Enron, Lehman, UMICH

Last week, I had the privilege of attending Provost Philip Hanlon’s presentation on the university budget. He discussed various factors influencing tuition rates, the most prominent of which is the decreasing amount of capital appropriated by the state of Michigan to institutions of higher education. Unfortunately for students, and in order to support the growing functions of the University, this means tuition rates need to increase to make up for the loss of funding. One graph he presented demonstrated that over the past decade, tuition has been increasing at an annualized rate of 5.6%.

University of Michigan Provost Philip J. Hanlon

While this did not particularly surprise me, I did want some further clarification on that, so I posed Phil a question during the Q&A session following his presentation. It went something along the lines of,
"As an out of state student, my tuition rate is approaching nearly $50,000 a year, and if those projections (5.6%) are correct, then in the near future we may be seeing rates as high as $80, $90, or maybe even $100,000. I personally believe this cannot continue forever and many prominent economists have theorized that higher education is going to be the next bubble. So, does the University have a contingency plan for if and when such a bubble does occur, and what present actions should it take to prepare itself for such an event?"

Although he acknowledged that my question was good and valid, Phil did not have any concrete response to the prompt I gave him. Essentially, he dodged around the actual question and said that the University does not try to project tuition rates into the future. Now, let it be known that the University tries to be as transparent as possible with all of its budgets and funds, so this was in no way a refusal on Phil’s part to address the issue I raised. However, I believe this points to a deeper problem, and one with which all of us BA students are familiar: Collins’ stages of decline.

Jim Collins’ Stages of Collapse, and where Michigan stands.

That’s right folks, I am claiming that the University of Michigan - a business, at the end of the day - is going to fall on financial hard times much like its public counterparts in California. It is currently in Stage 3: denial of risk and peril; "Internal warning signs begin to mount, yet external results remain strong enough to ’explain away’ disturbing data or suggest that difficulties are ’temporary’ or ’cyclic’ or ’not that bad...’" Taking a holistic approach to collegiate funding, it becomes clear that attending any institution of higher education is becoming harder and harder.

Phil talked about how the University is attempting to provide more and more financial aid and scholarship opportunities to make attending easier, but I believe that if the funding for these programs comes from further tuition increases, then these initiatives are fundamentally unsustainable. He mentioned how, on average, a $200,000 investment in the education of one individual at UM generates returns of $900,000 some 40-or-so years down the line. I.E., seemingly strong external results used to justify internal problems unrelated to the results. As an aside, that $900,000 is not inflation-adjusted, so the real value would be quite a bit lower. These examples all fit Stage 3 perfectly, but the clincher is, as far as Phil is willing to disclose, the University does not have a contingency plan for (what I believe is) the inevitable black swan.

The University needs to plan for failure in order to mitigate potential losses.

However, before everyone jumps on me for decrying the health of our sacred Havard of the West, be aware that this is, by far, not an isolated instance. If anything, my interest lies in protecting the University by raising awareness of these issues in order to generate discussion, and hopefully, change the way administrators perceive our current situation; we are not immune but we can be stronger. Analyzing the collapse of Lehman and Enron leads to several conclusions about bubbles in general. First came tech, then housing, and soon, education. Several factors common among both firm and market collapses include:

• Inflated asset prices - Enron’s energy securities were vastly inflated in the years during which the company was profitable. However, they chose the unethical path instead of going down gracefully. In the tech and housing bubbles, both the values of tech companies and houses got inflated far higher than their fundamental values; the same is currently the case with university tuition across the country.
• Excessive borrowing and lending - The excessive borrowing and lending of credit during the housing boom ultimately injured the global financial system because most major financial institutions were too interconnected through the creation of security bundles tied to massive amounts of loans that were discovered to be unpayable. One of the root issues here is the fact that originators decided to give out loans like candy and home buyers were none the wiser to realize they were infused with arsenic. Students in today’s society are taking out more and more loans from the government, while tuition prices continue to soar across the board, and discovering they cannot repay what they borrowed in the foreseeable future. See the similarity here? And let’s not forget how much Enron took out from its partnering banks in order to sustain its staggeringly high-risk trading operations.
• Underestimation of risk - In our already depressed economy, a few good weeks that indicate growth in factors such as national employment might alleviate fears for some, but treating a disease is very different from eliminating the factors that caused it in the first place. Yes, the DJIA is over 13,000, but at what cost? With events like the election rapidly approaching, volatility is high. To maintain express optimism, or even mild nonchalance, for the future without having any sort of contingency plan is irresponsible for any institution be it the government, a corporation, or a university.

In short, the University is going to be negatively affected by the forthcoming education bubble due to the factors listed above and a few others. However, with proper planning, it is possible to mitigate a solid percentage of the damage and eventually recover with minimized repercussions. Although my analysis is based on medium-term speculation, there is absolutely no reason to underestimate the risk of default in today’s economic climate. Fundamental asset values must be determined and priorities must be set. Any business must constantly reassess itself and its outlook on the future; the battle must be won before it has begun. Sans planning, only doom awaits.

Note - Phil’s presentation was recorded, but I was unable to find the video after searching extensively through the UM web network. Sorry guys; you won’t be able to see me in action!