The title of the post is drawn from today’s front-page NYT article by Andrew Martin, subtitled “Degrees of debt, a reckoning for colleges.” It’s the sixth part in a sobering series on college costs and debt – earlier articles mostly focused on the personal debt taken on by students and their parents, while this one focuses on universities borrowing for buildings and other capital expenditures.
The earlier articles focused on the availability of up-front money to parents and students to finance higher education – meaning, the front end of the higher education securitization machine, the equivalent step (more or less; there are important differences) in auto loan securitization of when the consumers go and buy the car with a loan. The students and parents get the money up front but immediately turn it over to the university; the university gets the money while the families have committed to long term repayment irrespective of, well, anything. The universities, on the other hand, get the money upfront, have an incentive to raise tuition prices as high as possible to capture easy and sure money now, and they do. (I recommend Glenn Reynolds’s short book as an introduction to the whole topic.) But this NYT article addresses not student loans, but capital expenditures by universities, financed by their own bonds – a downstream segment of the higher education securitization machine.
On the one hand, students and their families push universities for more and more immediate amenities, such as lavish dorms, recreational facilities, etc. As an excellent WSJ article pointed out a week or two ago, the universities understand the competition very well between each other (an undergraduate admissions officer at my university once said, not completely in jest, that the most important money the university spent was on landscaping, because while it was relatively cheap to have pristine lawns and fabulous flowers when families came to visit, the effect of a beautiful campus is considerable on admissions). But increasingly at least some universities also face competition in living facilities with “resort” living apartments aimed at students built commercially off campus. (A key takeaway from the WSJ article is the comment from a commercial property manager who says that students living in these facilities are going to face a significant downward step in living arrangements once in the real world.) The NYT article describes capital indebtedness on the part of universities this way:
The debate about indebtedness has focused on students and graduates who have borrowed tens of thousands of dollars and are struggling to keep up with their payments. Nearly one in every six borrowers with a student loan balance is in default. But some colleges and universities have also borrowed heavily, spending money on vast expansions and amenities aimed at luring better students ... Overall debt levels more than doubled from 2000 to 2011 at the more than 500 institutions rated by Moody’s, according to inflation-adjusted data compiled for The New York Times by the credit rating agency. In the same time, the amount of cash, pledged gifts and investments that colleges maintain declined more than 40 percent relative to the amount they owe.
Not all of this is excess, the article points out; even in bad times, a systematic program of capital expenditures, replacement of aging facilities, etc., continues to make sense. And of course interest rates at historic lows are an added reason to do it now. Still, ability to repay that debt, even if interest rates are cheap, is overwhelmingly a function of tuition for American higher education as a whole, and the availability of easy money to universities (from lenders to families to universities) can distort capital budgeting decisions. The Times quotes a credit analyst:
“We’ve had a lot more downgrades than upgrades in the last five years,” said John C. Nelson, managing director of the higher education and health care practice at Moody’s, which has a negative outlook on all but the top state universities and private schools. “There is going to be a thinning out of the ranks.”
The pile of debt — $205 billion outstanding in 2011 at the colleges rated by Moody’s — comes at a time of increasing uncertainty in academia. After years of robust growth, enrollment is flat or declining at many institutions, particularly in the Northeast and Midwest. With outstanding student debt exceeding $1 trillion, students and their parents are questioning the cost and value of college. And online courses threaten to upend the traditional collegiate experience and payment model.
At the same time, the financial crisis and recession created a new and sometimes harrowing financial calculus. Traditional sources of revenue like tuition, state appropriations and endowment returns continue to be squeezed, even as the costs of labor, health care for employees, technology and interest on debt have generally increased. Students are requiring more and more financial aid, a trend that many believe is unsustainable for all but the wealthiest institutions.
It’s important not to assume we know at this point how the capital debt problems might manifest themselves and with what severity. It could be a long time before problems come due for many institutions, and they might appear in many different ways. For some schools, it might be a genuine institutional crisis, as students simply don’t come or tuition can’t be raised sufficiently over time. For others, it might mean a long period of decay, in both physical plant and delivery of services. Much depends on factors outside the universities, or any particular university – interest rates, for example, or enrollment from abroad. The Times adds this general caution:
Almost no one is predicting colleges will experience default rates on par with those of indebted students and graduates, at least not anytime soon. While payments on debt principal and interest have increased over all, they remain a manageable piece of the expense pie for most institutions, partly because of historically low interest rates, financial analysts said.
That’s probably right. But the most interesting documents about a university sometimes turn out to be the credit rating agencies reports on university debt – you can often find them linked on the university’s website somewhere. You might find, for a particular school, that the rating agency report describes it as manageable over time. And it might well be for many schools; university debt is not the same problem today that student loan debt is. Still, if you are looking at the credit reports for particular schools, you might look to see the assumptions they’re built on. See, for example, whether the report premises the school’s ability to service the debt, for example, on continuing to attract students and offer university education in the way it is done now, in person and physically on-campus. What would happen to the repayment model if universities began offering online degrees as, of course, they are rushing to do now – American University’s School of International Service has just announced an online MA degree, for example – and then were driven by competition to charge prices lower than the cost of attending in person?
One credit report I looked at recently treated that university’s new online programs as a way of “diversifying” revenues – meaning, on the positive side of preserving or even enhancing them. It didn’t seem to treat them as potentially a way in which online education “cannibalizes” in-person education, or becomes online Amazon to bricks-and-mortar Barnes & Noble or Borders. That’s probably okay for a credit report taking online education into account in its current form – the “cannibalizes” theory is speculative at this point – but one wonders. What would happen to the repayment model if online and other forms of credentialing effectively “unbundled” the university degree, as Reynolds and others have pointed out, so that it were no longer priced and sold as a package wrapped up in a single four-year diploma?
For that matter, I also sometimes wonder the extent to which credit rating reports on university debt are implicitly modeled on assumptions not just about continued student enrollment, but on the ability to continue an upward glide path of tuition increases. Are increases implicitly built into what these reports sometimes refer to as “student demand factors”? I don’t know. While these might still seem like fanciful possibilities today as a matter of future debt service sustainability, however, they are exactly the business model questions that the Economist recently asked. Its fundamental assumption was that of course major change was coming to American higher education. Certainly those changes, whatever exactly they are, will have serious consequences for capital spending and debt service sustainability for American universities insofar as they are dependent on current tuition dollars from each successive year of current students.