Up to now private universities have enjoyed a pretty sweet deal. They have total autonomy to do whatever they want, but they still derive huge government-provided benefits through subsided loans for their students' high tuition and federal aid like research grants. Few industries get that sort of preference, but many in Washington argue that education is an important national priority, so universities get away with it. According to new reports, however, that the government isn't going to be quite so kind now that it backs all student loans.*
The Washington Post reports:
New federal rules, expected to be formally proposed in coming days, would tighten oversight of the industry. One much-debated proposal would cut federal aid to for-profit schools in certain cases if graduates spend more than 8 percent of their starting salaries to repay loans. Sen. Tom Harkin (D-Iowa) also plans this month to begin hearings on the industry, examining recruiting practices and student loan default rates.
The fascinating thing about this: the government is acting like a business. Imagine if you were a responsible bank that had a huge loan portfolio, sort of. You would care about the likelihood of the borrowers being able to repay their loans. Consequently, you wouldn't want the payment to income ratio (PTI) to exceed a certain limit as part of your underwriting practices. Normally, a bank would directly impose these limits on borrowers, but the government doesn't want to lessen college availability. So to get graduates' PTIs below 8%, it's pressuring universities by threatening to drop their federal funding instead.
Of course, these universities will argue that this will require them to shift around their budgets and spend less on some programs, which is bad for education. That's true, but at some point you have to ask how high tuitions can climb before they become completely unreasonable. For some prestigious private universities (though not currently affected by this change if non-profit -- see update below), total annual costs can exceed $50,000 per year. You have to wonder if attending such schools is really worth that much more than a public university education which could cost a few thousand dollars.
Is 8% PTI a reasonable threshold? For someone making $35,000 upon graduation, that would limit their loan payment to $233 per month, if you use gross income before taxes. If you take taxes out of pay, of course, the payment would have to drop by at least 15%. The $233 payment would amount to around $55,000 in loans, assuming 2% interest and a 25-year loan maturity.
For very expensive colleges, however, $55,000 isn't much. If total costs are $50,000 per year, and a student relies entirely on loans, then he or she would need to make a starting salary of $127,156 per year to cover an $847.71 monthly payment, under those same conditions as above. Even if you went to a top school, that's a pretty unrealistic starting salary. And remember, that assumes pre-tax income.
Since the government is ultimately on the hook for these loans, it makes sense to want to protect taxpayers by pressuring colleges to minimize costs. While schools cutting programs is regrettable, private universities' business models needs to be reexamined. If their customers are so far from being able to afford the service they provide, then there's an economic failure at work.
The worst case scenario, however, would be if colleges just accept the government withholding their federal funding. Then, they could just charge students even more to make up for it. After all, the government will still underwrite those loans, no matter how large. A really bad unintended consequence would be to see this action cause tuition to rise even more.
*Update: As msully72 points out in a comment below, this may only affect "for-profit" colleges, not all private universities. That's pretty odd, however, considering there's no reason to make such a distinction. Surely the government's risk is the same no matter what kind of college it is. So you can take the above argument to be for why the principle should be expanded to private college -- public or private.