Profit Motive Doesnt Mix With Education

By Markets

For-profit colleges and universities are under assault, losing critical access to funding that's necessary to stay alive. ITT Educational Serviceswas the latest and biggest victim, abruptly shutting down 130 of its campuses earlier this month and filing for bankruptcy.

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The Motley Fool's Gaby Lapera and John Maxfield discuss this and other aspects of for-profit education in this clip fromIndustry Focus: Financials.

A full transcript follows the video.

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This podcast was recorded on Sept. 26, 2016.

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Gaby Lapera: I don't know if people know, butstudent 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 dischargedin bankruptcy,which is crazy if you think about it.

John Maxfield:Yeah. Andthe other thing to keep in mind is that,when you think about all the things that are going onin the country right nowfrom an economic perspective,this is reflectedin the student loan issue. In fact, one could argue that that'swhat caused the whole student loan issue.Let me put some of this in perspective. Since the financial crisis,unemployment rates shot up, whichsent 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 hugestudent loan crisis has come from.

Lapera:Yeah,it's crazy. If you look at some of the figures,student loan debt has exceededautomobile loan debt, credit card debt. That's a lot of debt that's beensaddled on young people who are juststarting out. And sometimes,it doesn't really pan out.What you were saying about debt rising -- the average debt at graduationof 2015 was between $30,000-35,000. It was about $10,000 in the mid-'90s. That's a wild increase.

Maxfield:It'scrazy. And what's evencrazier is that most of that debtis backed by the federal government -- thereby, the federal taxpayers. To the same point,between 2008 and 2013,federal Pell Grants, which are thoseincome-dependent grantsthat help underprivileged students -- or, what's the appropriate word... they're need-based grants -- haveincreased by 72%over the period of 2008 to 2013.

Lapera:Yeah. Andjust to give listeners some context,about 44% of Federal aids -- not just Pell Grants, but everything -- 44% of those end up in default, which isastounding. You might be sitting there thinking, "So, why are John and Gabytalking about this on myFinancialspodcast?" It'sbecause there's a story that we've been ignoringin favor of theWells Fargostory,which is the ITTTech story.

Any listeners who arefrom 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-nightcollege 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 ofpeople in a corporate environment. Now his family is happy. Pictures of him and his happy kids." That'show it always went. But recently,ITT Tech shut down.

Maxfield:Or went bankrupt. They did it voluntarily. They basically losttheir ability to get federal student loansguaranteed, which cut offa 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 likeAT&T.

Maxfield:A nice little mantra; I'm sure AT&T will appreciate that. So, there's $1.4 trillionof outstanding student debt, a ton of itgoing 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. Whatdifferentiates them from for-profit universitiesis that non-profit schoolshave other sources of funding,like from the state and federal government,that doesn't involve just scholarships to students, but actual money that just goesto the school to keep the lights on,as well as endowments, especially forprivate 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 muchto the financing of the schools.

But for-profit universitiesdo not have that. They are there to make money. Theirultimate authority are their shareholders,because they are private companies. And their only way of making money is via tuition, whether they get that fromfederal 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 throughprivate loans thatthey originate, with huge interest rates on them.

Theproblem with for-profit universities is that, frequently, they don't have the students' best interestsat heart,whereas non-profit universitiescan 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-profituniversity to maybe be moreexploitativetoward 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 thatthe people who run these universities have to keep in mind. At a public university, yourprimary stakeholders are the students. At a for-profit university,your primary stakeholders are your shareholders.

That's important. The shareholders are the mostimportant, and the reason they're the most importantin terms of the executives of these companiesis because these executivesowefiduciary duties to theirshareholders. But they don't owe that samelegal duty to their students, theoretically. So they're always going to pick the shareholdersover the students. So what happens when you're picking your shareholdersover yourstudents? It means you're goingexclusively for profit,as opposed to quality of education. And what we have seenin this whole ITT Tech debacleis that, basically,these companies are just going out theretrying to maximize revenue inwhatever way possible,whether that's jamming people full of loans that they can't afford that they under no circumstance can get, orreducing costs, and they reduce cost by reducing the quality of the education that they're providing. So, atthe same time that they're maximizing revenue, they're cutting expenses. Andthat's great for shareholders -- at least, it was. Now it's obviously horriblefor 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.