The Scandalous Student Loan Scandal
The student loan scandal concerns the fact that many colleges and universities chose preferred lenders for financing student loans and then received remuneration for their recommendations from the lenders. The scandal has been going on since mid-March. Thus, it is startling to learn that it was not until April 30 that any evidence was provided concerning how anyone might have been harmed by the practice.
The New York Times of May 1 reports that Pratt Institute, a New York college of art and design, had temporarily entered into an arrangement in which a lender was charging students a rate of interest of 15 percent, a rate supposedly far above that available elsewhere. Apparently on its own, the school cancelled the arrangement and stopped recommending the lender. The lender had not given any compensation to Pratt but had instead agreed to “provide grant money for needy students.” (The article also appears on p. A17 of The Times’ Metropolitan Edition.)
“Details of the arrangement, and its cancellation,” The Times informed its readers, “were disclosed yesterday [April 30] by Pratt and Attorney General Andrew M. Cuomo of New York.” The Times then went on to state that “Pratt’s findings that its students were being charged such high interest rates are the first evidence to emerge from Mr. Cuomo’s inquiry showing how students could have suffered from undisclosed arrangements between universities and lenders that the attorney general has branded a conflict of interest.” (My italics.)
The meaning of this is that we had the spectacle of a public scandal going on for over a month without any evidence to justify it.
If one thinks about it, there is no difference in principle between a college or university receiving compensation from lenders that it recommends and compensation from dining halls and bookstores that it recommends. (There are undoubtedly many cases in which campus dining halls and bookstores are not owned or operated by the schools whose students they serve. Yet their location on campus serves as an extremely powerful recommendation of them by the school. The schools, of course, derive income from these establishments.)
And just as in those cases, the compensation to the school should normally be expected to derive from the lower costs of operation for the suppliers that the recommendations make possible, not from higher prices to customers, in this case, interest rates to students. This may not always be the case, as in the above-mentioned instance of Pratt Institute, but it is certainly very often the case, and probably is the case most of the time. This is because the preferred lenders enjoy reduced marketing expenses, for example. Similarly, the dining halls and bookstores benefit from the greater volume of business the school’s recommendation gives them, and consequently they have lower unit costs.
In all such instances, the recipients of the school’s recommendation have no need to charge more. They are in a position to share with the school part of the additional profits resulting from lower costs. Moreover, exercise of the most elementary degree of conscientiousness on the part of the school would normally serve to guarantee that charges to its students were competitive. Indeed, in order to be sure of capturing the volume of business that their preferred position and consequent lower costs opens up to them, preferred providers will often find it to their interest to charge less than most others. Charging lower prices or interest rates is the means by which their lower costs translate into a competitive advantage over other suppliers.
Finally, competition from firms not recommended always serves to strictly limit what can be charged by those who receive the recommendations. There is no more reason to prohibit schools from recommending lenders on the grounds that students will be charged higher interest rates than there is to prohibit them from recommending dining halls and bookstores on the grounds that these establishments will charge higher prices for the meals and textbooks that they sell. The student’s simple and obvious safeguard in all such cases is to look at what others are charging. If semester after semester it does not occur to a student to do this, then perhaps he is simply not qualified for college.
What is present in the schools’ receipt of payments for their recommendations is nothing other than the normal workings of an economic system that is based on the profit motive and trade to mutual advantage. When one party benefits another, he should normally expect payment in return. That is all that is present here. And, as I’ve indicated, contrary to the expectations of The New York Times and its reporters, and of most government officials, profits and the profit motive, in combination with competition, do not serve to make goods more expensive but less expensive.
It is difficult to resist the conclusion that what is actually being complained of in this instance and in so many others is the fact that under capitalism a supplier works for his own profit and is not the sacrificial slave of the buyer. It is ironic that in the present case, the victims of this anti-capitalistic attitude are colleges and universities. What is ironic is that they systematically instill such anti-capitalistic attitudes in practically every course they offer. There is thus a measure of justice in the fact that in this instance their teachings have been put to use against them.
This article is copyright © 2007 by George Reisman. Permission is hereby granted to reproduce and distribute it electronically and in print, other than as part of a book and provided that mention of the author’s web site www.capitalism.net is included. (Email notification is requested.) All other rights reserved. George Reisman is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics.
Comments (8)
Brent
And if there was no advertising, costs would be lower and since we all know P=MC, then (magically) the prices of all these things would be lower!
Anyway, I'm sure there is plenty of scandal/abuse of the government's student loan debacle. The heart of the matter won't get fixed or even talked about (after all, government spending money irectly/indirectly on education-type things is perfectly noble and an economically correct governmental function). Instead, we will see "abuse" stories that are really just "we hate business" or "we hate high prices" type of stories.
Published: May 14, 2007 12:26 AM
Gu Si Fang
It also seems to me that, since the student loans are subsidized, one would expect the subsidy to fall partly in the provider's pocket, especially if the supply is rather inelastic. In such a case, the subsidy might "help" the providers - colleges, universities - more than the customers - the students. Could this be the case?
Published: May 14, 2007 12:44 AM
Andrew Johnson
Lets look at this situation in a totally different way:
1) Monetary inflation by the federal reserve is causing compounding growth in college tuition.
2) Government over spending is causing inflation in higher education costs both with infrastructure and faculty.
3) Government sponsored propoganda promoting higher education is leading to decreased value in college education.
This "student loan scandals" stories should draw light on the real issues which everyone is ignoring -- government intervention is inflating the cost of education in America.
Published: May 14, 2007 12:55 AM
George Gaskell
the subsidy might "help" the providers - colleges, universities - more than the customers - the students. Could this be the case?
It absolutely is the case.
These subsidies consistently produce a readily-observable phenomenon -- tuition increases. In most cases, tuitions rise to the about the same level as the arbitrary amount that is available through the subsidized loans.
If the government guarantees loans up to $15,000 per year, the tuition rises to $15,000. If the government authorizes $17,000, tuition rises to $17,000. The cap is the amount that students are able to pay, and prises increase accordingly. (For less desirable schools, there is a discount, but the tuition at the most desirable school in a local market will be near the government-mandated loan cap.)
Is the education worth an extra $2,000 merely because the government raised the subsidy cap? We have no way to measure the true market price of the tuition, because the government has tinkered with it.
I have no problem with the supposed conflict of interest between lenders and schools, as long as the arrangement is voluntary. The solution to conflicts is disclosure. Wherever there is a bad deal in any given market, another market in information arises -- a system that steers people away from the rip-offs and toward the bargains.
The problem here is the price-fixing lurking in the background. Because of the caps, the school and the lender are not the only players in the student loan market. It is basically an invention of government, since there is pretty much no market viability for student loans in a genuinely free market for education.
Published: May 14, 2007 9:14 AM
N. Joseph Potts
In my long time, I've been a debtor AND a student, even both at the same time. I never encountered any PREFERRED lenders (this was just after money was invented), so I've been wondering all this time . . . WHO would prefer a "preferred lender," and WHY would they prefer them?
Where a lender (or a provider) is "preferred," if I can't figure out why *I* would prefer the purveyor, I conclude the OTHER party to the transaction (the university, the insurance company) must be the one doing the preferring.
Now, where the OTHER party is doing the preferring, I further conclude that either this preference has no bearing on my welfare OR it is actually harmful to my welfare. Either way, *I* should NOT prefer the purveyor - perhaps my interests would be better served if I AVOIDED them.
A little elementary logic - a mere moment's actual thought - should resolve the matter most satisfactorily for even the most ignorant of would-be borrowers. Then, perhaps a little shopping to find a better rate (net of kickback).
But that would require a little gumption - perhaps taking some responsibility for one's own welfare. And they certainly don't teach THAT in any government-subsidized school I know of.
Published: May 14, 2007 9:43 AM
Person
I stopped reading George_Reisman's post when I got his point, so let me see if I can better explain why it's scandalous. You see, supposedly universities are "non-profit", meaning they act in the students' interests. That's the image the public has of them, and why they're tax-exempt. This discovery (that universities were pushing students to get overpriced loans) tends to destroy that naive worldview, and people don't like learning this. In reality, of course, universities are for-profit; they simply don't distribute the profits to partner-owners or shareholders.
Published: May 14, 2007 10:15 AM
Person II
I agree with the previous poster. The for-profit nature of education is the dirty little secret and really the root of the problem. The question is, whether this assumption is "naive" or a fair expectation which foundation has just been eroded by bad decision-making. I believe the latter and I'm not even a communist!
I think there's a lot to be said for free and independent education, and it's most certainly the governments responsibility to ensure that.
The sad truth is, market and education is not a good match IMO.
I'm reminded of a skit from The Simpsons - in the classroom:
"If you have three Pepsis and drink one, how much more refreshed are you?"
"Um, Pepsi?"
"Partial credit!"
;-)
Published: May 23, 2007 11:40 AM
Chris W.
And do not forget.. If it wasn’t for the LAWS that make a nationwide student/alumni credit union ILLEGAL we wouldn’t need for profit sudent loans in the first place.
Imagine students, graduates, and schools coming together to keep
Tuition and Loans affordable….
Now ask yourself why that is AGAINST THE LAW
Published: July 23, 2007 5:39 AM