January 2, 2020

It Was a Good Run

I predict that 20% of colleges and universities will shut down or merge in the next 10 years, and probably more.

It was a good run.

Most people fail to understand that higher education is in itself countercyclical. When the economy is bad, and people lose jobs, many of them will go back to school. You have probably heard about the for-profit education boom and bust. That is old news. You might not have heard that total enrollment has been declining for the last eight years as the economy has improved. What comes next will pulverize nearly every institution of higher learning in the country, private and public.

The reason: demographics. Basically, an echo of the baby bust of the early seventies. I was born at the bottom of that baby bust in 1974. My small generation hatched a small generation, which is now making its way through college. Enrollment will drop 15% on average, on top of the eight-year correction that schools have already experienced. This may not seem like much, but finances at colleges and universities have deteriorated sharply, and many of them will not even be able to withstand a drop of a few percent.

There have been bull markets in dot-com stocks, homebuilder stocks, energy stocks, and FANG stocks. There can be a bull market in anything, even higher education. Unless you have been trapped under something heavy, you probably know that college is expensive. It is expensive because it is implicitly subsidized by the federal government, which will lend any amount of money to any student without regard for willingness or ability to repay.

The demand for higher education has been relatively inelastic, but demand elasticity is starting to set in. Today, 45% fewer 18- to 29-year-olds say going to college is “very important” than in 2013. A 45% drop in just seven years. I talk about it incessantly on my radio show. Higher education has become so expensive that it makes practically no sense for anyone, except as a luxury purchase for the idle rich. Not even a Wall Street job is going to be any help in paying off $200,000 to $300,000 in debt.

So we have fewer students going to college and fewer students wanting to go to college. Right.

The bull market was awesome. New academic buildings, new athletic facilities, new residence halls with swimming pools, climbing walls, and recreation facilities. Lots of administration and diversity staff. Ironically, the one cohort that utterly failed to benefit from the boom times was the professors, who are really the only people adding value and remain vastly underpaid. When the cuts come, they won’t come for the administration or the diversity staff. Academic programs will be the first to go, which raises some interesting questions about what the purpose of a university is.

A discussion on higher education would not be complete without a discussion of college football, which is a drain on resources in 99% of cases. Yes, Alabama is wildly profitable. Only a handful of football programs are, and hundreds of schools have tried to replicate what Alabama is doing. The economics of college athletics is widely misunderstood. Some people complain that football is a source of alumni support, but it really isn’t. It’s popular among alumni, yes, but financially speaking, the vast majority of schools would be better off without it.

Some schools are thinking outside the box and trying to recruit folks outside the rapidly shrinking pool of high school seniors. There are millions of people in the US who have “some college” on their resumes, all of whom are potential customers, depending on how much debt they have left over from the last time around. Schools will also be recruiting foreign students heavily. But it won’t be enough to plug the gap. Smaller liberal arts colleges are already closing, and many more will close their doors for good, or merge with larger schools to stay afloat. But state schools will suffer too, and many of them will require explicit taxpayer assistance, which will be politically distasteful to say the least.

Schools will resort to lowering standards to keep enrollment up, but that is a race to the bottom, and the value of every student’s degree will decrease correspondingly, setting off a vicious cycle that makes college even less attractive. My suspicion is that universities—allegedly with very smart people in charge—have done pretty much zero to prepare for the coming bust. Many schools have lots of debt, not much cash, and a lot of fixed costs. Almost nobody has prepared for what is about to come next. And this is operating under the assumption that the Department of Education continues to be as willing to lend money as it has been in the past.

As an investor who came of age in a bear market, I tend to look for bear markets. We have had some wingdingers in the last 20 years. This one will be up there, with pretty profound economic effects. Colleges and universities employ a lot of people and in many cases are the lifeblood of a single town. You’ve probably noticed that the nicest buildings in your town are the academic buildings. Wait until they are all empty.

Jared Dillian

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