Thursday, July 11, 2013

Rapunzel's College Financing Plan

The problem of college costs has been motivating politicians for a long time.   It is logical that they would, college costs have been rising faster than the underlying consumer price index for a long time and most families want their children to attain a degree.  

In the 1980s the State Treasurer of Michigan proposed something called the Michigan Education Trust.   Robert Bowman, proposed a plan which would have made Ponzi proud.   It allowed families to pre-pay tuition at a Michigan public university and guaranteed that the money once deposited would cover any changes in tuition.  Trouble was that the internal assumptions on the plan were seriously flawed.   The plan had no control over the price that would be charged in the future AND assumed that a conservatively managed portfolio could generate returns in excess of 8% over a very long time horizon.    After the Michigan legislature bought this scheme, he tried to peddle the idea around the country.

A few of us (I did the numbers in California) actually sat down and did some projections, based on prior tuition increases and reasonable rates of return.   The Michigan plan in its first year was something in the range of $150 million short of being able to pay its obligations.   At one point when (then) Senator Hayden proposed a Michigan like plan I went to the state treasurer (Jess Unruh) and asked him about Bowman's projections - Jess said something like "that guy must be smoking something illegal."   The state's pooled money fund was earning something like 3% at the time and that fund was considerably more successful than similar funds in other states(including Michigan's).   While  a few more states were talked into making this sucker's bet,  eventually wiser heads prevailed and states began to adopt college savings plans - which were more like a defined contribution plan for retirement.  Even the Michigan plan was eventually adjusted and when the prices became real, the demand dried up.

A few years after Bowman had peddled his nonsense, a group of independent colleges figured out a way to develop a reliable way to offer a tuition guarantee (which involves some risk sharing with participating colleges) which is now called the Tuition Plan Consortium.   Its financing assumptions are sound.   A family really can deposit a sum of money today for their children and be assured that amount of money will retain the same ratio to tuition at one of the participating colleges in the future.   So if you buy 1 year of tuition now, it will be worth 1 year of tuition in the future.  
But politicians still want to spin gold out of flax.   The current iteration of this fairy tale is a variation of an early attempt in the independent sector that came from Yale that allowed students to repay their loans on an income contingent basis.   The new proposal offers students the chance to go to a public university in Oregon for free but but then pay a percentage of their income back to the state  for 24 years after graduation.   The Oregon plan was described by the Atlantic as "very radical and very terrible."    The Atlantic argued that it could do all sorts of negative things.  First, because students don't just borrow for tuition costs, students would still have student loans to repay - plus 3% of their income.  (1.5% for community college students) Assuming that living expenses still constitute a significant percentage of college expenses, graduates could be hit with paying out a significant percentage of their income to cover college expenses (indeed they are now with the rate of borrowing in traditional programs - but this would exacerbate the problem).  Second, any student with a reasonable expectation of earnings would opt out of the plan understanding that their "bargain" could turn into a loadstone if they made a decent salary after graduation.   The experience on income contingent loans is not promising, what you would expect (that students in high income fields opt out) mostly happens.   What might well happen is a brain drain out of Oregon public universities.  The best students, with the best earnings prospects, would choose to go elsewhere.

Let's face it - the college cost issue involves many complex issues.  And we do need to have some continued careful thinking about reliable ways to make college more affordable.   But things like the Rapunzel Plan in Oregon will continue to pop up as long as politicians have a notion that P.T. Barnum was right.

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