Higher education regulation is failing America, and the costs may well be no less than those paid for the regulatory errors that led up to the financial crisis, an era that holds lessons for higher education.
Seven million Americans are now in default on their student loans—a number comparable with the five to 10 million Americans who lost their homes during the subprime mortgage crisis. Many more are paying off their student debts, but are stuck in low paying jobs because their degree is worthless or because they didn’t complete their programs. The biggest group of Americans suffering from the crisis in higher education, however, is those who haven’t gone to college at all—either because of the high costs or a lack of availability; these potential students remain non-consumers, shut out of American higher education entirely.
A Design with Fatal Flaws
In 1989, the federal government created the Office of Thrift Supervision (OTS) to regulate savings and loan associations (S&Ls)—small retail banks. The savings and loan crisis was in full swing at the time; shifts in interest rates meant that these small banks were paying depositors higher rates than what the banks could make off the loans they had issued. S&Ls attempted to plug the gaping hole in their business model with highly speculative investment strategies, which only made the crisis worse. The OTS was built to replace the regulators on whose watch the seeds of the crisis had been planted and initially, the OTS cracked down, overseeing the closure of hundreds of insolvent S&Ls.
The design of the OTS, however, had fatal flaws. Unlike many other federal agencies, the OTS wasn’t funded through the federal government. Instead, it received fees from the banks it oversaw. As the S&L crisis progressed—between 1989 and 1995, roughly one out of three S&Ls were shut down—the OTS saw its revenues plunge. Falling revenues meant staff cuts—the agency was losing talent as well as financial resources. In order to reverse the tide, the OTS changed tacks. Instead of drawing a tough line with the banks it regulated, the OTS began to be more “flexible.” It approved charters by many non-bank financial players. It began actively promoting itself as the regulator of choice for the industry, encouraging non-bank financial institutions to select the OTS as their regulator.
Why does the story of the tiny, now-defunct Office of Thrift Supervision matter? Because the ill-resourced and poorly incentivized OTS ended up “regulating” some of the worst actors in the 2008 financial crisis, including many of the mortgage lenders and, most expensively, AIG’s $1.6 trillion derivatives business, resulting in a $182 billion taxpayer bailout. While the OTS was originally designed to regulate S&L quality, its business model made it ultimately beholden to the institutions it regulated. Its actions to close failing S&Ls were the right call from a regulatory perspective, but they ended up laying the groundwork for the next financial crisis.