Thursday, February 3, 2011

(Non)Assumption of the Risk

Back in the day, when a prospective homebuyer wanted to buy a house, for example, the local bank scrutinized the finances of the prospective borrower. The bank had to decide whether the applicant was a worthwhile risk or not, and whether the investment in the borrower would pay off.

In this scenario, the applicant was weighing risk as well. Were they dependent on a job for income, or did they own a business? Did they have the finances to continue making their mortgage payments in the event of stormy weather? Would the property appreciate over time? Could it be a lucrative rental property?

Both sides were weighing risk but were also weighing return. Both sides were “invested” at some level. It was to their mutual detriment if things went badly, but it was to their mutual benefit if things went well. Risk was part of the game. Fast forward a few decades, and here we are. A crashed housing market, tight credit, high unemployment, and a sluggish world economy. While the events that led to this predicament are many and varied, one clear culprit is the attempt to transfer, rather than assume, risk. Somewhere along the way, people decided that instead of having some skin in the game, all investments should be high return with zero risk. This illogic of this position seems to contradict the core assumptions of the barter system let alone medieval contract and property law, but don’t you worry your collective pretty little heads - out came the Collateralized Debt Obligations backed by Credit Default Swaps. Hedge upon hedge upon hedge, in the pursuit of risk-free profit, created a tangled web bigger than anyone (except people like Warren Buffett) could comprehend or foresee. Like an anti-Ouroboros, what we thought was progress and creative investment was in actuality us consuming our own tail to our mutual detriment.

Nice history lesson, so what? My thesis is that Higher Education, like the mortgage investment crisis, turned into the pursuit of profit with the 100% transference of risk.

Just like the for-profit world, the “non-profit” institutions of Higher Learning wear whatever cap they need to wear to suit the prevailing winds, much like our politicians. One day, they are wearing the “Molding Minds and Preparing Future Leaders” cap. Another day, they wear the “School is a Business, just like any other” cap.

When criticism mounts regarding tuition or meager job prospects, the line is “Hey, we’re just the educators, it’s up to the student to succeed! We’re not in control of the market! If you want something as crass as vocational training, go to a technical school!” If a student does well and becomes famous, however, they get trotted out at fundraising events and milked for all they are worth. If a student does not do well, the message is past performance is no indicator of future results, they clearly didn’t try hard enough, or other blame the victim causes. Meanwhile, at Law Schools in particular, the deans and professors continue to rake it in.

Unfortunately, in the higher education world, risk has been piled on those most unable to bear it in exchange for higher returns for those who assumed no risk at all. What could have been characterized as noble in prior decades, the education of a human being, has resulted in a crash of thousands upon thousands of college and graduate students burdened by debt and no skills that are valued by the marketplace. When any group or institution has no skin in the game, be it Banks, Government, or Universities to name a few, society as a whole suffers. It appears that now that the educational and student loan market is “broken”, the time may nigh for a long-overdue market correction.

Non-trads, you know all this. Think long and hard before playing the game again, and don’t get distracted by the rosy projections and outcomes. Most importantly, if you are looking at student loans, bear in mind that you will be starting that multi-year payback later than when you went to school as a traditional student – juggling mortgages, child care, and student loans is a tough burden. Weigh the Law School investment in particular very carefully, as you likely have much more to offer them (tuition) than they have to offer you (connections to employment worthy of the investment). With tuition alone averaging $40k per year, not including cost of attendance, who is taking on the lion’s share of the benefit versus the risk here?