Rapidly deteriorating share prices; rampant short selling; abrupt quarterly declines in new customers, revenue and profits; proliferating federal and state investigations; multiple lawsuits; critical Congressional hearings and reports; executive resignations and replacements; proposals for significant new industry regulations; and endless talk of loan defaults.
No, this article is not about the mortgage finance industry or the Wall Street investment banking collapse -- although it could be. All these circumstances today surround an industry that for many people might conjure images of ivory towers rather than the steel and glass canyons of lower Manhattan: for-profit higher education.
Over the past three decades, for-profit colleges have designed and implemented a business model that propelled enrollment growth at six times the rate of other American universities. This outcome has occurred just as our economy demands that the U.S. produce significantly more workers with college credentials than we are now, and do so faster. To their credit, the for-profits have made a contribution to addressing our nation’s “graduation gridlock” by catering to the growing mass of working adult students, while traditional universities have made only modest efforts to accommodate them.
Even as public and private nonprofit colleges and universities have been cutting budgets, staff, faculty, classes, programs, and student resources -- and still losing money -- the for-profit sector has continued to grow enrollments and profits until very recently. It did so by focusing on education as a business, structuring educational offerings to focus on students as customers.
But when some forgot this principle and in fact exploited their students (as well as the American taxpayer), they began a process of killing their “golden goose." Today’s for-profit colleges have become captives, as well as beneficiaries, of the Wall Street money machines that created them. Many now find that their equity shareholders are turning their backs on them just when they need them the most -- a modern “live by the sword, die by the sword” parable. What has gone wrong for an industry that until recently was flourishing? Is the bloom indeed off the for-profit rose?
How They Got Here
The for-profits started with a clean slate in designing postsecondary degree programs without the baggage of academic systems or government structures that traditionally elevated academic policy (and faculty control) over business model considerations keyed to generating shareholder returns. They first created their own national accreditation bodies to vet their new educational models and thereby earn eligibility for federal education aid dollars, but then moved on to win approval by the 1990s for their nontraditional pedagogy by regional bodies that typically served as accreditors for traditional nonprofit private and state universities.
Despite their departures from traditional academic norms, the for-profits could thus show that they were accredited in exactly the same way as traditional colleges, which helped them win credibility with potential employers of their graduates. As a result, the sector grew enrollment tremendously over the past two decades among students eligible for federal financial aid. In turn, these students’ federally subsidized tuition dollars funded the robust, sophisticated marketing campaigns that have sustained the for-profits’ drive for even further enrollment increases to respond to their shareholders’ expectations for continued top- and bottom-line growth.
Meanwhile, stubborn and foolish resistance among traditional higher education institutions to online learning models also gave the for-profit sector a golden opportunity to capture a significant “first-mover advantage." The for-profits pushed hard to remove major regulatory barriers to the expansion of postsecondary education via the Internet. They won a huge victory in 2006 when Congress eliminated the prohibition against providing federal education aid to programs delivered more than 50 percent online. While the change applied to all colleges, the for-profits’ positive approach to Internet learning, contrasted with traditional institutions’ foot-dragging, generated big increases in online enrollment in the for-profit sector even into the teeth of the Great Recession of 2007-9.
This surge was further abetted by another federal rule change that expanded the limit on the amount of tuition funding that an eligible higher education institution could receive from federal resources to 90 percent. This deregulatory change significantly increased the U.S. taxpayers’ subsidy of higher education, for-profit style. Soon thereafter, The Financial Timesshowed how for-profits’ operating margins were surpassing those of even the government-funded defense industry. One example noted was the two-year-old Bridgepoint Education, which reported an 85 percent increase in quarter-over-quarter revenues after the tuition limit was lifted, with a 32 percent operating margin after spending $44 million on marketing but only $39 million on education and student support.
A related driver of nonprofit online growth was the federal decision to exempt military educational assistance programs from the 90 percent limit on federal tuition sourcing. A U.S. Senate report this month showed that 37 percent of the $4.4 billion in federal military education aid dollars in fiscal 2011 went to the for-profit sector.
For-profits deserve commendation for being enthusiastic “first responders” to the special learning needs and circumstances of active duty soldiers and veterans On the other hand, a New York Times front-page article last year asserted that some for-profit military education programs “have come at substantial taxpayer expense while often delivering dubious benefits to students” -- setting them up to default on untenable debts they cannot cover even with the jobs that their degrees will qualify them for.
The for-profit sector’s increasing profit margins are leveraged on a mountain of educational debt that mortgages an unsustainable proportion of for-profit students’ future income. Ninety-six percent of all for-profit students use loans to pay for school, compared with 64 percent at public and 72 percent at private colleges. According to the College Board, for-profit graduates with bachelor’s degrees carry an average indebtedness of $33,000 -- $13,000 more than public college graduates and $5,000 more than those finishing private colleges. The top recipients of federal student aid are all for-profit universities.
For-profit college students, however, are not profiting to the same extent. They are far more prone to default on their borrowings than students at other institutions of higher learning (perhaps because they are also less likely to finish their degrees). With 10 percent of higher education enrollment, they attract 25 percent of all federal aid dollars (including Pell grants, but also account for 25 percent of loan defaults and 44 percent of loan defaulters.
Loan defaults are truly a tragedy of the first order for students, especially for those who don’t manage to complete their degree. Those who default on student loans may have their wages and tax refunds garnisheed by the government, lose their credit standing, and be denied mortgages, car loans, credits cards, and even rental apartments and jobs. But defaults are also a tragedy for the U.S. taxpayer over the longer term.
Not surprisingly, high default rates among students at for-profit colleges have captured the attention of a Congress and executive branch focused on the federal deficit, since the taxpayer, not the institution, is on the hook for loans not repaid.
Regulators seized on the statutory requirement that colleges must achieve learning outcomes that enable graduates to find “gainful employment” sufficient to pay off their loans as a possible leverage point for disciplining for-profit marketing practices and pedagogical effectiveness. Officials cited anecdotal evidence that “boiler room" recruitment tactics and lax academic standards at some institutions have led to a waste of taxpayer money on student loans with dubious likelihood of repayment
With their federal tuition aid lifeline under attack, the for-profits used their ample resources to fight back, not with educational “3 Rs," but with what could be called a “3 Ls” strategy: $8 million in lobbying; litigation against proposed new federal rules; and phantom “loans” to students, direct from the institution but written off after they bring aggregate tuition funding under the 90 percent limit.
The final rules enforcing the “gainful employment” mandate adopted by the U.S. Department of Education in June 2011 turned out to be more lenient than the original draft,. For a college program to be disqualified from federal education aid, more than 65 percent of its students would have to be delinquent in repaying their loans, and its graduates would also show loan debts that comprise more than 30 percent of their discretionary income, or more than 12 percent of their total earnings -- in each case, for three out of four years running. Thus no programs can be disqualified from receiving federal student aid until at least 2015.
A perhaps more imaginative regulatory approach toward driving for-profit institutions toward a “best practice" model in recruitment and student retention practices would be to focus on the percentage of federally funded tuition that they spend on marketing as opposed to educating. The government surely has a legitimate interest in assuring that the bulk of its subsidies to the higher education sector are put to work in teaching and student support.
Just as the Affordable Care Act of 2010 has mandated a limit of 15 percent administrative expense for health insurance entities under certain federally subsidized coverage programs, Washington could look to setting a similar 15 percent limit on the amount of the 90 percent of government-funded tuition revenue maximum that for-profits (or any college, for that matter) can spend on advertising, call centers and other marketing activities. A sliding scale could be established with higher percentage limits applying for start-up institutions , and as dependence on federal subsidies decreases below 90 percent.
Such an approach would also level the playing field for nonprofit institutions (including community colleges and our own Golden Gate University) that appreciate the value of online platforms and also seek to serve the “working adult” and online markets the for-profits have captured, but without having to divert a massive share of tuition dollars to fund competitive marketing campaigns.
Because Golden Gate is routinely mistaken for a for-profit institution, given its focus on the same underserved higher education market, we have every interest in supporting whatever regulatory framework would clean up the excesses that have damaged the reputation of the for-profit sector.
The for-profits have up to now succeeded in keeping immense profits generated by their business model for themselves and their shareholders, while transferring the related student loan default risks to the U.S. taxpayer. If the subprime mortgage financial crisis taught us anything, it should be at least that this kind of separation of risk from reward is a particularly dangerous brand of economic alchemy.
Indeed, there is an eerie resemblance between practices at some for-profit schools and the subprime mortgage industry, not just in their common history of customer loan defaults, but also in their sophisticated telephone sales centers and aggressive marketing programs, which eat up almost as many federally subsidized tuition dollars as classroom and online instruction.
Some investment commentators have come to view the for-profit college industry as a clone of the subprime mortgage disaster zone. David Einhorn, a leading hedge fund guru, who correctly predicted Lehman Brothers’ financial collapse, specifically advised investors to “short” for-profit college stocks because of such similarities. This view paints with too broad a brush, but a reform agenda is nonetheless timely and essential.
For-profit lobbying and promotional organizations have insinuated that the U.S, Department of Education is actually allied with, and even doing the bidding of, the Wall Street analysts and short-sellers who have been highly critical of the shadier aspects of some of the sector’s business models. But even in a time rife with conspiracy theories, it smacks of desperation to suggest that the Obama administration is in cahoots with Wall Street speculators.
For-profit college managements should rein in their lobbyist and remember the names in the last business sector that tried to blame its regulatory and financial difficulties on the short-sellers: Lehman Brothers, Bear Stearns and Merrill Lynch, et al. That’s a whole bouquet of roses that clearly lost their bloom!
Last week, the College Board released its annual Trends in College Pricing report, finding that tuition at the nation’s public four-year colleges and universities had risen 6.6 percent, which is roughly equivalent to previous years but continues to far outstrip inflation and increases in family income.
Media coverage of college affordability almost invariably takes its cues from this report, focusing on the “sticker price” that colleges and universities charge students. But tuition alone is a relatively superficial measure that hides as much as it reveals, since it responds to changes in state allocations, political factors and fund raising success.
What has gone mostly undiscussed is escalating spending on college campuses across the country. A public discussion focused on tuition – the price of the education – gives institutions a free pass on how they spend the money they raise. Furthermore, this discussion reinforces the assumption that spending increases follow some sort of natural progression. But this is not the case. Spending can and must be contained if the price of college is to be brought under control.
This message is falling on deaf ears today in part because last year was a good state appropriations year for colleges and universities. But even in bad years, public institutions are raising spending. Today, higher education is a “seller’s market.” Demand for college has never been higher, and families are willing to take on dangerous amounts of debt to get their children through.
However, the willingness of families to reach deeper into their pockets is reaching a breaking point. Recent polling by my organization, the National Center for Public Policy and Higher Education, and Public Agenda shows that the public is concerned about how colleges and universities spend their money. Most Americans (83 percent) believe that today’s colleges should be doing a much better job of keeping their costs down. More than two out of three (68 percent) believe that colleges and universities could reduce their costs without hurting the quality of the institutions.
The American public is onto something. But many institutional leaders have not been willing to look under the hood of higher education expenditures. Typically, leaders have used a range of excuses to deflect questions about spending. Some common excuses, and my responses to them, follow:
Increases in tuition reflect the high demand for postsecondary education and financial aid keeps the net cost to families under control. Public college and university leaders think there is no crisis in higher education so long as there are students and families willing to pay. But tuitions at four-year public institutions have risen 22 percent in the past five years, after adjusting for inflation, while family incomes have increased only 8 percent. What’s more, need-based financial aid is not keeping up with increases in tuition, pricing many poor families out of higher education. Continual price hikes may respond to market forces, but do not honor the public mission of state colleges and universities.
Higher education is a labor-intensive industry and faculty salaries and health care costs are behind most of the recent run-up in spending. Because institutions use humans to pass on knowledge, historically a greater proportion of their budgets have gone to salaries and benefits than in other industries. But this is not where most of the spending growth is occurring. Faculty salaries have barely kept up with inflation for the past 10 years. Last year, faculty salaries rose on average 1.3 percent after adjusting for inflation – the first inflation-adjusted increase since 2003-2004. In addition, the use of cheaper part-time faculty is growing fast, now making up 48 percent of all faculty, according to the American Association of University Professors. On the other hand, universities are spending huge amounts of money on construction – for new dorms, new athletic facilities, and new student centers– as part of an “amenities arms race.” And administrative overhead at many universities has ballooned, due to an explosion in niche student services and fund raising apparatuses. It is doubtful that these developments have improved student learning.
There is great competition for applicants nowadays, and we have to spend to compete for the best students. This is probably the most common excuse offered by leaders at state flagship universities, but they are not referring to competition with other state institutions. Rather, leaders at public research universities are increasingly viewing themselves as competitors with private research universities such as Duke and Stanford, or even Ivy League institutions. These leaders feel that they can only “compete” if they offer the same amenities and practice the same aggressive recruitment tactics, including lavish merit aid for high performing students, which takes resources away from low-income students. Instead, they should refocus on their educational mission, and the advantage that public institutions have always had: the availability of need-based financial aid and the opportunity for a great education. Prospective students seeking high quality education at low cost will be smart enough to know the difference between style and substance.
There’s no political incentive to take on cost containment. Most institutional leaders don’t want to touch this issue because it almost inevitably leads to faculty concerns that they will be expected to do more for less. Faculty will revolt, if “cost containment” means across-the-board budget cuts. In cases where institutional leaders have contained spending and reinvested savings in teaching and learning, faculty have been very supportive. The University System of Maryland is a case in point. Chancellor William E. (Brit) Kirwan got faculty support for the Effectiveness and Efficiency Initiative, which identified areas for cost savings and redirected those savings toward priorities such as increasing enrollment capacity, containing tuition increases, and improving academic programs and services for students. Even though faculty teaching loads increased 10 percent, faculty largely supported the measure, because it was focused on improving student learning.
At the state level, lawmakers and system heads don’t want to engage cost because it requires a restructuring of higher education finance. States base appropriations on students enrolled, which encourages spending on amenities and recruitment -- not students graduating.
Where there have been incentives, universities have proven capable of cost management. In the 1990s, the Illinois Board of Higher Education established the Priorities, Quality, and Productivity initiative, which re-evaluated all academic programs with an eye to institutional priorities. Elimination of duplicative programs, technology enhancements, and administrative streamlining resulted in savings averaging $36 million annually. As at Maryland, faculty came to support PQP because the savings generated were reinvested in instruction. These funds were most often used to reduce class size and reliance on graduate teaching assistants; support minority student achievement; improve technology; and expand need-based financial aid.
My hands are tied, because the biggest decisions are made at the state level. Big decisions about allocations are made at the state level, but institutional leaders have a lot of discretion about how that money is spent. While there aren’t many incentives for cost containment now, there also isn’t much oversight of spending requests. Institutional leaders have lots of room to maneuver on this issue.
Cutting spending hits disadvantaged students hardest. Cutting spending only hits disadvantaged students hardest if need-based financial aid is the first target. In fact, cost containment, if it focuses (as it should) on increasing instructional spending, boosting degree completion, and streamlining administrative processes, can make public higher education work much better for disadvantaged students. That is because these are the students most likely to have trouble completing degrees and to have the most interaction with administrative offices.
There is another major reason why colleges are not acting on this agenda. There is too little data about how spending impacts learning. In contrast to business or the military, how inputs affect outputs is poorly understood in higher education. New research being conducted by the Delta Project for Postsecondary Costs to be released next year will set the basis for looking at the relationship between spending and student success.
But the lack of data is no barrier for action. We don’t need to wait for longitudinal studies to know that more spending on full-time faculty and need-based financial aid will impact student learning more than a glitzy new dorm.
Taking a hard look at the evidence shows that it is time to focus on college spending patterns and that there is a lot college leaders can do right now to contain the spending that drives up college prices. Many of the problems originate at the state level, but bold leaders will take action regardless of incentive structures and political rewards. It is time to expect more of college and university leaders than we do now.
Patrick M. Callan
Patrick M. Callan is president of the National Center for Public Policy and Higher Education.