The sub-prime education crisis

Coming soon and you heard it here first


A friend of mine turned me on to a recent piece in the New Yorker on the state of higher education in America. The author is responding to the supposed crisis in the education sector and essentially debunking it. Now you’re welcome to review the article, written with the style and in the elevated prose that one would expect from such an esteemed publication, but the piece also rests on what I consider to be an unimaginably ignorant premise. The system must work, or so we should believe, simply because so many people are lining up for school. If the educational system were broken, people would presumably be opting out of it.

Now, bearing in mind that this article takes an American context, there’s already one huge problem. Many people are opting out of the public system down there. If one allows that education includes any kind of organized learning at all then sure, I suppose it’s easy to establish that lots of people are in favour of receiving that. But in America it is increasingly delivered by private or partly private institutions. So taking all forms of education and throwing them into one big pot only confirms one of the most basic facts about today’s modern society that everyone knew already. We all need to spend more time learning, and while we may have some choices over what and how we learn it’s hardly an option at all to simply opt out of education entirely.

More critically to the Canadian experience, this article also omits any real attempt to grapple with the ballooning cost of modern education and the resulting debt that often follows. And here is where I’ll introduce a concept that we all need to hear and think more about. It’s the idea of sub-prime education. Degrees that we are putting out on the market that are unlikely to pay off. Education that doesn’t actually create higher pay or better jobs or new opportunities. Sub-prime education.

The sub-prime mortgage crisis is often referenced but rarely understood. I’m not an economist but allow me to give a primer. American politics and American citizens bought widely and deeply into the narrative of home ownership. Home ownership was seen as the route to both private and public prosperity. So huge government programs were created to get as many people buying homes as possible and many citizens gladly mortgaged themselves to the hilt in order to buy as much property as they could possibly afford. And for a while it seemed to work. Unfortunately, many of the home loans put out there so that people could afford these mortgages were sub-prime. Prime is the rate at which a lending institution loans money to individuals it considers to be a good bet. Sub-prime is a higher rate, reflecting the fact that the lending institution considers the borrower to be a worse bet. Spread the risk over enough weak borrowers and the extra tax helps cover the occasional default. That’s the basic premise. It gets more complicated when banks start trading these loans and packaging them as investment vehicles, but that’s the basic premise.

What banks did not count on is that when the property market started to tank it created a cascade effect. Lack of faith caused the value of everyone’s investment to plummet. It’s a classic market bubble. When it bursts it drags everyone down. Only in the market you catch investors who, with adequately good sense, have protected themselves through diversification. When you catch homeowners you catch everyone. Ordinary people who put all their eggs in this one basket not because they are bad investors but simply because they bought into the narrative that home ownership is the route to prosperity. Time was that everyone believed that as an article of faith. No longer. But not until we had a whole lot of wreckage to teach us otherwise.

Now let’s look at education. In Canada, the floating rate of interest on the federal portion of a student loan is prime plus 2.5 per cent. That is, in the most literal terms imaginable, the very definition of “sub-prime.” Our government is publicly acknowledging that investment in education is a sub-prime lending risk. That doesn’t mean it never pays off. That doesn’t even mean it’s a bad bet for everyone. That just means that spread out over a wide sample group it simply isn’t a very good bet, on average. And private lending institutions aren’t even eager to participate at that rate. Contrast that with the rates that professional students can expect on their student loans if they go to private banks. For degrees in law and medicine — education that banks consider to be good bets — students can expect to access sizable loans at straight prime rate or at prime plus 0.5 per cent. That’s what it looks like when the market believes in the value of an investment.

I’m not suggesting that every degree or form of education can or should be as bankable as a degree in law or medicine. That’s simply unrealistic. And if that prime plus 2.5 per cent rate reflects the real risk of investment in all college and university programs then I’d suggest we’re actually in quite good shape. But I also don’t think that’s true, and I believe that many people privately realize as much. As stories of students defaulting on impossible student loan payments become more and more common we have got to admit that there’s a problem. Not that we should shut down the whole system any more than we should suddenly give up on private home ownership. Just that the economic assumptions grounding the way we’ve encouraged people to pay any price, and to go into any amount of debt, have got to be reexamined.

We’ve all bought into the narrative of education as the route to private and public prosperity just as America bought into home ownership as the route to private and public prosperity. We accept it almost as an article of faith — so much so that attacking it brings swift and sure condemnation. It’s fine to talk about how broken our post-secondary sector may be, and in fact universities have become huge stationary targets for everyone who wants to take aim and get a shot in on the topic, but God forbid anyone suggest that a particular student should not go to one of those universities! Then you’re counseling that student into a life of failure! Somehow, we admit there’s a problem, but at the same time imagine a magic bullet solution where if we could only whip the institutions into shape our delusions about the limitless power of education to rescue absolutely everyone at the same time could be justified.

Here’s the awful truth. We have sub-prime education loans because we have sub-prime students. It wasn’t the properties in America that created the bad bets on home loans. It was the borrowers. Some people just were not in good positions to carry those loans. And some students simply are not going to excel in school or realize the same value from their degrees and qualifications as other students. They are sub-prime students, and bad bets to ever repay the massive loans asked of them in order to take even a shot at higher education.

Now I’ve just become the devil who suggested some students shouldn’t be in university — or even in college! And that’s partly true. I do believe that some students simply can’t justify, based on the job prospects and opportunities that follow, the tuition they’ll need to lay on the table to be in university or college. If anyone wants to return with a narrative about the public benefits of education, and how everyone deserves their shot regardless of the odds and how in the end it’s good for society, well, I’ll 100 per cent agree. But that doesn’t change the economics of the situation. So long as we are asking students to pay what we are asking them to pay, the equation will remain the same. Sub-prime student loans to sub-prime students.

So no, the mere fact that everyone is still lining up to get into college and university is not, of itself, proof that the system works. To begin with, it’s become an article of faith that defies rational behaviour, especially when decisions are made by students’ parents as often as themselves. Also, for lack of options, students are still driving up the one channel open to them because one way or the other, we are all going to spend more of our time learning in today’s modern economy. The credentials still carry considerable weight because alternatives are scarce. The bubble is sustained through a combination of optimism and resignation. But it can’t last forever.

The day of reckoning will come. This merry-go-round is going to stop eventually, and when it does we’ll all wake up and realized that we’ve saddled a significant portion of an entire generation with loans they can’t pay. And what happens then is anyone’s guess. I can’t foresee either the full consequences or what the resulting reorganization might look like. But some major adjustment is coming. When it does happen please remember that you heard it here first.


Questions are welcome at jeff.rybak@utoronto.ca. You can also follow me on Twitter.


The sub-prime education crisis

  1. Your central metaphor is basically wrong. Canada Student Loans come with an interest rate above Prime because they are subsidized while the student is enrolled. The interest premium is used to cover the costs of the in-study interest break. Moreover, your analysis would suggest that government wouldn’t provide grants, i.e., free money, to students because education is a “sub-prime” investment, yet the feds alone provide more than $300 million per year in non-repayable aid (plus huge tax incentives).

    More to the point, you need to familiarize yourself with the research, starting with the recent CD Hower paper by Boothby and Drewes that demonstrates the continually rising education premium (and the increase in the rate of return to PSE) during the last 25 years of massive PSE expansion in Canada.

    I guess you guys don’t have editors at Maclean’s these days.

  2. @JB – Because we’re talking about government loan programs here, public policy decisions behind them end up bearing little relation to real economics. We can settle this argument very easily. Just head into any private bank and find out what kind of interest rate they’ll offer a post secondary student on an unsecured student loan for an undergraduate degree or first entry college program. I referenced federal interest rates because they are convenient. But I’m willing to bet you won’t even find a bank to give you that loan.

    Further, your reference to research behind rates of return on PSE is flawed on two counts. First, the return premium isn’t “continually rising.” Research has only managed to suggest that there continues to be a premium. Second, and more critically, this research you cite is all about the typical or the average student. I did not even try to refute that education works a lot of the time – just as home ownership works a lot of the time! But all such research willfully ignores the bad risks that fold in alongside the good risks and conceals even the existence of sub-prime students (those for whom education likely will not pay off) by averaging outcomes.

  3. “The research” does, in fact, show earnings premia for PSE increasing over time. Both for college and university grads. In fact, research released (literally) yesterday shows this phenomenon occuring in Ontario:



    Choice quotes from the Globe article:

    “The gap in earnings between post-secondary graduates and those who completed only high school nearly doubled over 20 years, says a report being released on Monday by the Higher Education Quality Council of Ontario.”

    ““If there is an excess supply of these types of skills, the price should fall. The opposite is happening,” said Torben Drewes, author of the report and professor of economics at Trent University.”

    “College graduates in Ontario between the ages of 21 and 30 earned on average 25 per cent more than people who were only high-school grads, up from 12 per cent two decades earlier. The wage gap between university graduates and those with only a high-school diploma climbed to 50 per cent from about 30 per cent. Although the data refer to Ontario students, Prof. Drewes said the findings can be applied across the country.”

    While certainly not the last word (I’m sure) this is compelling.

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