Giving Colleges Some Skin In The Game

Career College Central Summary:

But before we get around to debating specific formulas, shouldn’t we ask some basic design questions?

What are we trying to accomplish? First, a question that’s often taken for granted: what are we trying to accomplish with such a policy? Do we want to put bad colleges out of business? Or do we want to lower the probability that the average student defaults? These aren’t mutually exclusive, and each has merit. But how you answer has implications for policy design. If your primary goal is to put bad colleges out of business, you’d create a system where the worst actors are subject to increasingly harsh penalties and other colleges are left alone. The Reed bill, for instance, would put colleges on the hook for an increasingly large chunk of defaults once their default rate exceeds 15 percent. At the top of the scale, those with default rates above 30 percent would have to pay back 20 percent of defaulted dollars. The bill also exempts lots of institutions, including Historically Black Colleges, two-year schools, and those where less than 25 percent of students borrow. Under this plan, then, only below-average colleges actually have skin in the game…
Should penalties ratchet up as default rates do? That brings up the second design question: should the size of the penalty ratchet up as a school’s default rate gets higher? Or should the penalty formula be smooth and continuous? To see why this is important, think about two colleges, one with a default rate of 29.9 percent and another with one of 30.1 percent. Statistically, the two schools are probably performing equally poorly. Yet under the Reed bill, the latter would be on the hook for a much larger proportion of defaults than the former. Such a system begs schools to game their default rates and invites potential legal challenges…
What about rewards? While skin in the game proposals have mostly focused on penalties, it’s also worth thinking about how federal policy could influence the other side of the ledger as well. In isolation, colleges will likely respond to this kind of policy by becoming more selective on the front-end. That’s not necessarily a bad thing, so long as they can effectively sort students who are likely to benefit from those who are not. More likely, though, colleges would use proxies like income or zip code to make those decisions, potentially locking out students that would benefit from education…

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