Sunday, May 13, 2007

The Scandalous Student Loan Scandal

The student loan scandal concerns the fact that many colleges and universities chose preferred lenders for financing student loans and then received remuneration for their recommendations from the lenders. The scandal has been going on since mid-March. Thus, it is startling to learn that it was not until April 30 that any evidence was provided concerning how anyone might have been harmed by the practice.

The New York Times of May 1
reports that Pratt Institute, a New York college of art and design, had temporarily entered into an arrangement in which a lender was charging students a rate of interest of 15 percent, a rate supposedly far above that available elsewhere. Apparently on its own, the school cancelled the arrangement and stopped recommending the lender. The lender had not given any compensation to Pratt but had instead agreed to “provide grant money for needy students.” (The article also appears on p. A17 of The Times’ Metropolitan Edition.)

“Details of the arrangement, and its cancellation,” The Times informed its readers, “were disclosed yesterday [April 30] by Pratt and Attorney General Andrew M. Cuomo of New York.” The Times then went on to state that “Pratt’s findings that its students were being charged such high interest rates are the first evidence to emerge from Mr. Cuomo’s inquiry showing how students could have suffered from undisclosed arrangements between universities and lenders that the attorney general has branded a conflict of interest.” (My italics.)

The meaning of this is that we had the spectacle of a public scandal going on for over a month without any evidence to justify it.

If one thinks about it, there is no difference in principle between a college or university receiving compensation from lenders that it recommends and compensation from dining halls and bookstores that it recommends. (There are undoubtedly many cases in which campus dining halls and bookstores are not owned or operated by the schools whose students they serve. Yet their location on campus serves as an extremely powerful recommendation of them by the school. The schools, of course, derive income from these establishments.)

And just as in those cases, the compensation to the school should normally be expected to derive from the lower costs of operation for the suppliers that the recommendations make possible, not from higher prices to customers, in this case, interest rates to students. This may not always be the case, as in the above-mentioned instance of Pratt Institute, but it is certainly very often the case, and probably is the case most of the time. This is because the preferred lenders enjoy reduced marketing expenses, for example. Similarly, the dining halls and bookstores benefit from the greater volume of business the school’s recommendation gives them, and consequently they have lower unit costs.

In all such instances, the recipients of the school’s recommendation have no need to charge more. They are in a position to share with the school part of the additional profits resulting from lower costs. Moreover, exercise of the most elementary degree of conscientiousness on the part of the school would normally serve to guarantee that charges to its students were competitive. Indeed, in order to be sure of capturing the volume of business that their preferred position and consequent lower costs opens up to them, preferred providers will often find it to their interest to charge less than most others. Charging lower prices or interest rates is the means by which their lower costs translate into a competitive advantage over other suppliers.

Finally, competition from firms not recommended always serves to strictly limit what can be charged by those who receive the recommendations. There is no more reason to prohibit schools from recommending lenders on the grounds that students will be charged higher interest rates than there is to prohibit them from recommending dining halls and bookstores on the grounds that these establishments will charge higher prices for the meals and textbooks that they sell. The student’s simple and obvious safeguard in all such cases is to look at what others are charging. If semester after semester it does not occur to a student to do this, then perhaps he is simply not qualified for college.

What is present in the schools’ receipt of payments for their recommendations is nothing other than the normal workings of an economic system that is based on the profit motive and trade to mutual advantage. When one party benefits another, he should normally expect payment in return. That is all that is present here. And, as I’ve indicated, contrary to the expectations of The New York Times and its reporters, and of most government officials, profits and the profit motive, in combination with competition, do not serve to make goods more expensive but less expensive.

It is difficult to resist the conclusion that what is actually being complained of in this instance and in so many others is the fact that under capitalism a supplier works for his own profit and is not the sacrificial slave of the buyer. It is ironic that in the present case, the victims of this anti-capitalistic attitude are colleges and universities. What is ironic is that they systematically instill such anti-capitalistic attitudes in practically every course they offer. There is thus a measure of justice in the fact that in this instance their teachings have been put to use against them.

This article is copyright © 2007 by George Reisman. Permission is hereby granted to reproduce and distribute it electronically and in print, other than as part of a book and provided that mention of the author’s web site is included. (Email notification is requested.) All other rights reserved. George Reisman is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics.