How Recession Will Change University Financing

Illustration by Kate O'Connor Close

Illustration by Kate O'Connor

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Illustration by Kate O'Connor

The latest recession will probably be seen as a turning point for college and university financing.

Indeed, the initial reaction by many youths to soaring unemployment was to stay in or return to college to wait out the bad times and get better prepared to face a tough job market. For-profit and community colleges have been especially attractive, and in the fall of 2011, there were 22 percent more students enrolled in the nation’s 1,200 community colleges than in the fall of 2007. Nevertheless, less than half graduate.

Also, those now leaving college are finding few jobs. Only 54 percent of those age 18 to 24 are employed, the lowest share since data began to be collected in 1948, and the unemployment- rate gap between this demographic group and all working-age adults is the widest on record. Only 49 percent of graduates from the classes of 2009 to 2011 found jobs within their first year out of school, compared with 73 percent of those who graduated three years earlier. About 54 percent of bachelor’s- degree holders under 25, or about 1.5 million people, were jobless or underemployed last year.

In addition, there is now research challenging the economic value of a college education. Data comparing the average earnings of college graduates at each age with those of workers with only a high-school diploma indicate that the first group has an advantage of $1 million or more for full-time work from age 25 to 64. But college-bound students usually have better abilities, better grades, more maturity, better support from home, higher test scores and better job prospects than those who enter the workforce out of high school.

Lifetime Income

Furthermore, the raw lifetime-income differences don’t account for tuition costs, interest on student loans, lost wages while in college, and the discounting of future earnings.

Various studies that take these things into account indicate that each year of college adds 6 percent to 10 percent to annual incomes, so lifetime earnings increase by a range of $300,000 to $600,000, not $1 million or more. The College Board calculates that using 2008 data, a student entering college in 2010 at age 18 who borrows his way to a degree earns enough by age 33 to make up the cost, including wages forgone and loan interest. That’s a 5 percent to 6 percent return on investment - -- meaningful but not huge. These results partly reflect the 184 percent increase in real tuition costs in the past 20 years, which has occurred as the real pay of college graduates has risen only 9 percent.

The cost of college certainly makes raising children more expensive. The Agriculture Department reports that a family with $59,410 to $102,870 in pretax income will spend almost $300,000 to raise a child for the first 17 years. But that doesn’t take into account the unpaid time spent on parenting, including income forgone by parents who stay at home or work less in order to care for their offspring. It also doesn’t consider the opportunity costs of not investing the money spent on the child, or college costs. There are estimates that raising a child to age 22, including college, would about triple the cost, to about $900,000.

With few job prospects and high levels of student loans -- 55 percent of the 2010 graduates of four-year public institutions left school with debt averaging $22,000 -- many young people are disillusioned. The average real debt for new graduates rose 24 percent from 2000 through 2010. And about a third of those who are employed take jobs that don’t require a four-year degree.

Liberal Arts

Most thought that a bachelor’s degree was the ticket to a well-paid job, and that the heavy student loans were worth it and manageable. And many thought that majors such as social science, education, criminal justice or humanities would still get them jobs. They didn’t realize that the jobs that could be obtained with such credentials were the nice-to-have but nonessential positions of the boom years that would disappear when times got tough and businesses slashed costs.

Some of those recent graduates probably didn’t want to do, or were intellectually incapable of doing, the hard work required to major in science and engineering. After all, afternoon labs cut into athletic pursuits and social time. Yet that’s where the jobs are now. Many U.S.-based companies are moving their research-and-development operations offshore because of the lack of scientists and engineers in this country, either native or foreign-born.

For 34- to 49-year-olds, student debt has leaped 40 percent in the past three years, more than for any other age group. Many of those debtors were unemployed and succumbed to for-profit school ads that promised high-paying jobs for graduates. But those jobs seldom materialized, while the student debt remained.

Moreover, many college graduates are ill-prepared for almost any job. A study by the Pew Charitable Trusts examined the abilities of U.S. college graduates in three areas: analyzing news stories, understanding documents and possessing the math proficiency to handle tasks such as balancing a checkbook or tipping in a restaurant.

The results were deplorable. Half the graduates of four- year colleges and three-quarters of those from two-year institutions lacked the skills to understand credit-card offers. They also couldn’t interpret tables relating exercise to blood pressure or understand newspaper-editorial arguments.

And what’s expected of students at all levels has been dumbed down tremendously in recent decades. Perfect scores on SATs used to be unheard of. Now they’re routine.

Furthermore, the best graduate students in the top universities are often foreigners. And they come from countries that have much cheaper education systems. Yet American 15-year- olds rank in the middle of the pack in math, reading and science scores, and their high-school graduation rates are below international averages.

Education Standards

As higher-education quantity has soared, quality has dropped. Many institutions are mere diploma mills, graduating students of limited capability. Wall Street companies and management consultants fawn over MBAs from Stanford and Harvard, but won’t even interview the legions of night-school MBAs, who were taught by poorly paid adjunct professors at lesser institutions.

The realization that many recent college graduates were poorly prepared for nonexistent jobs, that they will be burdened for years with crushing student loans along with the resulting frustration, may be bringing about a great revelation: Going to college doesn’t make you smart and ready for a good, well-paid job. There’s little causal relationship between going to college and financial success despite the statistical link. And you can’t prove causality with statistics.

Indeed, causality probably runs the other way. Today, most smart people go to college, especially as the top institutions beat the bushes for able, but disadvantaged, students with brains who lack legacy or other connections. But bright people would be successful without college, as was common before the days when a degree became almost mandatory. This direction of causality is also suggested by the high dropout rates of low- income students, who often lack the intellectual preparation for college. Furthermore, those who demonstrate the brains needed for college while in high school usually enter four-year institutions and graduate.

A minimum of a bachelor’s degree is needed to be considered for a decent job; it’s the initial screen used by most employers. And, of course, employers generally are assured that top school graduates have the best prospects for success -- whether it’s because those institutions do a great job at education or because they attract the cream of the crop. At the same time, so many people graduate from college that even bartenders have degrees. Did the chemistry courses teach them how to mix martinis? The money spent on people who don’t require more than a high-school diploma for their jobs is wasted, as is their time in college.

Vocational Training

If it becomes widely apparent that college doesn’t make people smart, high-school students will probably be much more efficiently directed to institutions that match their capabilities. Those with high IQs, grades and test scores will be encouraged to attend four-year colleges and universities. Those in the middle will be guided to community colleges with the option of transferring to four-year institutions if they do well. And less-able students will be channeled toward vocational training for occupations that suit them and often pay very well.

Employers could encourage the rationalization of post- secondary education to match ability with the proper educational and training institutions by making it clear that a college or graduate degree by itself doesn’t cut much ice. Those who don’t come from credible institutions or can’t pass rigorous tests need not apply. This would discourage many from spending their time and money on worthless degrees and encourage them to pursue more fruitful education and training.

Just consider the demand for carpenters, plumbers, electricians and mechanics, and the high pay they now command, even in this weak economy. Community colleges with two-year courses in technical specialties are training people for these jobs and for manufacturing positions such as machinists, robotics specialists and other highly skilled trades. An estimated 600,000 skilled middle-class manufacturing jobs remain unfilled nationwide, even as millions of Americans are still unemployed. German companies with operations in the U.S. such as Siemens AG, Bayerische Motoren Werke AG and Robert Bosch GmbH are transferring their nation’s system here. It involves apprentice programs in partnerships with technical schools.

The student-loan glut is depressing college financing, but so too are other woes unleashed by the recession. With high unemployment, depressed incomes, still-reduced investment portfolios and collapsed house prices, alumni giving is under pressure. And it is likely to remain so in the slow-economic- growth atmosphere of deleveraging that will probably take another five to seven years to complete.

The financial status of students’ parents will remain troubled for the same reasons. Many, as they approach retirement, will confront vastly inadequate savings and need to save for their own well-being, as well as to help finance their kids’ educations. Home equity used to be available to fund children’s college tuition, but no more.

Declining Appeal

In 2010, one-third of parents surveyed by the education- lender Sallie Mae strongly agreed that children should attend college for the experience, regardless of the effect on their potential earnings. In 2011, that number slipped to 24 percent.

Most college endowments have recovered from the huge losses of 2008, but remain more cautious, with weaker gains likely in future years. They are now prepared for lower returns as they emphasize dividends, investment-grade bond interest and other here-and-now income rather than pie-in-the-sky capital gains.

According to a new study by student-loan provider Sallie Mae (SLM), grants and scholarships fell 15 percent in the 2011-2012 academic year to $6,077 on average from $7,124 in 2010-2011. This category includes money from colleges as well as scholarships from other institutions and federal funding such as Pell grants.

State governments, hard-pressed by persistent budget deficits and vastly underfunded pension plans, are cutting costs, including aid to state colleges and universities. After decades of growth, state funding for higher education has fallen 15 percent since 2008, adjusted for inflation. Federal funding for university research is also declining.

Responses to the crisis in higher-education financing are developing and varied. Some institutions are raising tuition. Some are reorienting their programs away from the liberal arts and toward training for careers.

While some institutions are considering tuition freezes as a way of containing costs, the University of the South, known as Sewanee, has gone even further. Last February, Sewanee cut tuition and fees for the 2011-2012 academic year by 10 percent. Last November, the school announced that for current students, costs for the 2012-2013 year were frozen at $41,518. Then in January of this year, the university froze the annual costs for incoming freshmen in 2012 at $44,630 for four years, or through the spring of 2016.

Sewanee Experiment

Sewanee wants to address the spiraling costs of higher education, the lingering effects of the recession and the siphoning-off of prospects by state schools where student costs are rising in many cases due to cuts in state funding, even though costs remain lower than at private colleges. The tuition cut and freezes also reduce the pressure to buy attractive students with merit scholarships and help Sewanee compete with other private schools, where tuition and fees continue to rise much faster than the consumer price index. Sewanee now plans to concentrate its financial aid on needy students.

The marketplace has responded very positively to these actions. Applications for this fall have risen 15 percent from last year, and the quality of applicants has improved. The entering freshman class in 2011 numbered 433, up from 401 in 2010.

The school has also become more selective, offering admission to 56 percent, compared with 60 percent earlier. It will be interesting to see if other colleges follow Sewanee’s lead.

(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own. This is the second in a two-part series.)

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Today’s highlights: the editors on the panic over Greece; Margaret Carlson on mothers in the workplace; Clive Crook on central banks’ mission creep; Peter Orszag on why the U.S. Postal Service should be privatized; David Gordon and Sean West on why the U.S. emerging-market moment is over.

To contact the writer of this article: Gary Shilling at insight@agaryshilling.com.

To contact the editor responsible for this article: Max Berley at mberley@bloomberg.net.

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