Lending bubble has produced student debt crisis

One of the reasons imperial China was stable and successful for thousands of years was the tradition of meritocracy among the bureaucrats who ran its far-flung empire. Bureaucrats were chosen by taking a high-stakes standardized test that included esoteric Confucian philosophy, literature and poetry.

It was not uncommon for students to study for 20 years to have a reasonable chance at passing the exam. Families invested in tutors and private schools to increase their sons' chance at passing. Still, typically the vast majority failed.

All of this might seem painfully familiar to generations of American students that collectively spend hundreds of billions of dollars to get a college degree and with it they hope a golden ticket to the middle class. That ticket is getting a lot more expensive.

The cost of college is rising at double the rate of health care costs. According to the National Center for Education Statistics, the total cost per year of college at a 4-year institution went from $5,500 in 1985 to $28,000 in 2018. Even after adjusting for inflation that is more than doubling. Why has the price of college gone up so much?

One incorrect answer is that government spending has declined. According to the Urban Institute state and local government spending has gone up 180% since 1977. Federal outlays have grown even faster. The total cost of colleges and universities is over $1 trillion. If we were spending the same per student as in 1985, after adjusting for inflation, that number would be only $485 billion. Total government spending on higher education is already $450 billion.

The true culprit for the rise in college costs is government-guaranteed loans. In "Indentured Students: How Government-Guaranteed Loans Left Generations Drowning in College Debt," Elizabeth Tandy Shermer recounts the last century of federal government intervention in the higher education loan market and its baleful unintended consequences.

Her work is a damning historical case against government loans. She writes, "[President Lyndon Johnson] particularly liked guaranteed lending because government accounting practices at the time hid ... how expensive this form of tuition assistance would be." Subsidizing something will get you more of it, and using borrowed money as the lever for subsidy hides the true cost from students, parents and the broader society.

For colleges, the logic of skyrocketing costs is a compelling illustration of basic economics. Every college and university has an infinite supply of good things to spend money on: new dorms, more research, higher staff salaries, etc. So simply giving a college more money doesn't produce any reason for total tuition costs have no reason to go down. It doesn't change what families are willing to pay. The new dorm gets built, tuition inexorably rises.

In fact, for students, a high sticker price for a school might not be a reason to look elsewhere. With lenders ready to loan any amount, a high price might make the school more attractive. As Prof. Shermer notes, "Students conflated higher price tags with the prestige necessary for landing lucrative positions and being accepted into top professional and graduate programs."

Few teenagers have the foresight to imagine the impact of debt decades in the future. Since easy loans have made students and parents less price sensitive, colleges are further incentivized to raise prices to attract students based on amenities, name recognition and prestige, further driving tuition increases.

For years, this financial bubble in education has seemed poised to pop, just as the housing bubble (also fueled by cheap, easy loans) popped in 2008. But Song Dynasty China showed that when a rich society is dedicated to preserving a system, bubbles can persist — for years, decades or even centuries.

Justin Merritt is a professor of music at St. Olaf College in Northfield. He will lead a virtual conversation with Elizabeth Shermer on Oct. 20 at 7 p.m. More information can be found at institute.stolaf.edu.