Tick . . . Tock: The Growing College Debt Crisis

Dennis Cariello, a lawyer and former US Department of Education senior administrator writing in The Hill this week, offered a sober and troubling assessment of the growing college debt crisis.

In his article, Mr. Cariello notes that American colleges and universities face heightened financial pressures as the Great Recession sputters to an end. He reports that college leadership is severely constrained by college enrollments down by one million students nationwide since 2012, discount rates – or the subsidy that colleges pay through discounted tuition to put students in their seats – rising, and technology innovations and the cost of campus wide capital investments.

To support his assertion, Cariello cites a Bain & Company study that suggests that over sixty percent of American colleges and universities are on an “unsustainable financial path” or at financial risk.

To address this situation, Cariello proposes a change in the law to allow American universities to restructure themselves through bankruptcy. He argues that “despite the general nondiscrimination provision in the bankruptcy code, changes in the Higher Education Act in 1992 require that a college filing for bankruptcy immediately and irrevocably loses access to the federal loans and grants authorized under Title IV of the HEA (Higher Education Act).”

Cariello points to the relationships between lenders and regulators to illustrate this escalating problem. Lenders know that a college-declared bankruptcy will reduce the value of the institution, making debt collection far more difficult. As the economics worsen, regulators concerned about the college’s financial health add new regulatory demands and financial restrictions effectively creating a “death spiral.”

To provide relief, Cariello makes four suggestions in an effort to preserve the American system of higher education. First, institutions cannot walk away from debt to the US Department of Education through bankruptcy. Second, colleges facing bankruptcy would seek new leadership, as current boards would resign or be replaced. Third, any process should rely on the standards already established in the existing bankruptcy process. And finally, students must be assured that they can complete their education, allowing the institution and student to operate “as if nothing happened at all.”

Cariello’s well-intentioned proposal is likely to be simultaneously interesting and frightening to college leadership.

At first read, the idea that colleges could restructure through bankruptcy might appeal to many institutional leaders as a way to force changes that would be otherwise unacceptable within shared governance, especially to staff and faculty rightfully fearful of program disruption, department closings and faculty and staff pink slips.

But the cold reality is that a legal and bureaucratic solution must also account for consumer preferences, where most families have a financial stake in the education of their children. Would you send your child to a restructuring college publicly branded as bankrupt?

Additionally, there is a strong two-part message in Cariello’s argument that college and university leadership should note.

It is widely known in higher education circles that lenders and their consultants have been discussing what leverage they might have as the holders of the college “paper.” Sometimes debt provisions can be made explicit. Still, there are other ways to force change to protect investment, particularly with “at risk” colleges and universities whose options are limited. For some colleges, it’s not always possible to shop debt if there are few takers.

If the comprehensive fee revenue is flat or declining, then decreasing cash flow makes the level of debt payment – and the need to restructure it to provide cash flow relief – that much more critical.

Trustees should arguably be the principal consumers of Cariello’s message. At the heart of it is his belief that replacing leadership – including trustee leadership – is a first step in restructuring. There’s a case to be made for trustee negligence at nearly bankrupt colleges and universities. It is logical and quite fair to ask not only how bankruptcy happened but also who is responsible.

Obviously, faculty leadership and administrative staff – including the president – shoulder their share of responsibility. But, trustees are the institution’s financial stewards and annually approve the level of debt as well as the operating and capital budgets. While there can be many levels of pressure over which an institution has little control that can lead to bankruptcy, the failure of trustee leadership is perhaps the principal culprit in a potential bankruptcy decision.

One recently retired college president e-mailed me this week to speculate if restructuring debt was just another way to kick the can further down the road. He raises a critical additional argument as well to suggest that colleges that do not break out of their age-old operational models will only marginally extend the life of an institution already unable to respond to flat or declining revenues.

It is historically hard to “fail” a college. Over the next decade, however, many may close or where possible merge while maintaining wide green lawns and nearly full dorms, as the discounted tuition rate soars above sixty percent. Consumers will be surprised as the American higher education system contracts and regroups adding further instability into the higher education consumer market. And it is entirely possible that a combination of factors, including the inability to pay back an unsustainable level of debt, could crash the financial house of cards altogether.

The growing college debt crisis is a symptom of a much larger problem. What happens when the governance in place relies upon short term fixes like debt to fuel an operational model that no longer works?

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