Run a Google search on “university debt” and you will be overwhelmed by stories concerning the growing mountain of student loan debt; projected to top £1.2 trillion by 2049. With an eye-watering (in the post-2008 climate) interest rate of 6.3 percent, there are serious concerns about graduates ability to repay loans and purchase houses and raise families; and the impact this will have on the wider economy.
There is, however, another university debt bubble that looks for all the world like a Ponzi scheme. This is the way in which universities themselves are funded. This results from the usual desire of the British affluent classes for Scandinavian public services on US rates of taxation… that is, they have always wanted someone else to pick up the tab.
Political pressure for the expansion of the university sector has a long history. As Keith Burnett at the Financial Times points out:
“Two world wars created the desperate need for people trained for a new world where science, engineering and mathematics was fundamental to defence and wealth. A new generation started on the path to a well-paid career by studying for degrees that would have been irrelevant to and beyond the ambitions of their parents. The grammar school boys and girls of the postwar years created an image of university as a focus for the hopes of ordinary families.
“The path was still narrow, but there was a crock of gold at the end. So parents whose offspring were still excluded looked at the prosperity of university graduates, and said: ‘More please’.”
In the 1970s, pressure for further expansion resulted in the incorporation of polytechnics and HE colleges into the university sector. However, by the early 1980s this expansion put pressure on public finances leading to various tinkering around the edge of the student grant system (for example, married and mature student grants were abolished) and growing pressure to move from grants to student loans. Even the Thatcher government, however, baulked at introducing loans to cover tuition fees. That additional burden had to wait for the Blair government’s decision to expand the university sector to cover 50 percent of the population.
It goes without saying that Blair’s calculations had less to do with the value of a university education and more to do with the large Millennials generation reaching voting age in the early 2000s – providing Labour with a potential block of voters with which to combat the pro-Tory pensioners. The trouble was that education is susceptible to the same laws of supply and demand as the rest of the economy; as Burnett notes:
“The economy, meanwhile, is no longer absorbing the supply of graduate recruits at the same rate. The first generation of grammar school graduates had emerged to take new jobs created in a booming economy. Their successors were still well off. But as more graduates emerged, and as the global economy changed, the financial advantage in life of a degree was bound to drop off.”
The problem was compounded after 2010 as a result of George Osborne’s desire to shrink the government deficit without really shrinking it. As Michael Forsyth (Lord Forsyth of Drumlean) chair of the House of Lords’ Economic Affairs Committee explains:
“When higher education was reformed in 2012, overall funding increased by £3bn but with higher tuition fees and student loans replacing direct grants, George Osborne was able to record a reduction in the deficit of £3.8bn. This magic money tree has a lifecycle of over 30 years: around £16bn was lent by the Government to the 2017/18 cohort of students, it is estimated that almost half of this will never be paid back but these write-offs will only show up in the deficit at the end of the loan term which is 30 years after graduation. This generation of students who are graduating with around £50,000 of debt will therefore be hit twice: they will be the taxpayers in the 2040s and 50s who a future government will have to ask to foot the eventual bill (by this point the total student loan book will be worth £1.2 trillion in nominal terms).”
To add to the problem, Osborne’s LibDem coalition partners, having lost their political credibility over a broken promise to abolish tuition fees, insisted that Osborne impose a cap of £9,000. Although this was supposed to be the maximum fee, in practice each potential student became a new kind of currency worth £9,000 to whichever university could snap them up. Moreover, this direct income could be leveraged by universities smart enough to enter into pacts with the private sector devil to provide purpose-built student accommodation (which is generally preferable to rooms in private rented houses). The average UK student leaves university owing £50,000 – £27,000 for tuition fees and £23,000 in living expenses (largely rent).
The problem for most universities was that they had been built to accommodate far fewer students. In order to meet government targets (and to maximise their income) they needed to expand. But expansion required new facilities and new accommodation. This, however, could only be afforded after the universities had received payment from their students. To square this circle, the universities did what most businesses are encouraged to do; they went to the banks and asked for loans.
According to Universities UK (the sector’s trade association) debt had risen to 28.1 percent of universities’ income by 2015; and was expected to reach 30.4 percent by 2017. In an article for International Financing Review last October, Gareth Gore paints a more troubling picture of university debt too risky to be taken on by the banks:
“The market is growing fast. University debt has trebled over the past decade to £12bn, and much of that growth has come through private placements. With banks, traditionally the biggest lender to the sector, pulling back because of new capital rules, and the European Investment Bank – which has funded £2bn of projects over the years – halting new loans because of Brexit, private funding deals are in big demand.”
To service these debts, however, universities need to bring in ever more new students with each intake. But this expansion comes with costs of its own. As the Guardian reported last May:
“Ever since tuition fees rose to £9,000 in 2012, UK universities have seen a fall in real-terms funding. To plug the gap, oversubscribed institutions sought to rapidly expand when the government lifted the student numbers cap. There is startling confirmation of this in recent figures: between 2011 and 2016, Aston University grew by 80%, Coventry University by 53% and Surrey by 50%.
“But this is a short-sighted decision that risks growing tensions between the university and its local community and damaging student wellbeing. Universities have more to lose than they are perhaps prepared to accept.”
The problem with those walking £9,000 units of new currency that the universities were depending on was that they also had the choice to walk away. As Gore notes:
“Access to new sources of capital has become especially important for lower-ranked universities, some of which continue to run big operating deficits. With the potential pool of UK students expected to fall by about 200,000 by 2021 (due to demographic changes), Brexit looming (which could cut demand from foreigners), and government funding being cut, the market gives them the option to invest so as to remain competitive…
“But concerns are beginning to grow about some of the deals that have taken place. In some cases, already heavily indebted universities running large deficits have been able to raise new funds in the private placement market. A growing assumption among investors is that the government will step in if a university ever gets into difficulties. Moral hazard, it seems, is very much alive and well.”
Government policy, however, is that any university that cannot service its debts will be allowed to fail. In reality, of course, top-tier universities like Oxford and Cambridge will be treated as too big to fail. Nevertheless, responding to concerns about a recent £900,000 bailout of an unnamed university last year, Michael Barber, chair of the new Office for Students (OfS) is reported to have stated that:
“The OfS will not bail out providers in financial difficulty. This kind of thinking – not unlike the ‘too big to fail’ idea among the banks – will lead to poor decision-making and a lack of financial discipline.
“Should a university or other higher education provider find themselves at risk of closure, our role will be to protect students’ interests … [but] we will not step in to prop up a failing provider.”
The organisations financing the debts run up by the university sector are taking a huge gamble that Barber will be forced to eat his words when one or more of Britain’s universities goes to the wall; as is looking increasingly likely due to three key demographic trends:
First, and most obviously, the Millennial generation has finished university, and Generation Z is a lot smaller. This alone spells trouble for universities whose students’ tuition fees are their primary means of servicing their debts.
Second, as noted by Burnett, the economic value of a degree (particularly from lower tier universities) is decreasing even as the debt required to attend is rising. As a result, a greater proportion of Generation Z is looking to apprenticeships and on-the-job training as a better career option.
Least obvious of all is an often unreported divide within the Baby boomer generation. While the early boomers fared extremely well from the expansion of grammar schools and universities coupled to the unprecedented economic boom between 1953 and 1973, the late boomers (born between 1958 and 1965) were the test group for comprehensive education, and left school just in time to reap the bitter fruit of the inflationary late-1970s and recessionary early 1980s. In a research paper on the student property market, James Pullan points out that:
“In the longer term, the capacity within the ‘bank of mum and dad’ is likely to diminish significantly due to lower housing related wealth within the younger ‘baby boomers’.”
The combination of these three trends is already impacting some UK universities, as Pullan warns:
“Research conducted by Knight Frank highlights this. A ‘flight to quality’ in recent years has resulted in a fall in full-time student numbers at lower tariff universities, while generally the opposite has been true for higher tariff institutions.”
This morning’s Times (paywall) reports that:
“Universities have been warned that they are on the brink of a ‘credit crunch’ after embarking on a record borrowing spree despite deep uncertainty over their financial future. The sector’s debts have risen over the past year to £10.8 billion, three times more than before the financial crash.”
That credit crunch will be realised when the first university declares insolvency and the ragtag band of shadow banking organisations that have been providing the loans make a run for the exits. Whether this happens this year or next is a moot point. However, we can say with certainly that it is going to happen sooner or later simply because that is what happens to all Ponzi schemes in the end. And to be clear, any business/financial arrangement that depends upon expanding the base of the pyramid in order to pay off the debts it already owes is, to all intents and purposes a Ponzi scheme.
The irony, of course, is that the Ponzi finance sector may be about to do to the UK university sector what successive governments of all persuasions lacked the spine to do. Sooner or later the British affluent class was always going to have to choose either US-style taxes and a US-style absence of services or Scandinavian services at Scandinavian rates of tax. When the university debt bubble bursts, whichever cabal of politicians happen to be in government will have to choose between universities being “too big to fail” and funding them in future out of general taxation, or universities being too expensive to save and allowing all but the top-tier institutions to remain in business. Either way, business as usual is no longer an option.
As you made it to the end…
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