The Hole In A Key Higher Education Accountability Rule

Nashville Barber and Style Academy in Tennessee has a high default rate but a low number of defaults. Liberty University in Virginia has a low default rate but a very high number of defaults.

Are you confused yet?

Each year, the Department of Education calculates a cohort default rate (CDR) for colleges and universities that receive taxpayer support through federal student loan and grant programs. The CDR measures the share of student borrowers at each school who defaulted on their loans within three years of entering repayment. If a school’s CDR rises above 30% for three consecutive years, or 40% for one year, the institution might lose access to taxpayer subsidies, which for most colleges means a quick closure.

In theory, CDR protects students and taxpayers by kicking schools where former students fail to repay their loans off the government dole. But this design suffers from a serious problem: the vast majority of student loan defaults occur at schools with relatively low default rates.

Source: Department of EducationPreston Cooper/Forbes

More than half a million student borrowers who entered loan repayment in 2015 have since defaulted. But fewer than 6,000 of those defaulted borrowers—1.2% of the total—attended a school where the default rate exceeded 30%, the range where the school might face penalties. If the government wishes to hold institutions accountable for student loan defaults, the current accountability regime misses almost 99% of the problem.

While a handful of institutions have a default rate that exceeds 30%, these are mostly small colleges that contribute little to the overall default problem. Rather, the largest sources of defaults are some of the nation’s largest colleges, including the University of Phoenix, DeVry University, Indiana’s Ivy Tech Community College, and Liberty University. But none of these large schools exceed the 30% default rate threshold, and thus all escape penalties.

Congress might capture more student loan defaults in accountability rules if it lowered the default rate threshold. But lowering the default rate threshold to 20% would still exempt schools enrolling more than three-quarters of defaulted borrowers. The median defaulter attended a school with a default rate of just 14%.

Given this dynamic, perhaps a binary threshold that leaves a school either in or out of federal grant and loan programs is not the best way to construct accountability policies. Rather, this suggests that a form of “risk-sharing” would do a better job of holding colleges accountable for poor student outcomes.

Risk-sharing proposals take many forms, but they generally follow the framework that each government-dependent institution pays an annual fine that varies with the volume of poor outcomes associated with students who attended that college. If student loan default is the metric policymakers wish to use for accountability purposes, then risk-sharing might take the form of a flat fine for each borrower who defaults on a loan, or a fine equivalent to a set percentage of outstanding student loans in default.

Most student loan defaults are concentrated at institutions with relatively low default rates. Using a simple cutoff threshold for federal funding, Congress would not be able to hold those institutions to account without closing a far greater number of institutions than political reality will permit. To reduce student loan defaults, policymakers will need to get more creative.

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