Igloo Building: A Primer on the Financial Aid Fiasco

Peter Wood

As The Chronicle of Higher Education puts it, “the Bush administration and Congress have moved with blinding speed, agreeing on and passing a ________ in less than a month.”  I have the impression that relatively few academics could fill in that blank.  When I spoke about the looming crisis at a meeting of faculty members in April, many members of the audience reacted with astonishment.  Some asked why the matter hadn’t been in the news.  

The words that fill in the blank are “student-loan bailout bill” and the matter has, of course, been in the news for much of the last year—on the front pages of The New York Times, The Wall Street Journal, and The Chronicle of Higher Education, and as a lead topic on Inside Higher Education.    My guess is that quite a few scholars suffer MEGO (“my eyes glaze over”) when the headline includes the words “student loans.”  

It’s understandable.  The student loan industry is not a crucible of intellectual excitement, and normally doesn’t even connect with entertaining antics of the AAUP, Stanley Fish, or Yale art shows.   When I write about the student loan fiasco, I feel a bit like I’m explaining the principles of igloo building to beachcombers in Key West, and some recapitulation is needed.  Think of snow.  Think of a lot of snow.  Then double it.  

The snow in this case is federal loans.  American higher education existed for several hundred years without this snow.  George Washington wanted a national university, but Congress never acted.  The first major involvement of the federal government with higher education was the Civil War Morrill Act, which set aside federal lands to create—what else?—land-grant universities.  The greatest change, however, came in 1944, when Congress passed the Serviceman’s Readjustment Act—better known as the GI Bill—which helped 7.8 million veterans attend college between 1944 and 1956.  The GI Bill worked splendidly to advance its avowed purpose.  America reaped the benefit in the years that followed of having a large number of highly-motivated college graduates who, were it not for the federal assistance, would have foregone a college education.  

But the GI Bill also had three unintended consequences.  First, it showed college administrators an easy path to previously unimagined riches.  According to the Veterans Administration, “In the peak year of 1947, veterans accounted for 49 percent of college admissions.”  Simply by scaling up the size of entering classes, college administrators could bring in millions of dollars of federal largess.  The nature of this temptation was immediately noticed by faculty members, who came under pressure to relax grading standards and dilute the curriculum.  One can find in faculty statements of the period widespread anxiety over what academic administrators were willing to do to capture as much of the federal funding as possible.

Another unintended consequence was that politicians had discovered a hugely popular new form of pork.  Federal spending on higher education could always be packaged with the noblest of sentiments.  Soon the GI Bill itself was renewed for members of the armed services who had not fought in World War II, and we were off to a bidding war for federal aid that in sixty years has never even paused.    Our crisis of the moment is a direct consequence of that dog-chasing-its-tail cycle of federal spending.

 The third unintended consequence was a tuition price spiral.  The more the federal government was willing to subsidize higher education, the higher the tuition colleges could charge.  This is the only one of the three unintended consequences over which there is any doubt.  Some defenders of the pricing structure in higher education deny that it is subsidy-driven.  The actual data unmistakably show that colleges and universities raised their tuition to swallow up increases in federal aid, but for the sake of brevity, I’ll leave the reader the task of sorting this out.  

 In any case, once American colleges and universities discovered the tonic of federal grants for tuition and federally-subsidized loans for students, there was no turning back.  In 1965, Congress consolidated the growing list of federal subsidies under Title IV of the Higher Education Act, and Title IV student loans became, next to the mortgage deduction on federal income taxes, the biggest single middleclass benefit of the federal government.  The history of federal spending on student loans since 1965 is merely a matter of details—ever bigger details to be sure, but still just details. 

But it is helpful to think for a moment about how these subsidies transformed higher education itself.  On the positive side of the ledger, they hugely increased what educrats call “access.”  More people found their way to attending college.  From 1950 to 2008, we went from a nation in which 2.6 million attended college (not necessarily graduating) to over 18 million today.   As of 2007, 42,349,000 Americans had attended at least some college.  In 1950, only 34.3 percent of Americans over age 25 had completed high school.  By 2000, 80.4 had—radically increasing the pool of potential college enrollees. In 1950 6.2 percent of Americans had earned a college degree; by 2000, 24.4 percent had a bachelor’s degree.  The gains have included huge increases for women and minorities.  Not all the barriers to college had been financial, but once colleges had a powerful financial motive to expand, expand they did, and most non-financial barriers fell by the wayside.   

On the other side of the ledger, federal subsidies gave many colleges and universities a business model in which they financed their operations by pushing a large percentage of students into significant long-term debt.  The college in effect pays its current bills with dollars that it coaxes students and their parents to borrow.  Some of this debt is collateralized with a second home mortgage—a dwindling option these days.  And much of it is simply borrowed against the dreamed-of earnings that the student imagines he will obtain by virtue of his college degree.   In this light, American higher education has a little of the air of a casino.  It conjures the impression that everybody who gets the degree gets the monetary prize as well.  

Which brings us to the matter at hand.  What happens if the student loans, upon which this business model is built, suddenly become less available?   If student loans become less available, many colleges and universities will face cutbacks.   Everything else is speculation.   In a severe loan-drought, some colleges and universities might close their doors.  In a less severe drought, they would simply defer some spending and tighten their belts.  

And, oh yes, some students who were counting on loans to attend college would have to make other plans.

No one in Washington wants to see this happen, which is why “the Bush administration and Congress have moved with blinding speed, agreeing on and passing a student loan bailout bill in less than a month.”    This might pique the curiosity of even the most soporific MEGO sufferer.  What in the world happened that the student loan merry-go-round, which has operated reliably (if not efficiently) for more than half a century should be in danger?  

Two things.  Or maybe three.  Or four.  The events close in on each other in a way that makes it hard to tell where one leaves off and another begins.  In January 2007 Attorney General Andrew Cuomo of New York State announced an investigation into some possible collusion between a student loan company and college officials.  He quickly discovered wide-spread patterns of abuse involving many loan companies and many universities.  Meanwhile, the biggest supplier of student loans, federally-subsidized Sallie Mae, announced that it was closing a deal to sell itself, and by the way, its CEO was exiting with a golden parachute.  The combination of sleaze, political favoritism, and corporate rapacity finally reached a point where, in September last year, Congress felt it needed to do something.  What it did was pass the College Cost Reduction and Access Act—CCRAA—which I wrote about here.   It might best be thought of as a way to whip the student lenders for their bad behavior in taking full advantage of the incentives and subsidies Congress had passed on earlier occasions.  

CRAA slashed those federal subsidies and incentives, and some lenders immediately announced they were getting out of the business or scaling back.  This was the beginning of a bleak season for the student loan industry.  Not only were the opportunities to bribe campus officials drying up, the mortgage crisis had begun to spook credit markets.  Investors had become especially skeptical of the pig-in-the-poke instruments in which bad debt was mingled with good debt in indigestible bonds.  It turned out that the student loan industry, just like the home mortgage industry, had built its empire on “securitized” debt.   By October, those bonds weren’t selling, and by December, some of the industry giants were teetering on insolvency.  I wrote about it here.  

What’s happened since then is the exodus of more and more lenders from the student loan market, or from parts of it.  The details are complicated and analysts disagree whether they portend a crisis or merely a contraction.  A good place to look for expert opinion is the website of the National Association of Student Financial Aid Administrators, which collects news stories on the mess.  The reader will quickly discover where I have simplified.  The story is more complicated than a short article can bear, but I think my account is accurate on the essentials.  

The balm that Congress and the President are now applying to the wounds in the financial aid system is a little mysterious.  The idea is that the Secretary of Education will be able on behalf of the federal government to “buy” the loan portfolios of lenders.  The terms of the purchases will be up to Secretary Spellings, who could go either way—by making munificent offers that get the lenders off the hook for billions of dollars in doubtful loans,  or alternatively by making parsimonious offers that give the lenders a choice between losing lots and salvaging something.  In any case, the American taxpayer is likely to end up owning many more billions of dollars in underperforming student loans.   

Few of the experts seem to think this is a permanent fix.  The underlying problem, as in the housing bubble, is that the basic investment has been widely overvalued.  Many college degrees aren’t worth what students have been paying for them.   That’s a problem that can be fixed only by profound reform of higher education itself. 

Scholars need to look up from their microscopes, lay aside for a moment their papyri, pause in grading that pile of term papers, and belay that next blog—and consider that maybe we are going to be jolted a bit in the days to come.  Maybe not.  “The Bush administration and Congress have moved with blinding speed,” which may postpone the reckoning until after the fall election.  OK, back to work.  

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