There is a way to determine risk in bailouts for higher education

Higher education is one sector of the American economy that has suffered disruptive losses during the coronavirus pandemic. With spring classes canceled or moved online and residence halls vacated, refund expenses have mounted. Enrollments for fall are uncertain, as are prospects of even opening up classrooms by Labor Day. On May 12, the California State University system, a behemoth of 23 campuses and 500,000 students, announced that it was canceling nearly all face-to-face classes for the fall. This decision has created new waves of fear within the postsecondary education community.

While other sectors of the economy, such as airlines, retail stores and personal services, were booming until mid-March, higher education was already facing disruptive change. Total student enrollments dropped by more than a half-million in five years, from 20.4 million in 2013 to 19.6 in 2018, the latest year available from the U.S. Department of Education.  

At the same time, private colleges were increasing their tuition discount rates, the percent of gross tuition set aside for institutional scholarships and grants. Discounted tuition rose from 36.9 percent in 2008-09 to 46.3 percent in 2019-19. Meantime, net tuition was actually decreasing.

The COVID-19 pandemic has intensified financial stress for higher education. In March, Moody’s downgraded the entire sector to a “negative” rating. Numerous articles in media outlets have pointed toward a likelihood of deep enrollment declines this fall. Finally, the stock market upheavals have no doubt led to declines in college endowment funds.

To help cover the added costs of the pandemic, congressional Democrats have proposed $37 billion in direct aid to colleges and universities, less than the $50 billion in relief sought by the higher education trade associations, but more than Senate Republicans are willing to support at present. Previously, $14 billion had been appropriated for higher education in the CARES Act.

Assuming there will be some funding for the higher education sector in a compromise package that may emerge by summer, there are two questions that would undergird such appropriations:

• How can taxpayers be certain that the funding would be limited to actual losses directly traceable to the pandemic?
• How can such spending be restricted to those institutions with reasonable chances of financially surviving the pandemic and remaining open for at least the next half-dozen years?

The answers to the first question can be gained through strict accounting and audits of the disbursed federal funds. The second question is more complex, and it may call for data and methodologies not currently utilized by the U.S. Department of Education.

For many years, the department has calculated a financial responsibility composite score between zero and three for private institutions (both nonprofit and for-profit). Extracted from required annual audits of these colleges and universities, the scores consist of three factors: A primary reserve ratio, an equity ratio and a net income ratio. These ratios are distilled into a single numerical score. Colleges with scores above 1.5 are considered financially responsible.  Those between 1.0 and 1.5 are considered at risk. To continue participation in federal student aid programs, at-risk schools typically must post a letter of credit to cover refunds to students in the case they close. Finally, those below 1.0 are considered not financially responsible and can be limited, suspended or terminated from federal programs. 

Those who have studied the department’s composite scores have found them to be flawed measures of an institution’s financial health. Writing for The Century Foundation last fall, Ariel Sokol and Yan Cao strongly criticized the composite score as “gobbledygook” that looks backward at past financial performance, instead of forward toward sustainable financial health. They note that “an enterprise’s financial health simply cannot accurately be boiled down to a single number devoid of any expert judgement.” Their analysis uses a variety of institutional examples to show how the three ratios the department uses can be gamed — and even without such artifices, how they can paint a distorted picture.  

The result is that the Department of Education uses its primary tools of requiring letters of credit and “heightened cash monitoring” after sometimes-fatal financial weakness comes to light.  Sokol and Cao note that “the department’s ineffective and delayed use of key corrective tools is akin to a doctor who routinely withholds life-saving chemotherapy long past the point when a cancer should have been detected, and prescribes it only when the chance of success barely outweighs the harmful side effects.”

In late March, the American Council on Education and the National Association of Independent Colleges and Universities, on behalf of 45 other higher education organizations, called for a three-year suspension of the federal composite scores. Certainly, such a move would foster a Hippocratic Oath-philosophy of first doing no harm, should Congress enact additional targeted appropriations for higher education.

The proposed suspension, however, begs the question of exactly how the department would assess the financial viability of non-public institutions that would receive federal pandemic-related funding. While funds for public colleges and universities presumably would flow through the states, along with restrictions limiting such funds to pandemic-related expenses that would not supplant regular state appropriations, private institutions likely would be funded directly, possibly in proportion to student enrollments.

The onus would be placed upon the Education Department to protect taxpayers and students from sudden institutional closures. Caught between the rock of potentially harming financially viable colleges by misapplying the flawed composite score and the hard place of doling out direct subsidies to financially failing institutions, what should the Congress and the department do?

One solution would be to agree to suspend the composite score for at least the current and upcoming federal budget year. In its place, Secretary of Education Betsy Devos could convene a special panel of financial experts to develop interim financial risk standards to help private institutions qualify for coronavirus aid. This panel would recommend emergency regulations that would supplant the composite scores for one or two years. Members could draw upon the work done by researchers Robert Zemsky, Susan Shaman and Susan Campbell Baldridge in their new book, “The College Stress Test.” 

The very real metamorphosis reshaping higher education must give federal spenders pause. Robert Zemsky predicts that 20 percent of colleges and universities face an “existential crisis” because of the pandemic and factors preceding the coronavirus. The last thing the harrowed public needs is more money being poured down a rathole.

Ronald Kimberling, Ph.D., is a research fellow with the Independent Institute. He was the U.S. assistant secretary for postsecondary education during the Reagan administration.