The next bubble to burst: higher education

Bloomberg and the New York Times recently confirmed what I have believed for several months now: higher education is the next bubble to burst. Applications at non-Ivy League schools are declining. Private college expenses have increased at a rate far above inflation for too long, and households are no longer willing nor able to tap an inexhaustible supply of home equity to pay $150,000 for a bachelors degree that will not even guarantee a decent wage. Meanwhile, colleges felt the wealth effect as endowments rose and they embarked on grandiose construction plans, often building dorms that would fit in better at the country club than an educational institution. A recent study of university salaries found over 200 presidents making more than $500,000 per year.

As with most things in our economy over the last few years, all of this growth was fueled by cheap debt. An investment in education became one of the most highly leveraged investments you could make (100% financing implies an infinite debt-to-equity ratio). Just as people believed house prices could never go down, they felt that any college degree was worth its price. Obviously, not everyone should be an accountant - but you can justify the $150,000 price tag for an accounting degree much easier than you can justify $150,000 for an art history major. The long-term trend will be massive trading-down in the market for education: those considering private schools will switch to quality in-state public universities, and those who formerly considered state schools will move down to community colleges. Ivy League schools will always be in demand, but they'll have a harder time affording the financial aid they have committed to maintain an economically diverse student body. State universities that have unnecessarily committed to becoming a research institution will also have to scale back their plans.

Ultimately, a return to rational pricing is a good thing. Higher education was becoming unaffordable for an increasing percentage of households. State universities need to focus on their core mission of providing affordable high quality undergraduate education.