For-profit colleges and universities are under assault, losing critical access to funding that's necessary to stay alive. ITT Educational Services was the latest and biggest victim, abruptly shutting down 130 of its campuses earlier this month and filing for bankruptcy.
The Motley Fool's Gaby Lapera and John Maxfield discuss this and other aspects of for-profit education in this clip from Industry Focus: Financials.
A full transcript follows the video.
This podcast was recorded on Sept. 26, 2016.
Gaby Lapera: I don't know if people know, but student loan debt has reached just gargantuan levels in the United States. It's around $1.4 trillion right now. Unlike most other debt, it can't be discharged in bankruptcy, which is crazy if you think about it.
John Maxfield: Yeah. And the other thing to keep in mind is that, when you think about all the things that are going on in the country right now from an economic perspective, this is reflected in the student loan issue. In fact, one could argue that that's what caused the whole student loan issue. Let me put some of this in perspective. Since the financial crisis, unemployment rates shot up, which sent people back to school. But the big issue is that state spending went way down -- they were cutting back the budget -- and federal spending went way up. That's where this huge student loan crisis has come from.
Lapera: Yeah, it's crazy. If you look at some of the figures, student loan debt has exceeded automobile loan debt, credit card debt. That's a lot of debt that's been saddled on young people who are just starting out. And sometimes, it doesn't really pan out. What you were saying about debt rising -- the average debt at graduation of 2015 was between $30,000-35,000. It was about $10,000 in the mid-'90s. That's a wild increase.
Maxfield: It's crazy. And what's even crazier is that most of that debt is backed by the federal government -- thereby, the federal taxpayers. To the same point, between 2008 and 2013, federal Pell Grants, which are those income-dependent grants that help underprivileged students -- or, what's the appropriate word... they're need-based grants -- have increased by 72% over the period of 2008 to 2013.
Lapera: Yeah. And just to give listeners some context, about 44% of Federal aids -- not just Pell Grants, but everything -- 44% of those end up in default, which is astounding. You might be sitting there thinking, "So, why are John and Gaby talking about this on my Financials podcast?" It's because there's a story that we've been ignoring in favor of the Wells Fargo story, which is the ITT Tech story.
Any listeners who are from the East Coast -- I'm not sure if this happened in other parts of the country -- will be familiar with ITT Tech. They ran late-night college ads. Austin, I don't know if you remember this? He's nodding his head yes. They have the exact same format. It's "Man who was sad because he cannot catch a break in life, images of his children sad at the dinner table. Then he goes to ITT Tech! Montage of people at school. Then he gets a job in IT! Montage of people in a corporate environment. Now his family is happy. Pictures of him and his happy kids." That's how it always went. But recently, ITT Tech shut down.
Maxfield: Or went bankrupt. They did it voluntarily. They basically lost their ability to get federal student loans guaranteed, which cut off a huge honey pot for the school. Let me bring up one more point. On the spectrum of schools, these for-profit schools like IT&T, and those educations...
Lapera: It's ITT.
Maxfield: Isn't that what I said?
Lapera: You said IT&T, which is like AT&T.
Maxfield: A nice little mantra; I'm sure AT&T will appreciate that. So, there's $1.4 trillion of outstanding student debt, a ton of it going to these for-profit schools. You cited that 44% statistic earlier. Think about this -- almost half of outstanding student loans in this country are either not being repaid as planned, or are behind in their payments. So the thought process is, in the financial crisis, the issue was, we had all these subprime mortgages that weren't being repaid. Now the conversation is, the same thing is going on in the student loan market. Since the financial crisis, student loans, to your point, have now exceeded auto debt, and now are second only to mortgages in the United States. That's the second-largest source of debt, and we're having these huge potential default issues in that pool of loans. Then you trace it back, as we will in this conversation, to ITT. You think, wow, there's some similar malfeasance going on in that market as there was in the mortgage market.
Lapera: Definitely. And this opens up a topic that I think we should talk about, which is the difference between for-profit and non-profit universities. Non-profit universities are going to be your state schools and your private schools. What differentiates them from for-profit universities is that non-profit schools have other sources of funding, like from the state and federal government, that doesn't involve just scholarships to students, but actual money that just goes to the school to keep the lights on, as well as endowments, especially for private colleges, and then, student tuition. And even for them, tuition rates have been going up, because since the financial crisis, the federal and state governments have not been able to contribute as much to the financing of the schools.
But for-profit universities do not have that. They are there to make money. Their ultimate authority are their shareholders, because they are private companies. And their only way of making money is via tuition, whether they get that from federal student aid -- ITT Tech got about 83% of the revenue from federal student aid. That's not unusual for for-profit universities. It hovers around 80% for a lot of them. Or they also get money through private loans that they originate, with huge interest rates on them.
The problem with for-profit universities is that, frequently, they don't have the students' best interests at heart, whereas non-profit universities can have more leeway in making sure that students actually get a good education, because in theory, they're not there just for the money.
Maxfield: And, you know what an interesting coincidence is, Gaby, you mentioned that, we've been talking the last couple weeks about Wells Fargo. It's a very similar situation here, isn't it? What would cause a for-profit university to maybe be more exploitative toward their constituents, i.e. their students, than a public university or a private university that isn't for profit? And the issue is, you have an additional set of stakeholders that the people who run these universities have to keep in mind. At a public university, your primary stakeholders are the students. At a for-profit university, your primary stakeholders are your shareholders.
That's important. The shareholders are the most important, and the reason they're the most important in terms of the executives of these companies is because these executives owe fiduciary duties to their shareholders. But they don't owe that same legal duty to their students, theoretically. So they're always going to pick the shareholders over the students. So what happens when you're picking your shareholders over your students? It means you're going exclusively for profit, as opposed to quality of education. And what we have seen in this whole ITT Tech debacle is that, basically, these companies are just going out there trying to maximize revenue in whatever way possible, whether that's jamming people full of loans that they can't afford that they under no circumstance can get, or reducing costs, and they reduce cost by reducing the quality of the education that they're providing. So, at the same time that they're maximizing revenue, they're cutting expenses. And that's great for shareholders -- at least, it was. Now it's obviously horrible for shareholders because they went to zero. But for students, it's an absolute nightmare.
Gaby Lapera has no position in any stocks mentioned. John Maxfield owns shares of Wells Fargo. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool has the following options: short October 2016 $50 calls on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.