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Apollo Group Inc (APOL), ITT Educational Services, Inc. (ESI): Why Rising Student Loan Rates Aren’t the Real Problem

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Yesterday, interest rates on new federally subsidized Stafford student loans doubled from 3.4% to 6.8%. The move brought an angry response from students and parents who could see their financing costs soar if the government doesn’t take action to reverse the move.

Taking positions that have students have to pay more for their college educations isn’t popular. But all the attention on student loans distracts from the real root of the problem for students: the increasing disconnect between the value of an education and the price that colleges and universities charge for it.

Apollo Group Inc (NASDAQ:APOL)

More proposals than you can count
Lawmakers have no shortage of rate-reducing alternatives to consider. Both President Obama and House Republicans suggested tying interest rates to the prevailing yield on 10-year Treasury bonds, with differing margins added on for various types of loans. For instance, the House plan would set Stafford loan rates at 2.5 percentage points above the 10-year yield, with parental PLUS loans getting a 4.5-percentage-point add-on.

Other proposals have used a variety of other benchmarks. Sen. Elizabeth Warren suggested using the Federal Reserve discount rate of 0.75% as the prevailing rate, while two other Democratic senators suggested using the short-term three-month Treasury bill rate as a baseline for loan rates. Several lawmakers are working on possible extensions that would temporarily keep the old 3.4% rate for another year or two.

Getting rid of loans entirely
The government response to the college-cost crisis focuses on the wrong part of the problem. That’s not particularly surprising, given that addressing interest rates on student loans simply repeats the government’s own bipartisan fiscal mistakes that have irresponsibly ignored the need to avoid incurring excessive debt in the first place.

In response, students have to be smarter about making financially savvy choices about their education. There’s plenty of evidence that there’s room for improvement on that score:

  • When you look at how much you have to pay for college tuition, there’s little correlation between tuition cost and reputation or post-graduate job prospects. Indeed, lower-cost state schools often rank better than a wide variety of private schools with much higher costs.
  • As a Wall Street Journal opinion piece by Prof. Glenn Reynolds of the University of Tennessee recently noted, a Fidelity study found that 70% of 2013 graduates have college debt averaging more than $35,000. Yet half of new graduates are unemployed or underemployed in professions where a college degree isn’t really a necessity, leading to the question of why they incurred the debt in the first place.
  • The worst-case scenario for students is incurring large amounts of debt without actually completing a degree program. As Fool contributor Morgan Housel noted earlier this year, institutions with the lowest graduation rates tend to have higher default rates on the loans their students incur, yet 40% of full-time four-year students don’t get degrees within six years, and 75% of community-college students don’t finish within three years.

On the other hand, students do seem to be making some moves that indicate greater fiscal responsibility for their own financial lives. Just last week, for-profit educational institution Apollo Group Inc (NASDAQ:APOL) reported sharply lower enrollment, including a 25% drop in new students. ITT Educational Services, Inc. (NYSE:ESI) saw more modest declines when it reported in April, but new student enrollment was still down 3.6%. A new investigation last month from the SEC over Corinthian Colleges Inc (NASDAQ:COCO) marked just the latest in a string of regulatory crackdowns on for-profit educational institutions. More generally, increased government scrutiny as well as reports of higher student-loan default rates among many players in the for-profit industry compared to nonprofit educational institutions have led would-be students to question the value proposition for-profit educational companies offer.

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