Photographer: Chris Goodney/Bloomberg

Obama Administration Floats Plan to Crack Down on Shaky Colleges

A new proposal meant to shield taxpayers from losses might be too late to protect against the next for-profit college failure.

A last-minute proposal by the Obama administration to clamp down on shaky colleges that risk saddling the Treasury with losses may come too late to help taxpayers. 

The U.S. Department of Education has long had broad authority to demand that schools provide money up front to cover the potential cost of their collapse, but on Monday it published a draft of sweeping revisions to its rules that clearly defined, for the first time, instances in which those demands would be automatically triggered. 

Federal rules authorize Education Secretary John B. King Jr. to demand that schools stump up cash equivalent to at least 10 percent of its previous year’s haul of federal student loans and grants, if he determines they’re financially troubled or lacking in “administrative capability,” department shorthand for schools that don't follow the rules governing the federal student aid program. But federal data show that the department traditionally has foregone its option to require higher amounts of collateral in cases where allegations of school wrongdoing are rampant. And in some instances the department hasn’t followed through on its demands, allowing schools to skirt federal requirements. This week's proposal would mandate that schools automatically set aside minimum amounts of cash relative to their student aid revenues under a variety of scenarios, such as pending fraud lawsuits by state or federal authorities, high student loan default rates, or declaring dividends when already on precarious financial footing. By taking the guesswork out of when, and how much, struggling schools would have to shell out, the government hopes it can force schools to cover the cost of their collapse before it occurs.

Behind the proposal is the Obama administration's effort to avoid a repeat of disasters like the one that befell for-profit chain Corinthian Colleges Inc. In November 2012, the Education Department demanded the publicly traded for-profit chain post $175.7 million in collateral, or 10 percent of the company’s previous year’s federal aid receipts, after the government determined Corinthian failed a key financial metric. Corinthian appealed and told its investors it might not be able to afford the guaranty. As Corinthian fought the collateral demand, California’s attorney general sued the company the following year alleging widespread fraud. The Education Department never actually collected the funds. Less than two years later, Corinthian collapsed under the weight of federal and state lawsuits alleging the company’s schools systematically defrauded students. The growing cost to taxpayers of Corinthian's collapse was at least $90 million as of March.

The department wants to finalize its proposal by November for it to take effect in July of next year. It doesn't need congressional approval.

“It’s the most significant step we’ve seen the department take to hold colleges accountable for their bad behavior and limit taxpayers’ liability,” said Chris Hicks, a former student debt-focused organizer turned independent researcher who has published two reports on the department’s letter-of-credit policies. “They’re going after the largest for-profit colleges.”

The triggers affect only nonprofit and for-profit schools, since public colleges are backed by their respective state governments and don’t need to prove their financial fitness. Some for-profit colleges, such as ITT Educational Services Inc., have previously warned that they may not be able to afford the federal government’s surety demands. For some schools, the demands could be onerous. The department is proposing to require an automatic surety based on each time a school breaches one of the government's list of triggers.

Apollo Education Group, owner of the University of Phoenix, said potential collateral demands in excess of 10 percent of its previous year’s federal aid haul would be a “burdensome condition” that could scuttle its planned sale of the school to a consortium of private equity buyers that includes Tony Miller, chief operating officer of the Vistria Group and a former Deputy Education Secretary during the Obama administration. No school disbursed more federal student loans last year than the University of Phoenix, federal data show. Its students collectively received more than $1.5 billion, or about double the second-largest recipient.

“The complex and burdensome nature of this regulation will crush career education with financial requirements not imposed on others in higher education—including institutions that have lower graduation rates and higher default rates,” Steve Gunderson, president of Career Education Colleges & Universities—the for-profit college industry's main lobby in Washington—said in a prepared statement.

Hicks thinks the next Corinthian could come soon, well before the Education Department finalizes its proposal. What's more, he thinks the proposal isn't strong enough to prevent a college's collapse—rather, it'll only reduce the government's eventual losses.

Several large for-profit colleges are selling off their campuses or shutting them down. Enrollment across the for-profit sector is plunging, and so are profits. ITT is strapped for cash and battling fraud lawsuits filed by three separate government agencies. Though the company reckons it has enough money to survive and maintains it has done nothing wrong, the Education Department and its accreditor are concerned enough that they have asked for financial guarantees and a detailed plan that would spell out an orderly wind-down.

In its proposal, the Education Department said that its experience with Corinthian “highlight[s] the need to develop more effective ways to identify events or conditions that signal impending financial problems.”

The department’s proposal at its earliest would take effect a year from now. For-profit colleges, which have sued the department to overturn other regulations, could challenge this one, too, prompting Hicks to ask, “Who knows if troubled schools will have gone under by the time the government declares that these standards are the ones schools have to live by?”

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