There's Plenty of Risk to Go Around

Only half of all students who started college in 2009 have graduated.  Many other students leave college loaded with debt and a useless degree. Meanwhile, the institutions that these students attend have assumed very little responsibility for the quality of education that they provide -- and the federal government has done little to change this situation.

Last August, Senators Jeanne Shaheen (D-NH) and Orrin Hatch (R-UT) introduced a bill that they hoped would address at least one major weakness in the current federal higher education accountability system: The use of cohort default rates as a measure of institutional quality.

New data released today suggests that if Congress were to adopt the Student Protection and Success Act right now, 1,103 campuses* across 588 institutions would lose all access to federal funding. Without loans and Pell Grants, many would subsequently close.

While one might assume that the proposed law must have extremely strict requirements for shutting down so many institutions, the threshold is in fact (worrisomely) modest. To continue receiving federal aid, less than half of the students who enrolled in the school -- 45 percent -- would need to be current on their debt and repaying at least one dollar toward their principal loan balance.

To be sure, this isn’t completely the institutions’ fault. The federal government now provides borrowers lots of options that allow them to not pay down principal, while balances continue to grow. Forbearance, deferment, and Income-Based Repayment (IBR) offer critical  protections for students who have taken on debt they now can’t afford to repay. 

Nonetheless, given that there are nearly 600 institutions at which the majority of students who borrowed federal loans are making interest-only payments, or no payments at all, many schools are not preparing their students. Federal protections, which were intended to guard students in exceptional cases, have become the norm at these institutions. And when most of a school’s students rely on federal safeguards to avoid default, something is structurally wrong. 

So why haven’t these colleges been shut down? Under current law, if the percentage of borrowers defaulting on their loans at a school surpasses thirty percent for three consecutive years or 40 percent for one year, the institution could theoretically lose all access to Title IV funding, which includes Pell Grants, loans and other forms of federal aid. While these sanctions sound steep, the cohort default rule that triggers them has proven extremely easy for colleges to work around.

In fact, only 11 institutions have failed this test and have been excluded from receiving Title IV funding. Meanwhile, last year, 80 colleges had cohort default rates equal to or above 30 percent.

Schools most commonly avoid sanctions by exploiting federal protections offered to students. By encouraging  students to enroll in income-based repayment, forbearance or deferment, low-performing colleges can all but guarantee their borrowers won’t default within the three-year window. Also, because the system is binary--institutions with a default rate of 29 percent get all federal aid while those at 30 percent do not--the rule encourages them to do just enough at the margin, to dip back below the 30 percent threshold, and nothing more.

Colleges need to be held better accountable, and a lot of housekeeping could be in order after years of federal neglect. But binary sanctions that close nearly 600 institutions all at once may not be the best approach. Still, with so many low-quality colleges evading federal oversight, many advocates, academics and lawmakers agree that if a significant number of students fail to repay their debt, the institution ought to be held at least partially responsible for the costs levied on the student and taxpayers. Policymakers are now demanding that institutions more closely share some of the financial risk that students face when using loans and federal aid to pursue a degree. This approach is called "risk-sharing.”

Most risk-sharing proposals contend that colleges should have to pay a fee, either a flat dollar amount per student or some percentage of the school’s total federal aid portfolio when a significant number of students aren’t in a position to repay their debt. In some approaches, schools would be required to pay a relatively small penalty for every student who defaults. Other proposals would require that an institution either pay a flat percentage of a cohort’s remaining loan balance after the 10 year repayment window has elapsed, or pay a certain percentage based on a sliding scale. In the sliding scale model, institutions with worse student loan repayment rates would have to pay a higher percentage fee. These fees would generally still be low so as to get institutions attention without threatening their ability to stay open.

Institutions and their representatives understandably have some concerns about risk-sharing. They claim that by requiring schools to pay penalties, they may be forced to raise the amount of tuition that students pay or may have to cut academic services. Furthermore, they worry about being held to a one-size-fits-all standard. Institutions have wide differences in mission, resources and student demographics, meaning that some colleges’ success rates could be much lower than others for external reasons. Finally, schools blame student loan servicers for not helping borrowers manage the repayment system after leaving.

In response to a few of these concerns, some have proposed measuring colleges relative to an average peer group. Peer groups could be constructed using factors like institutional sector, average SAT scores, or the most common degree awarded, to name a few. Furthermore, by introducing a bonus structure for high-performing schools instead of solely punishing bad actors, this could change the discourse at the institutional level. Those who are doing right by their students would have every reason to voice their support for this change instead of merely being a silent and unaffected bystander. 

Given the difficulty of shutting down just one egregious for-profit chain, passing a law that would shut down 600 institutions may be nearly impossible. Nonetheless, when so many institutions cannot meet basic requirements, clearly something is amiss in higher education accountability. Sharing some of the risk with institutions could get their attention. There’s plenty of risk to go around.

*This post has been corrected to reflect the fact that 1,103  "campuses" would close across 588 "institutions." Many of the campuses that would close are branch campuses of the same institution. Institutions with multiple campuses sometimes jointly submit data to the federal government. After excluding branch campuses, 588 institutions would be affected by a law that excludes those with a repayment rate of less than 45 percent. The new numbers also exclude the recently shuttered ITT Technical Institute, which as of September 6 operated 145 campuses.