Dr. P.V. Viswanath
The Coming College Education Bubble
Jerry Bowyer, December 16, 2010, Forbes.com
The overwhelming cultural consensus of the post-WWII generation was that if you are middle-class, then you simply must own your own home and your children must go to college. Out of that cultural consensus emerged a complex system of tax breaks and special lending deals designed to make sure that the number of Americans who bought houses and bachelor's degrees was as high as possible--or maybe more so.
Many people now understand that this system of tax-and-lend has created a multigenerational housing bubble. But only a few have noticed that a very similar tax-and-lend system has also created a multi-generational higher education bubble.
Bubbles arise in nature when some sort of film, bolstered by surface tension, contains a pocket of air under greater pressure than the general atmosphere. Bubbles arise in markets when some factor external to the market (usually tax engineering or a regulatory mandate) creates a pocket of concentrated capital in which asset prices rise well above levels that can be justified by the assets' underlying value.
So, the recipe for an asset bubble is one part social engineering, one part easy money. In recent years we've seen a tech bubble form and burst, a housing bubble form and burst, and a higher education bubble form but not yet burst. But just because it didn't burst yet, doesn't mean it's not a bubble.
Higher education shows every reasonable sign of having a completely unrealistic, astronomical price tag. Beyond that, the sacred cow psychology that commonly accompanies other mania is clearly present.
Over the past year I've invited some of the fiercest critics of higher education finance onto the radio to discuss the problems with college. Numerous authors have minutely detailed the dangers to college consumers: the price tag is too high; the lending is too lax; the product is too low-quality; the socialization process is too coarsening; the parents are kept too much in the dark; the earning advantages are too aggressively touted; the alternatives are too cheap.
And yet, when I asked these critics whether it was worth it any longer, some of the harshest of them still piously genuflected to the college altar and rebutted the idea that higher education had entered a bubble phase. What greater sentiment indicator could there be? It reminded me of one of those third-world dictatorships where even the opposition candidates effusively praise the virtues of the glorious leader against whom they run.
But the financial data are making a college education tougher and tougher to defend. If we were to follow the lead of college marketing departments and treat tuition as an investment, what price-earnings ratio--or P/E--would we assign to it? Unlike a traditional stock, both the price and the earnings are fairly opaque (a warning signal in and of itself), but let's make some ballpark assumptions. A typical private school charges about $25,000 per year; the typical public school about half to a quarter of that, depending on residence.
On average it takes six years to finish college nowadays. That's because students increasingly are dropping classes late in the term in order to avoid failing grades--dropping out of a class does not mean they avoid tuition costs on the class. So, hard cost for a college degree is roughly $150,000 for a private school and a little less than $50,000 for public (depending on residency discounts).
But that's not the only cost: Students are foregoing six years of full-time income for their six years of full-time education. Let's say an average of $10 per hour (something like $8/hour right out of high school, trending toward $12/hour after six years' work), which comes out to $20,000 dollars per year, which is $120,000 over six years. Add that opportunity cost to our hard cost and we get $270,000 to $170,000. Let's just make it an even $200,000 and keep the numbers round and the nitpickers mollified. That's the P.
Then what's the E? It should not be total earnings, because non-college grads can still earn. The E is the difference in earnings the young person will earn, having gone to college, and the amount that she would have earned had she not gone.
This, by the way, is not the same thing as the difference between average college grad income and average non-college grad income. That would not be a fair comparison after all, since on average college enrollees are prescreened for intellect and ambition.
So not all of the (roughly) $4,600 initial per-year after-tax income gap between grads and non-grads is due to the value of a college education. A lot of it is due to the drive/ambition premium.
Richard Vedder, probably the leading expert on the economics of higher education, told me he believes roughly two-thirds of that earning advantage comes from the character and intelligence of the earner herself, and not what she bought from school. Let's generously and roundly assign the initial E from college a value of $2,000.
Voilá, our P/E is 100. Is that a good deal? Not really. Even if one argues that the difference, the College E, grows over time, so what? So do stock earnings. If you think that the E grows quickly over time, then you can think of a degree as a growth stock and compare a 100 P/E to that. It still doesn't look very attractive.
And let's keep something very important in mind: A college education contains a risk factor that no stock or bond does: zero liquidity. For good or for ill, you're stuck with it. You can sell a security back to the market, but you can't sell your degree back. Every college in the country hangs out the same invisible sign: No Refunds.
And things are only going to get worse. To call the policy drift of the Obama administration pro-college is an understatement. College is becoming the new high school, and the recent nationalization of secondary education financing affords a policy lever through which capital can be shoe-horned toward the only industry in which our president worked for an appreciable span of his life.
Progressivity of income tax rates only shrinks the College E differential. And, most troubling of all, so far the data on the current recovery indicate that a college degree is dropping in employment value relative to the alternative. Perhaps the alleged intangible benefits of a degree--status, socialization and sophistication--can outweigh the increasingly heavy costs, but taken as an economic proposition, a college degree is looking more and more like Nasdaq circa 1999, or Nevada housing circa 2007. Caveat emptor.
Jerry Bowyer is a CNBC contributor and author of the upcoming Free Market Capitalist's Survival Guide.