Summary: The easy access to cheap federal financing has created a tuition bubble. The cost of tuition is not tied to it's true value or the real costs of educating students, but to the massive demand for education which has been inflated by federal programs.
I've railed several times against the cost of education, especially graduate education. I'm convinced that tuition and state funding are tied to manipulated supply and demand curves rather than the actual cost of service. Unfortunately, since schools are mini government bureaucracies, the expenses tend to rise to or above the revenue.
There has been a recent hub-bub about subsidized student loan rates going up (the reductions are expiring). Allowing these rates to return to 6.4% is seen as an assault on students and the poor/middle class families many of them come from. I recognize that the immediate effects of a rate hike can be nasty, especially on those students who pay their interest payments during school. However, I would like to focus on students entering school in 2014.
Let's assume that President Obama or Romney decide to extend these lower rates into 2016. Also assume that President Obama takes other measures to ensure access to government loans and more affordable education through grants and other financial instruments.
The direct effect of rate reductions is to make leveraging your future wages more affordable. The interest costs of $50,000 in student loans are $266.67 per month at 6.4% and $141.67 per month at 3.4%. That $125 a month in savings would pay your electric bill or your car insurance.
The indirect of rate reductions, however, is to increase the demand for education at expensive institutions. (The rate changes won't affect demand at cheap colleges as much because the savings will not be as significant). Furthermore, the effect of easy access to financing in addition to a rate reduction is to explode the demand for education.
For example, there is no way I could have personally financed my legal education, and private loans seemed insane to me. The easy access to federal loans and great consolidation programs provided just enough security for me to invest so heavily in education. I added up all the loans I would need and figured out what the payments would be in the future. Then I decided whether my probable income as a lawyer would be sufficient to cover the lifestyle I wanted, retirement (ha!) and the loan payments. Because of the semi-affordable (yet soul crushing) interest rates, I decided that it was a worthwhile investment.
But what if the rates were high, or if the schools required a massive down payment? Or what if every student loan required four co-signers? Demand for education would drop. Universities would be left with a few options: 1) Raise tuition on those who can pay (not likely to work for lower ranked universities); 2) cut costs and drop tuition; 3) Beg the state for more money; or 4) cut costs, keep tuition the same, and have less students.
If option 1 happened, you'd inevitably see more low-end competitors dropping prices. Better students would opt for lower ranked institutions, and more employers would hire from lower ranked institutions, and those institutions would suddenly rise in the rankings. Alternatively, employers would be forced to hire workers who were not as educated or finance the education of their employees. Professional and technical schools would quickly begin to take a greater share of the market. Additionally, you'd see degrees that do not generate significant income either vanish or become much cheaper. (Why in the world does an english degree cost the same amount as a organic chemistry or computer science degree?) Liberal arts education might suffer, but much of this education could now be done online.
If option 2 happened, then the more expensive financing options would be offset by lower tuition costs. Anyone who has ever gone to a major university knows that money is wasted like crazy. Tuition, donations, and state funding are all hogged up with ravenous hunger, and trust funds continue to grow regardless of waste and luxury. If the numerous "non-profit" schools could somehow tie tuition to actual cost of education, you'd see the market work much more effectively.
Option 3 is a no-go at this point, but some states might do it. I think it would be insane.
Option 4 would probably be fine as well. Education is wonderful, but it's not as restricted as it used to be. You can access free Harvard and MIT lectures on a number of websites. Obviously the information is valuable, but institutions charge for the degree, not the information. A fancy school degree is great primarily because employers hire students with fancy degrees. The quality of education at cheaper institutions is often very high (depending on the quality of the student). If a prospective employer wanted you to take 6 credits of math, science, and foreign language, they could require all applicants to possess it. If society benefited greatly from a well-rounded education, then charities, states, and donors could supplement the "less practical" fields.
So while I understand that there are drawbacks to options 1-4, I think they are necessary to make the cost of formal education more closely resemble it's true value. You'll hear thousands of people whining about student loan interest rates and an "unfair deal", but I doubt they've really thought through the ramifications of federal interference in the education market.
Consider an additional example in the legal field. There are several Tier 4 law schools (presumed to be ranked below 130 in the nation) with tuition levels every bit as high as the top 14 law schools. There is a high demand for these low end schools because there are plenty of students with average LSAT scores and GPAs who cannot gain admission to Harvard or Yale. In most areas, the lower quality products are cheaper because everyone has access to the higher quality stuff and the price point determines whether they will buy a particular good. (Demand on goods is rarely lower than supply, but there are exceptions like nintendo wiis and iphones.)
Harvard and Yale's high rankings are primarily due to prestige, which attracts the best teachers and students. (I'll write about how rankings are driven by student quality (aka employer demand) later). As a result of the high student quality and high ranking, most ivy educated law students get good jobs, and the investment pays off. However, a high percentage of tier 4 law students end up wasting a ton of time and money because there are more students than jobs.
So why do so many people risk so much to go to crappy schools and face a 50/50 shot of never being a lawyer? Human Nature. Humans are far more eager to risk future gains than sacrifice current money. If you required a $50,000 down payment in cash to go to a T4 school, almost nobody would go. But when you spread out the 100,000-150,000 in loans over 25 years, many students figure they are the exception, and the "investment" is worth the risk.
Now read through that again and see if you agree with me on how ludicrous it is. In what industry can you obtain the same level of financing regardless of product quality or reasonable rate of return? If you can prove you can pay the payment, you can probably get 500k in financing for a 550k home. But you can't get 500k in financing for a 250k home. The truth is, most private lenders would never invest money in a tier 4 law student unless they could come up with a true business plan for how they were going to make money. Only the government would apply funds so recklessly... they can get current voters by offering great "education" reforms, and then they'll be long out of office before the taxpayers get nailed with the billions (or trillions) in defaulted loans.
Reducing the rates is a grant... and the grant is applied evenly regardless of merit. Why subsidize all programs the same? And why subsidize all students the same? If you want to give a grant because a student is poor, then do that. If you want to give a grant because the student is exceptional, then do that. But don't pretend that lower student loan rates are good for anyone in this insane economy.
