Wednesday, November 11, 2009

Regulation Of the Law School Loan Market Is Needed

As reported on Above The Law, and the National Law Journal, the ABA is lobbying President Obama to allow law students to convert their private student loans to federal student loans.  As federal student loans, the loans will be eligible for a hardship deferrment of up to three years.  That's a great benefit to law students struggling to find a job, but it doesn't solve the problem and a more extensive reform is needed.  More after the break.
Admittedly, the ABA's proposal would be helpful to law students in the short term.  However, the real root of the prolem is the massive amount of student debt that the increased cost of law school now requires lawyers to saddle themselves with, as I have previously discussed here amd here.

Our current thinking is that the greatest virtue is to "provide access" to law school by allowing students to take out massive debts.  We focus on getting the student into the law school, not on the overal financial impact of the law school decision on the student's life and on society.  We like to pretend that the student's career choice is a product of a "free market in education."  The thinking is that potential law students won't go to law school - and won't take on the massive debt - unless it is a winning proposition for them. 

However, in reality the student is typically making the decision to go to law school based on faulty and inaccurate information.  More specifically, the salary information provided by law schools and the popular press is typically highly suspect, as we have previously discussed here, here, here, and here.  To use an analogy from the stock market, you have sellers pumping potential buyers with inaccurate information in an effort to persuade the buyers to make a huge financial purchase. 

Further, we have sellers (law schools) raising their prices based on the ability of the potential purchaser to get a loan.

It is very disappointing that we insist on a very high standard for truthful information from a seller when the seller is selling a $20 stock, but when the seller is selling a $200,000 legal education we have virtually enforcement provisions - or even standardized ways of measuring value/salary from one law school to another.  This lack becomes even more distasteful when we realize that the prospective purchasers of a law school degree are typically making a very highly leveraged decision that may have a very long-lasting adverse impact.

In the financial world, we attempt to moderate this risk in several ways: 1) Uniform rules for disclosing risk and performance information across companies, 2) Harsh penalties for misrepresenting this information.  Also, for investments that are deemed to be more risky, we only allow certain "accredited investors" to participate in the investments.  The idea being that 1) the accredited investor would be more savvy and perform better due dilligence, and 2) if the investment goes bust, the accredited investor is not likely to be ruined.

Translating this structure into the legal education field, here are some aspects that should be warranted to make the market safer for all participants:
  1. Standardized information reporting.  All schools should calculate their salary in the same way.  The process for determining the "average starting salary" should be transparent and uniformly applied.
  2. The ability of the student to accumulate student loan debt from all sources (both public and private) should be limited to a total amount for which the payments represent a reasonable risk-adjusted number based on the law school.  For example, if a true determination of the average starting salary for a law school is $60K, and the law school has a placement rate of 80%, then the risk-adjust salary for the law school is $48K.  Subtracting out $15K to meet poverty-level expenses leaves $33K.  Imposing a percentage cap of 25% leaves $8250.  This number would represent the maximum loan payments for a year.  $8250 works out to about $687.50/month.  That leads to a cap of about $60,000 in law school loans, according to this calculator. 
Limiting the total amount of student loans initially seems adverse to our sacred principle of "providing access" to law school, but it really isn't.  We are not preventing anyone from going to law school, but they will have to be saving up some of their own money first before they can go.  The student can still attend law school, but their attendance will most likely be delayed.  This has a couple of beneficial factors. 

First, the students will likely be a little older and have some experience working in the real world.  Consequently, they will more likely look at the law school "opportunity" with a better appreciation of the relative risks and rewards.

Second, the whole transaction of going to law school will be less highly leveraged becase the student will no longer be leveraging 100% of the cost.  This could provide for a softer landing if the job search does not go as expected.

Third, the impact on law schools will mostly likely be to drastically cut demand because potential students will be a little more savvy and be paying for a larger percentage out of their own pocket.  This reduction in demand should in turn put pressure on law schools to reduce their tuition, which would benefit students.  It may also put pressure on law schools to lower their class sizes or force the bottom-of-the-barrel law schools to close - both of which would further help the opportunities for the remaining law students.

In conclusion, we need to back away from enabling the "gotta-have-it-right-now" attitude and help potental law students make better finncial decisions.  Ensuring information uniformity and right-sizing the amount of law school debt to match the potential oppotunity are two badly needed market reforms.


  1. I think that's an interesting idea.

  2. 10:31 - Thanks! It just blows my mind that we don't have some sort of standardization in place. If you want to buy a stock - standardization and protection. If you want to buy a house - standardization and protection. Here we have a legal education that costs much more than stocks and more than the average house, but it's just the wild west. That's not in our long term best interest. The lack of reliable information distorts the marketplace - as does the massive use of "leverage" by using student loans.

  3. The problem is that this would lead to a public outcry. Let me give you an example:

    About a year ago, I was reading a newspaper article about a new law school that was going to be built in Dallas. Once approved, the school would be the first public law school in the Dallas-Fort Worth area (the other two are private).

    Under the comments, there were many recent grads posting about how it was a waste of taxpayer money and how hard it is to find a job.

    But there were also a bunch of comments from people who had long dreamed about going to law school but could never afford private tuition. Or perhaps they weren't admitted to the current Dallas law school but couldn't afford to leave the area.

    No matter what the attorneys posted, these dreamy-eyed 0Ls couldn't be dissuaded from their delusions.

    Although I really wish your idea would become law, I just don't think any bureaucrat/politician would have the guts to make it more difficult for someone to pursue such a "noble calling" like the law.

  4. Will - I have had much the same experience of dreamy-eyed 0Ls with inaccurate expectations. That's why the standardized information reporting is so important - it might be able to give the potential students accurate information that might dissuade them. Even if only the standardization of salary reporting is implemented, we should see some advantages. For this part, it would seem like there would be little in the way of public outcry. Lots of weaseling on the part of law schools, but little public outcry.

    With regard to limiting the loan amounts available to potential students, if the public law school can actually deliver a degree within the loan constraints, then great! The loan constraints actually encourage the development of lower-tuition options.

    At root, one of the factors behind the foreclosure problem was that loan money was given out without verifying the ability to repay. We recognize that the ability to repay is essential in that context - why don't we recognize it here? It would seem to be even more important here because the home loan could be dischargable in bankruptcy while the student loan generally isn't.

  5. One of the big problems is that the jobs and wages necessary to build a solid middle-class lifestyle aren't available to college graduates. It's been moving in that direction for a number of years, but the current recession has accelerated the secular trend. If you're an econ grad from a decent college, and the best job you can find pays 35k/yr (min benes and little upward mobility), gambling 100+k in loans for a 20-30% shot at 130-160k law firm job doesn't seem all that irrational.

    There are a number of factors in play, but the overarching ones are structural and relate to widespread wage deflation both inside and outside of the legal job market.

  6. 4:41 - My initial impression was that you were right and that we were devaluaing the college degree. However, some data suggests that the starting college grad salary is effectively keeping up with inflation - at least since 1982. See
    "To date, the average job offer to a 2009 graduate with a bachelor's degree is $48,515, down about 2% from last year, according to NACE. (Parents who got their first jobs in the early 1980s had it slightly better. The average job offer for the Class of 1982 was $22,450 — or, adjusted for inflation, $49,485)."

    Also, I have to agree that if a graduate finds themselves in a dead-end 35K/year job and views themselves as having the option to gamble 100K on a 20-30% shot at 130-160K, then the graduate will be strongly tempted to take that option. However, that person is probably not evaluating the risks correctly. Taking the midpoint of your numbers, a 25% chance of earning 145K is a risk-adjusted salary of $36,250 - and that is very generously assuming that 1) the degree will only cost 100K in loans (it will cost more in reality ) and 2) that the chance of making that salary is 25% (it is much less in reality).

    So I agree with you that if the facts were as they are undersood to be by the potential law student, then the law school opportunity would look enticing. Unfortunatly, they are basing their decisions on erroneous facts - and this is a decision that will impact them for decades.

  7. Actually the risk-adjusted salary is more like 75k

    (145*.25)= 36.25+ (.50*60)=30 + (.25*30) = 7.5

    Total risk adjusted salary is 73.75k. Even if true that median salaries for a BA have kept up with inflation (doesn't jibe with what I'm seeing, but accepted), going to law school is still a perfectly rational decision. It just won't work out for the vast majority because the "fat tails" distort expected value calculation. But that's true across the economy.

  8. I like your idea, but here's a simpler one: Go to a private loan system and make the loans dischargeable in bankruptcy like pretty much any other debt.

    In that scenario, lenders will be incentivized to perform essentially the calculation you described and refuse to lend money beyond a reasonable limit.

    Lenders will not lend money to people who want to attend the Third Tier Toilet School of Law and it will have to either (1) go out of business; or (2) drastically reduce tuition to the real value of the education they are providing.

    Back before private student loans became non-dischargeable, there were lenders who refused to lend money to students who wanted to attend bottom-of-the barrel law schools.

    Which is exactly what we want to happen.

  9. nycsolo - In principle I like your proposal! We pass the risk and burden onto the private sector and they are incentivized to only fund productive loans. However, I have a couple of things to think about. First, inaccurate estimation of risk - I think that you are generally right that lenders would refuse to lend money beyond a reasonable limit. However, we have recent counter-examples in the housing market - and that was lending based on a secured, capital asset that should have been - and historically was - less price sensitive. A meltdown of the student loan market, especially in the middle of a student's education, could be very detrimental to our economy in the long term. You can probably come up with some way to manage this, though.

    The second thing that I am thinking about is that we are currently in a trend of the state governments providing less and less funding to the state schools - which effectively makes the state schools adopt the pricing models of the private schools. Frankly, I don't see this trend reversing itself, so I would think that public law school tuition would still rise to that of private law school tuition.

    The third thing that I am thinking about is that parsing risk might have to be done on a finer basis than school-by-school. For example, the person taking loans to go to Harvard law who is going to work in social work in third world countries is probably more of a risk than a person with an IP or corporate background going to a Tier-2.

    Overall, I think you are right in that much of the current increase in law school tuition is due to the easy availability of federal student loans and that removing those loans would have an impact on the ability of law schools to keep increasing tuition. It is certainly something worth exploring. Having benefitted from the federal student loans, however, I am a little hesitant to dump them all together!

  10. "Having benefitted from the federal student loans, however, I am a little hesitant to dump them all together!"

    Honestly, I doubt that you benefitted from federal student loans. Because your law school set its tuition knowing that you would be able to borrow 55k no questions asked.

    Student loan programs only seem to benefit students. In reality, it seems to me they hurt students and help colleges and universities.

    If the federal government raised the Stafford limit from $18,500 to $22,500, universities would quickly raise tuition to soak up the increase and students would just end up deeper in debt, it seems to me.



    "However, we have recent counter-examples in the housing market"

    Believe it or not, I'm not a libertarian. Even so, I'm pretty confident that the problems in the housing market were due to the government leaning on lenders to relax standards.

    "The second thing that I am thinking about is that we are currently in a trend of the state governments providing less and less funding to the state schools - which effectively makes the state schools adopt the pricing models of the private schools. Frankly, I don't see this trend reversing itself, so I would think that public law school tuition would still rise to that of private law school tuition."

    I disgree in large part. It seems to me law schools set tuition based on what they think they can get away with charging, not based on the the actual cost of providing education minus the amount of funding from other sources.

    "The third thing that I am thinking about is that parsing risk might have to be done on a finer basis than school-by-school."

    Well that's fine too, no?. Of course your hypothetical Harvard student is a good risk because Harvard has a loan repayment program.

  11. nycsolo - Thanks for your comments and for helping to provide a fresh view! I like to think that it really helps make the blog more interesting. With regard to the federal student loans - I can see your point. Law schools have an incentive to raise their tuition when the market can bear more due to the availability of student loans. That is a problem and we should figure out some way of addressing it. Anything that would help to make law school mroe affordable and a better experience for students is great in my book. From another angle, based on the price of law school when I attended, I could not have paid for it out of my pocket. I recognize your point that the inflated price that I had to pay was already the result of the availability of student loans and that without them maybe I could have just worked during school and graduated without loans like they did in the 1950s. I really wish that had been my experience!

    With regard to the housing market, I certainly agree that the government was leaning on lenders to relax their standards. It is also a great lesson in "ethics" about how the government is not taking responsibility for it now. However, in addition to government pressure to relax standards, I think that a lot of other factors came into play and there was a serious misjudgment of risk.

    With regard to law school cost, I think that you are certainly right in some cases. For example, law schools in the thrid and fourth tier that charge prices similar to those in the first tier seem to be on shaky ground with regard to justifying their prices. However, I have spoken with the Deans and Assistant Deans of several law schools and at least some of them don't just want to rise the tuition to the sky.

    However, one of the big problems seems to be how they are "metric-ed" in how it is determined whether they are doing a good job. For example, if moving up 2 places in the US News ratings is the metric that they are told to meet, then meeting this metric usually results in an increased expense. For example, providing tuition breaks to top students to better the school's numbers causes the school to raise the overal tuition that others pay to make up for the shortfall.

    Another thing that I can say with regard to a lot of Deans and Professors (at least at state schools) is that their compensation is not outrageous - and is not increasing at the rate of tuition. One way I can verify this is that state schools publish the listing of salaries of all employees, so you can just go and see how much professors or Deans make. Most professors at Midwestern State schools are really looking at 140-160. You have some Deans making less than 200. That's a big contrast to the super-premium pay that private New England law schools have (I went to law school in Boston). I do occasionally get the impression that some law schools are just trying to make a buck. However, from the majority of public law schools, I get the impression that they really just want to do a great job.

  12. I have a feeling that if you studied the books carefully, many -- perhaps most -- state schools are charging a lot more than is necessary.

    Of course it's not just greed (although I think greed plays a role.)

    Part of the problem, as you point out, is that there is pressure to move up in the rankings. Constructing fancy new buildings is one way to increase reputation.

    And ironically, another way schools are judged is by how much their tuition is.

  13. By the way, one of the anti-law school blogs just did a comparison between median family income in Michigan and tuition at U Mich law school over the past 20 or 30 years.

    It seems tuition has risen dramatically in comparison to median income.

  14. nycsolo - Feel free to post a like to the other blog! Also, did you see this comparison that I did in October on the changing cost of law school? I compared it to the change in the minimum wage and determined how many hours of work the law school cost represented.

  15. LINK - feel free to post a LINK to the other blog