How For-Profit Colleges Are Like Subprime Mortgages

How For-Profit Colleges Are Like Subprime Mortgages
Report: Both Subprime-Mortgage Business and For-Profit Colleges Are Built on Giving Loans to People Who Can't Pay Them Back
By MARK GIMEIN - ABC News - 6/19/2010 - original
Ashford University of Clinton, Iowa traces its beginnings all the way back to the end of World War I a fact underlined for visitors to its Web site by the proud "Founded 1918" that hangs off the bottom of the school's logo.

It's an extraordinary and improbable record of longevity. Ninety-nine percent of Ashford's classes are online, yet its founding precedes the birth of the Web by about 75 years. For a 92-year-old school, Ashford is conspicuously obscure. You won't find it in any of the lists of best colleges, though Peterson's college guide does note its "24 acre small town campus with easy access to Chicago."

In the world of for-profit education, though, Ashford is less obscure: It's one of the most incredible growth stories of the past decade. In 2005, a startup company called Bridgepoint Education Inc. (BPI) spent $9 million to buy a struggling 332-student religious school, the Jesuit University of the Prairie, from the Sisters of St. Francis. BPI renamed it Ashford. Now Ashford, together with the University of the Rockies (another tiny school, the former 75-student Colorado School of Professional Psychology, which BPE bought in 2007) enrolls more than 65,000 students.

Last year, BPE's two school took in $454 million in tuition and fees from its students. If Ashford's academic reputation has not grown as fast as its enrollment, it is no surprise, considering where all that money went: $145 million was spent on marketing and recruitment, which is $25 million more than the colleges spent on instruction.

As striking as how little of Ashford's money is spent on education is how much of it comes from government grants and federally backed loans. 85 percent of BPI's $454 million in revenue last year was funded with federal student aid.

Even among for-profit schools, Ashford's growth is exceptional. But Ashford's basic formula of pulling in federal aid dollars and using them to market to ever-more students, however, is much like the template for the entire for-profit higher-education industry. Extolled as a free-market solution to rising education costs, schools like Ashford have instead turned into a study in how to repurpose public resources for private gain.

BPE, Ashford's parent company, is one of several corporations featured in a striking report from the investor Steve Eisman. Eisman is well known from Michael Lewis's The Big Short for having anticipated the subprime crash. Now Eisman has turned his attention to for-profit education. He's catalogued how federal education aid is now funneled to for-profit schools that have delivered stellar profits to their owners and dismal graduation rates for students while leaving taxpayers with a bill for billions of dollars in defaulted student loans.

Over the past year, there have been reporters, such as Daniel Golden at Bloomberg, who've done extraordinary work detailing the abuses of the for-profit education sector. What Eisman brings to the table is a wealth of data and a well-trained eye for the economic underpinnings of the industry and the striking ways in which it resembles the failed subprime loan business.

How is for-profit education like subprime mortgages? Three points stand out in Eisman's report:

* Both the subprime-mortgage business and for-profit colleges are built on giving loans to people who can't pay them back. Just as the housing boom was fueled by bad mortgages that could be sold to Fannie Mae and private investors, the for-profit education boom relies on students taking on debt that is guaranteed by the federal government even when students have little realistic hope of repaying it. As Eisman showed in an extraordinary presentation for investors, federal aid mainly loans is essentially the sole driver of the for-profit education industry.

The 85 percent of revenue that Ashford gets from federal education programs (it gets another 5 percent from military scholarships like many such schools, it vigorously recruits soldiers and veterans) puts it in the middle of the pack. At the Apollo Group, the owner of the University of Phoenix, government aid pays 90 percent of tuition.

Because the federal loans that students take out are guaranteed by the government, colleges and lenders don't need to worry about whether they are repaid. The Education Department monitors student-loan default rates for two years after students leave school; for-profit colleges make sure that even students who can't pay fill out deferment or forbearance forms to keep the numbers in line. After that, the former students are on their own, and things get worse fast. Eisman estimates the default rate after three years at Corinthian Colleges, a 105,000-student for-profit school group, at a startling 41 percent.

* On the ground floor of both the mortgage and for-profit college business, growth is driven by bonuses to marketers. The role that mortgage brokers and bank account representatives played in the subprime business is held by recruiters in the for-profit education business.

In his presentation for investors, Eisman traces how the for-profit business took off when rules on recruiter compensation were loosened in 2001. What's more, he catalogues what happened to the officials in the Bush administration Education Department who made that happen and then became lobbyists for the for-profit college industry.

At the end of last year, BPI had 1,175 recruiters responsible for drumming up business. The company plainly discloses in its annual report that it sets tuition (currently $7,860 a year) to stay within the loan limits of Title IV, the regulations governing financial aid. One Ashford recruiter Eisman quotes is more blunt: "They conveniently price tuition at the exact amount a student can qualify for in federal loan money. If a person has money available for school, Ashford finds a way to go after them. It's a boiler room, selling education to people who really don't want it."

* Just like the subprime crisis, for-profit education is a slow-moving nightmare, eating up more and more incremental education aid dollars year by year. For-profit colleges are by far the fastest-growing sector of education, with Education Department data showing enrollment going from 364,000 to 1,469,000 in the decade from 1998 to 2008.

But if the growth in students has been great, the growth in the volume of federal aid dollars that for-profit education takes in is far greater. For-profit schools now enroll 8 percent of students but as Eisman's report shows, they take in a full 24 percent of federal student aid. Given the rate of student-loan defaults at for-profit schools, Eisman estimates that if they are to keep growing at the present rate, by 2020, students at for-profits will have defaulted on $275 billion in federally backed loans, and a cost to the government of $330 billion.

Numbers like that do get folks attention, even in these days when the country has gotten almost used to multibillion-dollar bailouts. There is some good news on the horizon. The Education Department is considering new rules that would clamp down on how college recruiters are paid and put some limits on tuition, based on the salaries graduates could expect. In the short term, Eisman thinks this will seriously cut into the industry's profit margins. But he says that they'll just slow, not stop, the growth of the business.

In an interview, Eisman advocated a far more dramatic step to rein in the industry. It's driven by simple economics and would get to the core of the issue. Right now, colleges bear none of the risk of defaulted loans. It's the same separation of risk and reward that Eisman saw in the subprime industry. The solution he'd advocate is simply making the colleges pay back the government a share as much as 50 percent of the loans that go back. "They're so profitable," says Eisman, "they can afford it."

Or, more directly, as Eisman puts it: "Let 'em eat it." That's a solution to the for-profit education bubble that's both simpler and more drastic than any of the regulatory changes being considered.

It's also a solution that should be an easy one for anyone who might genuinely believes in the role of for-profits in education. As it stands now, for-profit schools are one of the economy's embarrassments for believers in free markets. They have every incentive to skimp on the costs of education (recall how little Ashford spends on instruction) while collecting as much they can in tuition by encouraging students to max out their loans. Making them share the risks of those education loans makes them responsible for their failures. If you want for-profits to deliver a better profit, it's the natural free-market approach.

For the moment, though, that's a nonstarter. Legislatures remain filled with ex-lobbyists and future lobbyists for the industry. (As Eisman points out, a former chief lobbyist for the Apollo Group is now a top congressional education policy staffer). What's more, as enrollment grows and for-profit schools grow ever more ubiquitous Wal-Mart (WMT) just announced a partnership with one that will give its employees degrees in fields like "retail management" their political base grows.

In this way, too, you might say that for-profit education is a lot like subprime: At some point we'll get to the rational solution. Just don't count on it happening before the taxpayers are already staring at epic losses.

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