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Monday, September 12, 2016

Should financial unstable colleges be required to post surety bonds?

The New York Times posted an editorial last Thursday calling for more vigorous federal regulation of for-profit colleges and arguing that without federal oversight these college chains have been free "to prey on veterans, minorities and the poor by saddling students with crushing debt and giving them worthless degrees in return." This editorial focuses on ITT Technical Institute ("ITT"), which was also the focus of my prior blog post. The Times describes a litany of abuses by ITT, including (i) targeting desperate potential students, (ii) spending more on recruiting students than on teaching them, (iii) allegedly pushing students to take high-risk loans, (iv) allegedly concealing material financial information from investors and committing fraud, and (v) misstating its job-placements results.

The editorial ends with two recommendations. First, the Times called upon the U.S. Department of Education (the "ED") to "adopt and vigorously enforce recently proposed rules that shield the taxpayers from loss when a school is forced to close." Second, the Times suggests that for-profit college chains should be forced to "put aside money for debt relief for students" once these chains "show signs of financial instability — like being sued by federal entities or state attorneys general or failing to meet requirements for receiving federal aid." While I support the vigorous protection of vulnerable populations, I worry about the Times' recommendations. Isn't requiring financially unstable colleges to post surety bonds likely to harm some students even as it protects others?

Contrary to the tenor of the editorial board's letter, the ED had actively monitored ITT's finances and operations for at least two years. ITT was subject to "heightened cash monitoring," which required the chain to provide, among other things, bi-weekly cash flow projections, information about all "important financial transactions," and a monthly student census. In addition, the school was required to post a $94 million letter of credit to protect the ED in case ITT closed and the ED was forced to discharge federal loans made to ITT students. But when the ED required ITT's parent company to post an additional $153 million letter of credit, ITT shut the doors of all its campuses. Was forcing ITT to close really in the best interests of all ITT students?

According to the ED, former ITT students ought to:

  1. transfer ITT credits to a new school, if that school will accept the credits or
  2. apply to have their federal student loans discharged.

However, ITT has reportedly warned students that "it is unlikely that any credits earned at the school will be transferable or accepted by any institution other than an ITT Technical Institute," and private student loans are not covered by the ED's closed school discharge provisions. Even worse, veterans who used their G.I. Bill benefits to attend ITT have used up those benefits. Veterans are reportedly not credited for the months of eligibility already expended at ITT. In other words, veterans may be left with credits they cannot transfer and cannot be returned to their ex ante position (minus their time) like non-veterans. Of course, no ITT student is likely to be able to discharge their private student loans, absent Congressional intervention. Are former ITT students truly better off now that their campus has closed? Isn't it fair to presume that at least some of these students, particularly the veterans, would have been better off with a degree than a bunch of non-transferable credits and a used-up G.I. Bill education benefit?

Requiring financially distressed institutions to post large surety bonds (ITT's bond was reportedly more than 40% of the amount of federal financial aid it received in 2015) will almost surely contribute to some of these institutions closing. Instead of scurrying to do something after schools reveal that they are financially distressed, perhaps more proactive monitoring--like the ED's gainful employment rules--represents a better approach to protecting students from predatory schools.

I don't mean to suggest that ITT was a model institution, but it's far from clear to me that the ED's actions (or the Times' recommendations) represent the correct approach. What do you think?

 

Posted by Matthew Bruckner on September 12, 2016 at 10:58 AM | Permalink

Comments

Does anything about the value of ITT credits that not one of their peers will credit them?

If this is just a cash for credential system and no one cares about what the education actually involves, why not cut out the middleman and have the USG issue diplomas to anyone that asks for one?

Posted by: brad | Sep 12, 2016 11:54:42 AM

The approach recommended by the NY Times (surety bonds) is not dissimilar to the financial assurance requirements for hazardous waste treatment, storage, and disposal facilities (RCRA Subpart H).
The challenge for the for-profit education companies is adequate capitalization. If these well-established (not start-up) firms are relying on federally-backed student loans for survival, then their business model is broken.

Posted by: Paul | Sep 12, 2016 12:36:49 PM

My first comment should have the words 'it say' as the second and third words.

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I wonder if instead of a surety bond regulators could adopt the skin-in-the-game rule that was supposed to be a part of Dodd-Frank for mortgages (but was watered down to almost nothing in the regs)? Schools would have to contribute (via discount) 5 or 10% of the loan amount and then get the remaining reimbursed as their former students paid the government back or not as the case might be.

Posted by: brad | Sep 12, 2016 1:16:27 PM

Thanks for your comments, Brad and Paul.

Brad, I agree that in a perfect world degrees would mean something. But they often appear to be signalling devices. In such cases, ITT students may be better off with a degree than without. Your proposal is interesting but I think that it assumes there is some rational relationship between the cost of providing an education at one of these schools and the cost of tuition. Yet there is evidence that when the maximum amount of federal loans were increased, tuition went up. Similarly, some for-profit colleges would loan students money to get around the 90/10 rule (which is meant to prevent colleges from getting more than 90% of their revenue from government-backed loans and grants) even if many students never paid back those loans. In other words, getting federal grant money made it worth "losing" the 10% loan the colleges were making (and paying themselves with). Maybe it's just that the skin-in-the-game amount would have to be higher...


Paul, most colleges rely on federally-backed student loans for survival. Not just private or for-profit colleges.

Posted by: Matthew Bruckner | Sep 13, 2016 12:43:41 PM

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