The seeds of for-profit education were sown by the 1965 Higher Education Act. Title IV of that act provided federal funds to be made available for student loans. Since then, the industry has grown quickly and the vast majority of revenue has come from student tuitions paid for with those federal loans. This has led -- as industry critics charge -- to situations where students are coerced into applying for loans to get degrees in disciplines where they are unlikely to find work. Many of these students end up dropping out and defaulting on those loans, creating a bad credit record for themselves, and leaving taxpayers holding the bag for those bad loans. The only winners are the for-profit schools.
Defaults on those student loans have been increasing and have led to intensified scrutiny of the industry's enrollment practices. The Government Accountability Office even went undercover and found deceptive claims and fraud common in the recruitment of students. Sen. Tom Harkin (D-Iowa) held hearings last year on the for-profit education industry and added: "The whole business model of the for-profit school industry depends on taxpayer money."
Thus, the Education Department's proposed regulations include a ban on the practice of tying a recruiter's compensation to "putting asses in classes," as a Senate witness so delicately told the Harkin committee last September.
Congress has chastised the industry before. A 1991 document known as the Nunn Report accused some for-profit institutions of abuse, including "unethical and/or illegal recruitment efforts." This report led to a ban in the 1992 HEA reauthorization bill on the practice of giving a "commission, bonus, or other incentive payment [based on] securing enrollments or financial aid to any person ... engaged in any student financial recruiting or admission activities." However, loopholes were created in the regulation in 2002.
Limbo wrapped in uncertainty
The industry has been extremely profitable as a whole, but not knowing what the final form of the Title IV rule changes will be (if any) has taken its toll. The University of Phoenix has seen a 45% decrease in new student enrollment over last year, and other for-profits have taken enrollment hits as well. Apollo, Career Education
For those holding education stocks and for those interested in buying some, what to do? Will tougher rules completely strangle profits enough to kill the industry? Or will nothing change? More likely, an ugly compromise will be worked out pleasing neither side totally, but making it harder for the weaker for-profits to stay in business. For now, if you are holding on to a company you think is a survivor, maybe holding on a while longer is in order. If you are contemplating buying in, perhaps a wait-and-see posture is the wiser option.
Fool contributor Dan Radovsky owns shares of Strayer Education. 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.