The Higher Education Bubble

2 Comments

I recently had a conversation with a co-worker about the current state of the U.S. economy. This is always a fun topic, as he is working on his master’s in economics and is pretty well-read in the subject. After a long, serpentine discussion on the Gramm–Leach–Bliley Act and complex derivatives, our conversation happened upon the collapse of the internet and housing “bubbles” in the late ’90s and early 2000′s and their role in the current economic challenges. This topic prompted me to cite an article1 I had read that week referring to a potential “higher education bubble” in the United States. After much discussion, my coworker and I decided that a higher education bubble probably does exist in some form. Upon that discovery, our discussion turned to why that bubble might exist and ways to avoid having that bubble burst in your own life. That conversation led me to do a little bit of research. Here is a short compilation of my thoughts coming out of that conversation and what I’ve found thus far. This post will be made in 2 parts, the first of which will make the case for a “bubble” and the second of which will provide means of avoiding the bubble.

What’s a “Bubble?”

For a long time, I didn’t have a strong grasp of what exactly was meant by an economic “bubbles.” If you’re in that situation, it’s a pretty simple concept (at least as I understand it). The basic idea is that a “bubble” is created when large volumes of a particular good or service are sold/traded at prices that are much higher than they should be. Buyers/investors during the .com and housing bubbles were working under the assumption that internet startups and homes were worth the money they were paying for/investing in them. This assumption was supported by the thousands of similar transactions taking place around them. When the “bubbles burst” in the late 90′s and early 2000′s, the values of assets (shares in .com companies and homes) fell drastically. In some cases, this left buyers/investors with no value at all or negative value (more debt than equity). In retrospect, economists say the “intrinsic” or “real” value of these assets was much lower than the amount paid for them. This was due to a number of factors which I will not even attempt to begin delineating. The short of it is, there were “bubbles,” they “burst,” and thousands of people were out thousands of dollars.

To illustrate, let’s suppose an investor put $100,000 of his own cash into Pets.com back in 1999 for shares of stock/ownership. The fact that he was one of thousands of investors doing the same thing made it seem quite the reasonable thing to do. At some point shortly after that investment, the company discovered it had a non-existent business model and was selling pet supplies for less than it cost to buy them and ship them. The company went bankrupt and was dissolved…and those stocks are now worth $0. Thankfully, the investor does not have any debt and therefore must simply eat the loss. Sadly, he same is not true for a hypothetical couple who purchased a home in 2001 with a $250,000 loan. Everyone else in the neighborhood was getting their homes at a similar price, so why not? However, the massive demand for housing and the ridiculous availability of credit had pushed the home to that price from an actual value of $180,000 one years before. When the “bubble burst,” the home dropped back to its actual value. Now, even if the couple is able to sell the house for its full value of $180,000, they’d have to find $70,000 in cash to pay off the rest of the loan. They have negative equity…and are “underwater” or “upside down” on their mortgage.

Economic bubbles can ruin the best plans and intentions, and often come as a surprise since so many people made the same decision. So, is there a higher education bubble? Are hundreds or thousands of people paying more for college than they should be? I think there might be…in some circumstances. Why? Well, here are some “findings.” Hopefully they will help you get an idea of the current situation.

The Education “Bubble”

Apart from intangible benefits (the “friends” I’ll have for life that I met there), the intrinsic value of a college degree is determined by how much money the degree allows an individual to earn than he or she would otherwise not earn without it. Basically, using our house example, it’s the degree’s “resale value.” The question at hand, then, is whether the amount paid for a college degree exceeds the amount of money that will be earned by obtaining that degree. To make a fair evaluation, those numbers must be determined. That, however, is a sticky calculation fit for an actual economist. As I am not one, I’m going to use some average numbers I found from a number of varied sources to try to get a rough idea of what the actual numbers might look like.

So, how much does college actually cost?

The tuition costs alone to attend college span a vast array of possible numbers depending on the type of school, its reputation, the student’s residency status, and a number of other factors. The College Board website cites numbers ranging from a few thousand dollars a year for a public, 2-year school to upwards of $40,000 a year for a private, nonprofit school. However, tuition is just the beginning of the equation. One has to add in room and board for on or off-campus living, book costs, student fees, moving expenses, transportation costs to-and-from campus, parking, and, of course, ramen noodles. Also, as I’m sure my aspiring economist friend would tell me, one must factor in the opportunity cost of the wages missed out on due to spending one’s time in a classroom instead of in a job. When it comes down to it, there’s not an easily-determined across-the-board number to represent the cost of college. However, there is a number available that I believe is usable for this particular endeavor.

A CNN article2 last fall cited numbers provided by the Project on Student Debt12 showing that the average college student pursuing a bachelor’s degree at a public or nonprofit private college or university graduates with $24,000 in student loan debt. This sounds about right given the average tuition numbers cited by The College Board9 and the ratios of public to private to 2-year students given by the National Center for Educational Statistics10. Though it may not include many of the aforementioned factors, this number provides a somewhat startling picture of how college costs can affect a graduate long after a degree has been obtained. I will use this number moving forward as a reference for argument’s sake.

What is the value of a college degree?
Now that we’ve gotten a rough idea of the cost burden of college on a recent graduate, we can contrast this $24,000 number with a New York Times article from last month3 that cites a Rutgers University study8 that found the average college student graduating with a Bachelor’s degree earns just $27,000 annually in their first job. This number may surprise some (though not me…my first job out of college wasn’t too far from there) given the oft-quoted Bureau of Labor Statistics number which states that Bachelors Degree holders make, on average, around $1,000 a week ($52,000/yr). However, given that the Census Bureau11 reported the average age of Americans being 36.8 in 2009, the $52,000 number is slanted towards a mid-career holder of a bachelor’s degree.

So, graduates make $27,000, right? Well, this assumes that all graduates immediately find jobs. The Bureau of Labor Statistics reported last year4 that the unemployment rate among all people with Bachelor’s degrees is 5.5%. Comparatively, the aforementioned CNN article2 pegged the rate among recent graduates at 8.7% in 2009. I would venture a guess that it is higher now, given that in the UK, it’s currently at 20% 5,6,7. When all these things are considered, the argument for an education bubble begins to take shape.

Where does this leave us?

I don’t currently plan on doing any net present-value calculations to provide an actual number for comparison, but I think these rough numbers send a strong message. It’s hard to get rid of $24,000 in debt making $27,000 a year. Whether we like it or not, market forces have combined in such a way that the value of an undergraduate degree just isn’t what it used to be. Simultaneously, the cost of one continues to increase. So, should you abandon college altogether? Well, the main redeeming factor is that things are worse for those who don’t have a college degree. That same Bureau of Labor Statistics report4 shows that, on average, unemployment nearly doubles and wages are cut in half for those without a degree. I tend to browse the job markets a good bit just to keep apprised of what’s out there, and it’s hard to find a job that doesn’t require at least some college. So, the looming questions are “Can I get a college degree, but still avoid the bubble?” and “If so, how?” Well, those are pretty open-ended question…and I’ll be attempting to tackle it in my next post, so check back soon!

Sources

1 http://www.usnews.com/education/blogs/the-college-solution/2011/05/03/higher-education-bubble-will-burst
2http://money.cnn.com/2010/10/22/pf/college/student_loan_debt/index.htm
3http://www.nytimes.com/2011/05/19/business/economy/19grads.html
4http://www.bls.gov/emp/ep_chart_001.htm
5http://www.telegraph.co.uk/education/educationnews/8283862/Graduate-unemployment-hits-15-year-high.html
6http://www.guardian.co.uk/education/2011/jan/26/fifth-graduates-unemployed-ons
7http://www.bbc.co.uk/news/education-12286264
8http://www.heldrich.rutgers.edu/sites/default/files/content/Work_Trends_May_2011.pd
9http://www.collegeboard.com/student/pay/add-it-up/4494.html
10http://nces.ed.gov/fastfacts/display.asp?id=372
11http://factfinder.census.gov/servlet/STTable?_bm=y&-geo_id=01000US&-qr_name=ACS_2009_1YR_G00_S0101&-ds_name=ACS_2009_1YR_G00_&-_lang=en&-redoLog=false&-state=st&-CONTEXT=st
12http://projectonstudentdebt.org/

 

2 Comments (+add yours?)

  1. Adam Smith
    Jul 20, 2011 @ 00:50:50

    Chiming in with my own 2c about the debt-vs-reward tradeoff of a degree. There is a wealth of attention and information on the subject right now, particularly as it relates to professional training schools and for-profit colleges. The basic conclusion I’ve heard is that it’s not so important what the average bachelor’s degree holder makes, or borrows; the real issue is what you’re going to school for. As for-profit colleges are about twice as expensive as public in-state tuition, and often provide degrees not seen as equally valuable, students who have been affected by the economic downturn have sought out higher education at inflated cost. These are the people who will be affected most by any bubble in the education lending market.

    The ones affected least will be students attending public and private universities seeking degrees in Math, Science, Engineering, etc. Hopefully Economics as well, haha.

    It’s scary when you see predatory lending in the education market reflecting the kind of predatory lending on the mortgage market that is largely blamed for our current economic burden.

    Reply

  2. Bill Nabors
    Jul 20, 2011 @ 09:41:48

    Interesting post. One additional thing to think about is that the salary information is skewed. The portion of the population that pursues higher education tends to be more driven and intelligent than those who do not. Even without college, this population would likely be more successful than averaghe. I am not against higher education in general, as I have 8 years of college education, but increasingly people enter programs to “get their degree” without consideration of cost/benefit. Higher education is an investment and should be analyze as one. The benefits to this calculation can include things besides a higher paycheck, such as friends, life experiences, etc.

    Reply

Leave a Reply