United States do we think of higher education as not only a right, but a necessary investment in human capital. Not to belabor the point, but most of us know that most people are not truly in a position to sit down with a calculator and figure out what the ultimate value of a college education may be; we know only that such an education is practically a necessity, and the only way to get it is to borrow the money and pay what’s demanded. This dynamic is sure to put upward pressure on prices, particularly since the federal government seems supremely uninterested in making sure that it or the nation’s students get value for the buck.

Konczal goes on to discuss the latest right wing solution to the problem, and like all right wing solutions, it seems designed to comfort the comfortable and afflict the afflicted. The idea is for “investors” to fund a student’s education in return for a given percentage of that student’s future earnings. It’s called Income Sharing Agreements, or as Konczal calls them “human capital contracts”. It sounds like indentured servitude, and to boot, would require close government monitoring of each student to make sure that he or she makes the proper payment to their investors.

The way to stop the madness is fairly obvious. Public education should be free. That would put downward pressure on the private sphere. Student loans, if they must continue to exist, should be available only for attendance at truly non-profit colleges (not this sort of thing. If you want to run a for profit school, that’s fine, but why should we taxpayers subsidize an industry that has demonstrated beyond doubt that it is based on a fraudulent business plan. There is, by the way, only one presidential candidate making sense on this issue, though to give Martin O’Malley credit, he’s coming close. Guess who that one candidate is? Hint: His name is not “Hillary”.