The Coming College Bubble?

Maurna R. Desmond
Forbes

America's undercapitalized independent schools could be the next industry to pop.

In June, 157-year-old Antioch College decided to "suspend operations" at its flagship campus despite a push from alumni to rescue the flailing institution. At that point, only 60 students were enrolled, and their $40,000 per year tuition was being heavily subsidized by Antioch's five newer campuses.

Antioch Chancellor Toni Murdock said the plug had to be pulled. "It was a downward spiral where fewer students led to fewer professors, and eventually the deficit was projected to be so large that the other schools no longer wanted to subsidize their mother school."

They may soon have company. Home builders and banks aren't the only ones facing economic headwinds these days. America's undercapitalized independent colleges are staring at a spiral of major threats to solvency as penny-pinching students and parents consider cheaper options, and funding sources dry up. As a result, they could be the next bubble industry to pop.

The crush is coming fast. According to a September 2008 study by the National Association of Independent Colleges and Universities, of the 504 member institutions surveyed, one-third said the credit crunch had hurt enrollment, and about a fifth of respondents said they had fewer returning students than expected. Roughly the same number said they had a smaller incoming freshman class than expected.

But while head counts slide, needs rise. Demand for student aid is up, but charitable donations from foundations and individuals will fall during a downturn. Ditto for investment returns. And thanks to tanking tax revenue, federal aid may take a hit, too. Taken together, many independent institutions start to look vulnerable. "They are financially precarious for sure," says Sandy Baum, a Skidmore College economist and senior policy analyst at the College Board.

"Country Club" Closed?

The crunch will be particularly bitter for the institutions that drained coffers to build "country club colleges" complete with luxury dormitories, spas and top of the line sports complexes to lure choice students, hoping that a sharper crowd would lead to more accretive diplomas, entering a profitable cycle of more successful alumni and increased donations.

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Many had little choice. "If a college decides we're not going to have fancy dorms or build a shiny new gym, students are not going to that college," says Baum. "People are not choosing the lowest price college, and that's a consumer issue, not a public policy problem."

Adds William Powers, the president of the University of Texas at Austin: "The market is choosing quality regardless of incremental costs."

Blowing Bubbles

This is at a price. College tuition has increased by more than three times the rate of inflation for the last 20 years, despite U.S. wages flat-lining since 2000. The average tuition at a private four-year institution grew 6.6% year-over-year in 2007 to $23,712, according to the College Board. This is pricey in itself, but when you add in all the luxe living expenses, the total bill touches $50,000 a year at the high end.

To the chagrin of financial advisers, students are increasingly turning to higher interest private loans to meet the burgeoning college bill. Private loans made up 24% of total education loans in 2006-07, up from 6% a decade ago. In 2008, students secured $20 billion in private loans--amounting to roughly a fifth of total undergraduate borrowings for the year. Taxpayers pony up, too, chipping in an average $4,000 per student through government loans and grants to private institutions, which usually come up with $3,720 in aid (often in the form of discounted tuitions) as well.It's a scenario familiar to anyone who watched the housing bubble blow. "We are at a trend line that cannot be sustained," says Matt Snowling, an analyst at Friedman, Billings and Ramsey, who covers the student loan industry. "Tuition must go down, or there will be limited demand at high-priced private schools."

Not Everyone

Yet for many schools, tuition is the lifeblood of their finances. There isn't much to fall back on. In 2006, the College Board reported the wealthiest 10% of private four-year colleges and universities had an estimated average of about $454,100 in endowments per student, compared to about $15,000 at median institutions.

Larger academic systems with deep capital reserves, like the University of California or the 28 Jesuit institutions in the U.S., are in much better shape. At UT Austin--a public university in a state with a $12 billion budget surplus and a football program that brings in $5 million a year--the only cuts Powers is looking to make involve thinning out the number of five- and six-year undergraduate seniors on his campus. Getting students to graduate "expeditiously" saves a bundle, he says.

Consolidation Is Coming

Private colleges will be the next fragmented industry to consolidate as a result of this over-expansion, says Terry McCarthy, a managing director at executive search firm Horton International, in much the same way large hospital groups rolled up smaller and weaker rivals in the 1990s.

Absorption by stronger and possibly more academically recognizable universities will be good news for some schools. The trouble, he says, is that students who hold diplomas from the then defunct universities will risk a "loss of recognition" in their quality of education.

Others will fight the trend, too. "Particularly for schools that are financially weak, you might see some mergers," says Joel Seligman, president at the University of Rochester. "But faculty who are powerful at universities resist mergers because they have a lot to lose."

Resistance may prove difficult. Pinched students and parents are likely to be more curious about whether prospective institutions are at risk of going bust. Expect to see college marketing materials with increased emphasis on growing enrollment, robust endowments and healthy long-term financial prospects.

Antioch's Murdock sees opportunity in the troubles ahead. "Now we're developing a growth move because of the programs we offer for professional adults," she says. "Perhaps we'll merge with other campuses that are in trouble."