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INSIGHTS BLOG > Playing the Financial Aid Game

Playing the Financial Aid Game

Written on 31 May 2010

Ruth Fisher, PhD. by Ruth Fisher, PhD

Clash between Ideology and Reality

The Financial Aid Game

What's the Value of Attending College?


A recent article in the NYT, “Placing the Blame as Students Are Buried in Debt” by Ron Lieber, presents the case of a woman who graduated from NYU with $100,000 in student loans, and who is having great difficulty paying the loans back.

Mr. Lieber recognizes why the schools would resist counseling students against attending based on financial aid considerations:

Colleges don’t always know how much debt its students are taking on, which makes it hard to offer good counsel…

Then there’s a branding problem. Urging students to attend a cheaper college or leave altogether suggests a lack of confidence about the earning potential of alumni. Nobody wants to admit that. And once a university starts encouraging middle-class students to go elsewhere, it must fill its classes with more children of the wealthy and a much smaller number of low-income students to whom it can afford to offer enormous scholarships. That’s hardly an ideal outcome either.

Finally, universities exist to enroll students, not turn them away…

Mr. Lieber does fault parents and lenders for allowing students to take on heavy loan burdens that the students may have great difficulties in paying pack:

[T]here are so many people like her facing decades of payments, limited capacity to buy a home and a debt burden that can repel potential life partners. For starters, it’s a shared failure of parenting -- [“How could her mother have let her run up that debt, and why didn’t she try to make her daughter transfer to, say, the best school in the much cheaper state university system in New York?”] -- and loan underwriting -- [“plenty of lenders will step forward to roll the dice on desperate students, especially because the students generally can’t get rid of the debt in bankruptcy court”].

In the end, though, Mr. Lieber makes the case that the financial aid office is in the best position of advising students as to the appropriateness of them taking on massive student loans:

But perhaps the biggest share lies with colleges and universities because they have the most knowledge of the financial aid process. And I would argue that they had an obligation to counsel students … who got in too far over their heads… The financial aid office often has the best picture of what students … are up against, because they see their families’ financial situation splayed out on the federal financial aid form… University officials should take on this obligation, even if they aren’t willing to advise students to attend another college…


Clash between Ideology and Reality

When it comes to providing higher education, there is an obvious clash between ideology and reality.  Ideologically, everyone should have the opportunity to get the best education they can, and everyone should be encouraged to follow their bliss (i.e., make their career choice based on doing what they love rather than on doing what will pay the rent).  In reality, though, resources (e.g., space in schools, funds to pay for education, availability of jobs) are limited, and as such, society cannot afford to provide the best education available to everyone and to have each student educated in the areas of his or her choosing.

A less obvious clash between ideology and reality occurs with the timing of education.  Ideologically, education should be delayed until students are emotionally and financially prepared to make the most of their time in school.  In reality, however, the best time for students to become educated occurs at the earlier stages of their lives, so that they have the most time to benefit from their education.  In other words, the best time for students to attend college is precisely at that time when they’re least able to afford it, and perhaps also at that time when they’re least prepared (emotionally) to extract the greatest amount of benefits from their education.

From a social standpoint, given that resources are limited, how should society determine who gets to fill the most prestigious spots?  If the best spots go to those who can afford to pay the costs of their education (price-based allocation), then society will end up favoring (and perhaps perpetuating) the rich over the poor.  Alternatively, if the best spots go to those who have achieved the most by the time they reach college age (merit-based allocation), then society will end up favoring those with better access to quality teaching, those with access to better or more varied extracurricular activities, and those who mature earlier, which, arguably, again favors the rich over the poor.

Furthermore, from a social standpoint, given that resources are limited, should society encourage students to study those subjects they enjoy the most, or should society encourage students to study those subjects that will best prepare them to be “good” social citizens (how do you define “good”?)?

So even if we decide to use a system that allocates students to schools based optimizing social welfare, it’s not clear where each student should end up.  In particular, the results will strongly depend upon the amount of resources a society has (i.e., the extent to which society can afford need-based aid), the degree to which society values “happy” citizens (i.e., the extent to which students should be encouraged to study what they like vs. what will make them “good” citizens), and what society values (the extent to which businessmen or technicians earn more money than do artists and teachers).


The Financial Aid Game

Returning to the issue at the heart of the article – who should be responsible for making sure students’ education decisions do not leave them overly financially burdened – the article’s author, Mr. Lieber, makes the case for legal efficiency.  That is, society should place the responsibility for making rational financial aid decisions on the party who in the best position to make the right decision.

The financial aid office often has the best picture of what students … are up against, because they see their families’ financial situation splayed out on the federal financial aid form.

You have to admit that ideologically, this makes sense.  But will it work in reality?

Before we can be assured that assigning financial aid offices the responsibility of making sure students make “good” education choices will actually get us to the best available social outcome, we need to make sure that such a system would not suffer from conflicts of interest.  More specifically, we need to understand the schools’ objectives and incentives.  Because ultimately, if the schools’ objectives and incentives lead them to take actions that clash with their proposed legal responsibility, then we cannot be assured that the schools will actually end up “doing what’s right” from a social perspective.  And to understand what the schools are faced with, we need to also look at the objectives and incentives faced by the other players involved in the financial aid game.

Setup of the Financial Aid Game

The players in the financial aid game, along with their objectives and issues, are:

1.  The students who attend the colleges and universities ("the students"):  Each student applicant must choose which school to attend, given the value of the education each school will provide for the student’s expected field of study, together with the (ultimate) cost of being educated at each school.

Areas of uncertainty for students (and their parents) that might cause the students’ actual (ex post) outcomes to differ from their expected (ex ante) outcomes include:

•  Students might overestimate the value of attending any particular school:

      --  Students might not end up getting a job in their desired area after they leave school (whether or not they end up graduating);

      --  Students might not end up earning as much money as they thought they would;

•  Students might underestimate the ultimate cost of attending any particular school;

•  Students might not actually end up graduating from a particular school.

2.  The colleges and universities that educate students and provide students with (some) financial aid ("the schools"):  For each set of student applicants, each school must choose which students to admit and how much financial aid to offer each student to maximize the value of the school.

The value (prestige) of a school will be greater when

•  The school attracts smarter (or richer?) students;

•  The school attracts more renowned professors;

•  The student body (and faculty) is more diverse;

•  The school has higher graduation rates;

•  The school's alumni become successful;

•  The school is able to meet its budget requirements by:

--  Generating tuition from wealthier students;

--  Generating subsidies from government;

--  Generating donations from alumni;

--  Generating grants from sponsors.

When making their decisions as to which students to grant admission to and how much aid to offer, schools guide their decisions by taking advantage of historical information they have collected on

•  Enrolled students’ demographic and financial backgrounds

•  Enrolled students’ graduation rates,

•  Past students’ job placement, whether they graduate or not,

•  Past students’ success and failure rates for repayment of school-granted financial aid.

A school may err in predictions regarding the ultimate success or failure of any particular student if the school over- or underestimates that particular student’s motivation or drive.

3.  3rd party (non-school) providers of financial aid to the students ("3rd party lenders"):  Each 3rd party lender must choose which students to grant financial aid to and how much aid to grant to maximize company profits.

When making their decisions as to how much aid to offer each particular student, 3rd party lenders guide their decisions by taking advantage of historical information they have collected on past students’ success and failure rates for repayment of 3rd party financial aid.

This situation forms a game because each of the (sets of) players is independent from the others, each faces his own set of incentives, and each takes actions to optimize his own outcome (profit or well-being).  Yet, the outcome achieved by each player depends on the actions taken by the other players.  That is, while the players are independent entities, free to take whatever actions they choose, they are each dependent upon the others players and the actions these other players take for their outcomes.  The questions thus become: What actions will each player be led to take, and what will be the outcomes of the game?



What’s the Value of Attending College?

The issue at hand is who should bear the responsibility of making sure the student doesn’t get in over his head by amassing “too much” student debt.

How much student debt is “too much”?  Clearly, it’s not the absolute cost of attending the school (loans required) that’s most relevant, but rather, the amount of loans amassed relative to the value that will be generated by the student as a result of attending the school.  If the value a student can generate is substantial enough as compared with the debt, then even larger debts will not necessarily become too burdensome for students to pay off.

Start with the costs.  Certainly everyone would agree that the schools should be required to fully disclose the expected costs to the students of attending the schools, including the costs of tuition and any student fees, room and board, books, and incidentals.  The costs will obviously vary depending on the number and nature of the classes the student takes, as well as the lifestyle the student chooses to maintain.  However, the school should be able to provide either the costs incurred by the average student or a range of costs incurred by the majority of students.  But after that, surely the schools can’t be held responsible for particular students who are given this information but then subsequently underestimate the costs to them of attending the schools.

Let’s move now to value.  Clearly, both the schools and their students benefit from having the students get the most value out of their educations possible – the students become more “successful” (however you define that) and perhaps have an easier time financing their student loans, and the schools gain prestige and perhaps more alumni donations.  So there’s no conflict there.

But how do you quantify the value that any particular student will generate from attending any given school?  Is the value objective?  Is the value the same from each party’s perspective?  Is the value dependent upon the student at issue?  Will the expected (ex ante) value generally coincide with the eventual (ex post) value?  Does the school know what value that the student at issue will generate from attending that school?

Ah!  There’s the rub!

Consider various aspects of the value associated with someone getting attending college:

•  The value obtained by the student:

--  Higher income from being able to get a better job

--  The psychic value associated with being able to take specific classes

--  The psychic value associated with being taught by specific professors

--  The value associated with learning from specific students (peer education)

--  The current and future value associated with meeting specific students and having them as future contacts

--  The future (name brand) value (of opportunities to come) associated with attending that school

•  The value obtained by the school:

--  The prestige value associated with attracting that student

--  The value of education that student provides other students

--  The value of government/3rd party grants/subsidies generated as a result of educating that student

--  The value of future alumni support from that student

•  The value obtained by society (a rising tide lifts all boats)

From this list of the various aspects of the value associated with a particular student attending a particular school, it becomes clear that the value from the student’s perspective is different from that from the school’s perspective.  Moreover, when a school offers a student admission, it provides that student with an opportunity.  What the student ends up doing with the opportunity is up to the student.  Furthermore, the value eventually obtained from attending a given school can differ quite radically from the ex ante expected value, depending on the actions the student takes and the opportunities that end up presenting themselves.

It’s now clear that while the school has information on the ex post success of past alumni (graduation rates, loan payback rates, donation rates), that success is no doubt highly variable across students, it is difficult to predict for any particular student, and it is dependent upon the situations of the particular student (his background, the actions he took during and after the time he spent in school, and the opportunities with which he was subsequently faced, etc.).

So what we are left with is that the schools can be required to inform the students of the costs of attending the school, and it can be required to make certain types of statistics (e.g., graduation rates, job placement rates, starting salaries) available to the students for them to consider.  However, in the end what ultimately happens with the students regarding their future success (or lack thereof) is really dependent upon the particular student.  Therefore, it seems to me that since it is the students who control the outcome much more so than the students, it should be the students and not the schools who bear the ultimate responsibility of financial decisions.