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The College Tuition Debt Bubble

Anyone who has recently attended college or who has children who have recently attended college probably experienced “sticker shock” when they found out how much it cost.  It’s no secret that the price inflation in university tuition has far outstripped virtually every other sector of the economy over the past decade.

HS Dent has explained this phenomenon with demographics.  As you can see in the chart below, the number of 18-year-olds fell throughout the 1980s as the small Generation X came of age.  But in the early 1990s, the number of 18-year-olds began to rise again…and rise it did.

This massive surge of 18-year-olds is, of course, the Echo Boomer generation.  Assuming no increase in the percentage of kids that go to college, demand for college education still would have exploded throughout the 1990s and 2000s due to the fact that there are simply a lot more kids of college age.   When demand rises substantially while supply remains more or less unchanged, basic Economics 101 would tell you that prices have to rise.  And that is exactly what has happened.

Interestingly, an explosion in school loans have been both a cause and an effect of the price increases.  

According to the Wall Street Journal, two-thirds of college students borrow for college with an average balance of $23,186.  Unfortunately, this debt appears to be contributing to a bubble.  The Journal writes,

…the rising levels of borrowing may ironically be contributing to the accelerating cost of college, say some college-finance experts.  Loans can give colleges an artificial sense of a family’s ability to pay tuition.  To some extent, that false sense of security gets built into the assumptions schools make when setting prices, say experts.  The idea is that as prices rise, families borrow more and more, spurring prices to rise further, which in turn requires more borrowing.

This has all the markings of a classic bubble.  So, the question now becomes, “how does this end?”  

Our answer would be that it will end as all bubbles do, in a deflationary bust.  The number of 18-year-olds will begin to fall this year and will continue to fall for about seven years.  This means that, barring a sudden surge in the percentage of kids applying to school, demand for education will fall.  And with falling demand should come falling prices, or at least moderating prices.

An outright drop in the price of tuition seems somewhat unlikely to us, because lowering the price could be viewed as damaging to a school’s prestige.   But prices can fall in “hedonic’ terms.  In other words, while the quoted price remains unchanged, you might get a lot more for that price, with added sweeteners thrown in.    Free or discounted books, room, or board?  It’s hard to say.  Regardless, for the first time in well over a decade, university education is about to become a “buyer’s market” again.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy