After the student loan arms race: the disruption of hierarchy

Cassandra Burke Robertson

I am grateful to Renee Knake for organizing this online symposium and for including me as a participant. In a former life before I went to law school and entered legal academia, I was a state budget analyst. Perhaps as a result, the financial realities of funding legal education have become something of a preoccupation of mine, and I am thrilled to see the financial issues—especially funding mechanisms and financial outcomes for graduates—getting more attention.

In this post, I will take a look at the current state of student debt—and in particular, how the student-loan-fueled arms race relates to the law school prestige hierarchy. I conclude that changing the student loan system (a prospect some say is inevitable) will disrupt the traditional prestige hierarchy in some significant ways.

People are beginning to realize the impact of rapidly growing student loans on students and graduates. The Occupy Wall Street movement has brought significant attention to the student debt problem, and the legal world has taken note of recent grads whose extreme debt loads prevented them from passing the bar’s character and fitness evaluation.  But what institutional effect do these loans have on legal education itself? 

To understand the institutional effect, we have to look at some of the factors that have brought us to where we are now:

(1)   Students can take out the full cost of attendance in federal student loans. This means that at least for law school, the days of private loans are gone (and this is new; even 5-6 years ago, law students generally relied on private loans to some degree). The cost of attendance includes both tuition and living expenses. If a school raises tuition, a student can take out a larger loan to meet the increased tuition. There are no restrictions on how much can be taken out by a student beyond the cost-of-attendance limit; as Paul Campos has pointed out, “This means that most law students can borrow the full cost of law school tuition and living expenses from the federal government . . . no matter how high that cost may be.” Loans for living expenses will vary widely depending on the relative cost of living in the area.

(2)   Historically, law school applicants have been much more prestige-conscious than price-conscious. A recent article by Richard Sander and Jane Yakowitz found that “when students are deciding between schools of even modestly different levels of eliteness, ranking tends to drive decisions,” even though school rank was a relatively weak predictor of students’ career success. This emphasis on prestige has made law school choice fairly price-inelastic; higher-ranked schools could raise tuition without losing a corresponding number of students.

(3)   The US News rankings reward higher tuition levels by including a metric for "Expenditures Per Student,” which includes financial aid spent on students. So a school that raises tuition and raises financial aid at the same time does better in the rankings; it brings in more money to raise its expenditure per student. Law school constituents—students, faculty, and alumni—all uniformly want to see their school do well in the rankings, and all constituents are likely to be upset about even relatively minor declines. Nominal tuition has become quite different from the rates actually paid by students out of pocket.

(4)   At the same time, direct subsidies for state schools have declined, leaving those schools ever-more-dependent on the indirect subsidy provided by federal student loans.

(5)   Law school student loan debt is high and is growing fast. Average law school debt per graduate was close to $100,000 in 2010, and in the aggregate, as Matt Leichter has noted, “ABA law school graduates took on $3.6 billion in student loans, a sum that increased from $3.1 billion in 2008.” If current trends continue, “[a]ccording to the Office of Management and Budget, the U.S. will issue a grand total of $1.216 trillion in direct loans to all forms of higher education between FY 2011 and FY 2020” of which $54.3 billion (4.5%) “will be new law school loans.”

(6)   Finally, the government’s new Income Based Repayment program makes applicants even less price sensitive than before by capping student loan payments at 15% (soon to be capped at 10%) of the graduate’s discretionary income for either 10 or 20 years, depending on whether the student goes into public service or works in the private sector. The remainder is forgiven, though the private-sector program carries a potential tax impact. As a recent Forbes article pointed out, “Even individuals earning $150,000 can achieve savings if they managed to rack up $100,000 or more in federal student loans by attending graduate or professional school.”  Once the debt is high enough that the loan is subject to forgiveness (examples and estimates here), students’ monthly payments will not increase no matter what their debt level is. As a result, once the student’s debt level is high enough, there is no economic incentive to avoid further increases because payments will be capped at the same level—and students are well aware of that. The combination of unlimited lending and capped repayment is not unique to law; it affects all graduate programs, including medical school and dental school. The IBR program is not without risk, however; as Bill Henderson and Rachel Zahorsky have noted, “the Congressional Budget Office may have underestimated the extent to which students will be eligible for the federal Income-Based Repayment plan.” If so, IBR could potentially be subject to future budget cuts.

I believe that these factors are the prime drivers behind the rapid escalation of law-school student loan debt. And I agree with Bill Henderson and Brian Tamanaha that the trend cannot continue forever. But what happens when the system breaks? Tamanaha suggests that eventually lending limits will be put into place. An annual cap on student federal-loan eligibility would not be difficult to administer. Undergraduates already face such limits; it is only the Grad Plus program that makes law school and other graduate loans available for the full cost of attendance. The government also already has a mechanism it could use evaluate potential loan limits: the gainful employment metric proposed for for-profit colleges (and soon to be extended to nonprofit programs), which would require either that (1) in a given year, 35% of graduates are able to pay the interest on their debt plus at least $1 of principal; (2) the average graduate’s loan burden, on a ten-year repayment schedule, does not exceed 30 percent of his or her discretionary income; or (3) the average graduate’s yearly debt-service obligation (again on a ten-year payment schedule) does not exceed 12 percent of his or her total earnings.

The frequent assumption is that such limits would only affect law schools at the low end of the prestige hierarchy and the lowest-ranked schools would have to close. I suspect, however, that limiting student loans would actually disrupt the current prestige hierarchy in significant ways. With lending limits, students would be forced to become more price sensitive, giving a rankings advantage to schools that either (1) have managed to keep tuition costs down; (2) are located in low-cost-of-living areas; or (3) are associated with states or universities willing and able to support legal education. Schools without any of those characteristics will be the most disadvantaged. Looking at the last page of the US News Rankings, there is a big difference between the University of South Dakota ($11,208 per year in state) and the University of the District of Columbia ($8,850 a year in state) versus Touro ($41,070 a year) or Thomas Jefferson ($38,700); this disparity means lending limits would not affect low-ranked schools equally, by any means. And indeed all the law schools, regardless of current rank, would likely find that traditional assumptions of prestige cannot hold steady in the face of loan limits: once applicants are forced to become more price sensitive, schools’ LSAT and GPA averages will adjust as students with high credentials more often choose lower-priced schools. Interestingly, looking at the first page of the US News rankings, there is not a huge tuition differential among the most prestigious schools. But beyond the most elite, tuition and average debt vary significantly and are less correlated with ranking than many people realize. With greater price sensitivity, there is likely to be a more significant correlation between cost and rank.

What does this mean for the future?

First, schools must take a hard look at their own loan dependence and should make contingency plans for the future. Schools must plan how to fund quality legal education in the event that loans become less available, and schools should also plan for ways to minimize the student loan burden even in the current era of unlimited lending. This may mean making some hard choices: some of the most effective innovations in legal education are also among the most costly, as Michael Lewyn notes in a recent comment on The Faculty Lounge. A school’s dependence on student loans can be roughly gauged by this chart, which shows the average indebtedness per 2010 graduate, along with an estimate of the percent of students taking out loans (students at schools on page 5 and after are below the national median in law school indebtedness). If a school’s average debt burden is $145,621 per student ($48,540 per year), what would the school’s budget look like if federal lending were capped at $40,000 per student per year? What if it were capped at $30,000 per year?

Second, schools, professors, and bar admissions committees should all be aware of the loan burdens faced by new graduates. Income Based Repayment can help ease the burden for many. Nonetheless, we should not ask students to take on a large debt burden without also providing transparent data about the monetary costs and benefits of that investment decision—and we should be mindful of the fact that law students are in fact making a very significant investment.

Finally, we should all step away from the current US News rankings. Brian Leiter and others have already pointed out many flaws in the current rankings. If the rankings are likely to look radically different in the future—and I think they are—then we certainly shouldn’t base current policy choices on the rankings as they look now. As my own law school’s dean has pointed out, applicants should look at the real value of what a law school has to offer: what are the areas where a law school’s program excels, regardless of ranking? The true strengths of individual law schools have often been overlooked in favor of attention to the school’s overall ranking, but such an approach is shortsighted. The decision to invest in a law school education is not just a monetary decision, and the benefits measured in the cost-benefit equation are not just monetary gains; educational value matters. Law schools that invest in improving their ranking without also improving their educational value shortchange themselves, shortchange their students, and make an unwise investment. When we develop law school programs, we must do so with an eye toward lasting value to the students.

Comments

[John Steele]

Cassandra, thanks for all those insights into the financial side of the current crisis. It won't be easy to get students to move away from over-reliance on the US News rankings. As I've counseled pre-law students about their decisions to apply/enroll, in the down economy they seem to cling to the rankings more tightly than ever. And it's not clear to me how schools will have an incentive to break the US News dominance. A lot of the rhetoric I've heard from schools over the years is more of a longing to return to the quiet, guild days when schools said very little and did not invite a hard look at their economics. Perhaps the down cycle will change that. But the people who matter most within schools are not particularly market-oriented or consumer-oriented, in my experience. They are very prestige-oriented.

[Ben Cooper]

Like John, I found all of the financial data very interesting. Thank you. There are a lot of problems with the US News rankings, but the one that bothers me the most is your third point. It is absolutely perverse that Schools benefit from charging higher tuition. The flip side for schools like mine -- the University of Mississippi which offers in-state tuition for $11,309 and permits out-of-state residents to get in-state tuition after their first year -- is that we are effectively penalized for having low tuition. This in an era when students care more than ever about what law school costs because of the economy.

[Ray Campbell]

Part of the problem is the lack of transparency in what US law schools actually cost. The sticker price of published tuition does not translate to the actual cost paid by the average student. So long as schools can buy LSAT scores and GPAs with discounted tuition, offering a low tuition to all comers really translates to offering a low tuition to those who weren't sluiced off by higher ranked schools with scholarships based on LSATs or grades. This makes it harder for schools to compete effectively on price.

Another part of the problem is regulation that locks all accredited schools into more or less the same business model. If you look at businesses that successfully compete on price (e.g., Wal-mart, Southwest, Geico) they generally depart from the legacy business models. Accreditation standards that would have required personal sales assistants, long haul cross country routes or local agents would not have allowed these companies to drive down costs and prices.

[Douglas G Robertson]

Brava, Cassandra. May I suggest that the student indebtedness problem is prevalent in other disciplines also, notably the medical professions. One of the effects of the medical cost of education is the problem of inadequate numbers of medical personnel in small town USA and the overabundance of orthopedic surgeons in areas like Houston, Texas. I think I detect similarities in the field of Economics where students flocked to the sometimes obscene incomes of mutual fund management only to find that field so crowded that success seems to have required the privatization of profit and the the public assumption of risk(loss)..Doug Robertson

[bored3L]

Perhaps instead of completely scrapping the USNWR rankings, pressure could be brought to bear on the "magazine" (which is really a rankings company) to get rid of categories that drive costs upward and replace them with categories that reward schools for good job placement and low tuition and debt loads. Prospective students will still be able to obsess over a list, USNWR will keep a profitable branch, and schools will be freed of the incentive to burn money to increase per student expenditure, library size, and faculty reputation score.

[David Hricik]

Thank you - this was great. I had not heard of the cap on repayments, which is just nuts. The impact would appear to be increased borrowing and less downward pressure on tuition -- not exactly what you would want.
Thank you.

[CBR]

Bored3L--I think that would be a great idea, and I think that this is what the National Jurist was trying to do with its list of "best value" law schools. (http://www.nationaljurist.com/content/best-value-law-schools-2011-dominated-public-schools). But of course, this ties in with other issues--the biggest problem with the National Jurist rankings was that they were based on incomplete data--e.g., salary estimates based on a tiny percentage of the graduating class. Brian Tamanaha has a nice analysis of data problems with the salary averages here: http://balkin.blogspot.com/2011/10/depth-and-breadth-of-misleading.html.

I suspect that USNews would love to add a "return on investment" category that compares actual tuition paid and average graduate salaries--and I agree with you that it would benefit the company itself. I suspect it might even be financially worthwhile for USNews to directly survey grads in order to come up with a better data set. And while I'm dreaming, I'd love to see that data extended out by 15 or 20 years--entry level salary data is important, but I think that career salary data over time is even more important. Actually--I do wonder what it would cost for a survey research firm to do this kind of data collection. Small sample sizes wouldn't be as problematic if they were randomly distributed--I suspect it could be done, and I wonder if it could even be crowdfunded? If someone wanted to start a Kickstarter or other crowdfunding project to get funding, I would donate to it.