Stop subsidizing colleges' 100-year debt binge

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Article Highlights

  • The government can help US universities break debt addiction by ceasing enabling behavior.

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  • Government's policies are only fueling the higher-education arms race.

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  • Schools are exuberantly borrowing, in some cases issuing 100-year bonds.

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The Barack Obama administration and Congress purport to care about the rising costs of college. Yet the government’s policies are only fueling the higher-education arms race.

I have written before on how the expansion of federal student-loan programs has encouraged colleges to simply raise their costs. Students are left to pile up more debt while colleges indulge in their Edifice Complex -- building luxury dorms and gyms and stadiums (all “sustainable,” of course) at the expense of poorer students. There is another, related government subsidy that also has perverse effects and needs reform: the tax-exempt debt binge by universities.

Schools are exuberantly borrowing, in some cases issuing 100-year (century) bonds. Some bond offerings are justified, even wise, as schools are taking advantage of low interest rates to reduce future debt-service obligations. But a lot of this activity is financing construction of high-end student housing, faddish “centers” and stadiums.

These perquisites appeal to the most affluent. For many students, however, the costs of college are rising relative to the perceived benefits, pushing them to consider lower-cost substitutes (online education, nondegree certificate programs).

Many bonds are tax-exempt. The more money borrowed, the more generous the exemption, creating in effect a taxpayer subsidy for rich universities. Should there be no cap on the tax exemptions private colleges can claim on their bond debt, and is it appropriate for the government to subsidize all types of projects at these schools?

Government Support

For state universities, there is the implicit and explicit expectation of government support. Should Colorado State University be able to secure bond financing for a proposed $246 million stadium that has no direct academic purpose beyond the school’s claims that it will attract 5,000 out-of-state students who will pay higher tuition? At the University of Kansas, an $18 million structure is being built to house the first “rules of basketball” that James Naismith wrote more than a century ago (for which an alumnus recently paid $4 million).

The public institution where I teach, Ohio University, plans to spend almost $1 billion on buildings from 2013 to 2019, financed largely by borrowing $568 million -- far more than the total endowment. With the money in the pipeline, the school has decided to tear down a perfectly serviceable lab facility (against the wishes of several prominent researchers using the building) that is less than 50 years old and previously was merely going to be remodeled.

University presidents defend the spending splurge. President Barry Mills of Bowdoin College showed chutzpah last year in announcing that the school would borrow $128 million by issuing century bonds (at an average interest cost of more than $6 million a year, or about $3,400 for every student), largely to refinance old debt and partly for new construction. Mills said the plan provided unique opportunities “for the college to prosper, to grow our endowment.” He didn’t explain how borrowing money enhances the endowment.

The century bond fad is spreading. Ohio State University borrowed $500 million for 100 years, mostly to build new dormitories. Will the buildings last as long as the debt used to pay for them? Not likely. The University of California issued $860 million in century bonds last year and, as an encore, an additional $2.39 billion in conventional debt recently. (If that sounds like a huge amount, consider that Harvard University, which has about 22,000 students compared with the UC system’s more than 225,000, is more than $6 billion in debt -- about $300,000 for every student.)

These debt-financed building sprees are increasingly troublesome at a time of unsustainably rising college costs that should be met with a fundamental rethinking of the traditional methods of higher education. And bond-rating companies are beginning to raise the alarm.

Ratings Drop

In 2011, Moody’s Corp. (MCO) revealed that more than 20 percent of rated private colleges had ratings at the “B” level (low investment grade) rather than the more secure “A” level; only a handful of public institutions had “B” ratings. Last January, however, Moody’s said that the 2013 outlook was negative. “Even market-leading universities with diversified revenue streams are facing diminished prospects for revenue growth,” Moody’s concluded, adding that “most universities will have to lower their cost structures to achieve long-term financial sustainability.”

The negative assessments continue, despite the stock market’s strength. In August, a Moody’s spokesman said “the developing trend of expense growth outpacing revenue growth is unsustainable.”

A decade ago, no one seriously predicted cities would go bankrupt, forcing municipal bondholders to absorb large losses. In a few years, we will probably be hearing similar stories about some universities -- those that want to keep up with rich schools but can’t afford to -- if the debt-financed spending binge doesn’t end.

The federal government can help U.S. universities break their debt addiction by ceasing its enabling behavior. A first step would be to require universities to prove that any tax-exempt bonds they issue serve to further instruction or research.

Maybe such restrictions would encourage colleges to stop being so short-sighted about the unsustainability of their spending and start paying attention to the surging popularity of the college-ranking lists that quantify “bang for the buck.” If too many students are priced out, they will eventually do what other consumers do -- take their business elsewhere.

(Richard Vedder directs the Center for College Affordability and Productivity, teaches economics at Ohio University and is an adjunct scholar at the American Enterprise Institute.)

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