Old money sign

USA Today and Get Rich Slowly both featured an absolutely amazing statistic recently that blew me away:

The amount of student loan debt outstanding in the US now exceeds the amount of credit card debt outstanding.

Rattle that around in your brain. The legions of people buying crap they don’t need with money they don’t have are now second to kids accruing massive amounts of debt for an education of questionable value. College tuition has gone up to astonishing highs, in which students are graduating with a bachelor’s degree at price tags of a quarter million dollars.

How did this happen? Why did this happen? The answer lies in third-party payee systems. Here’s what that means. You generally don’t pay cash for college. You take out loans, you get scholarships, etc. Uncle Sam pitches in with loans, too. What happens then is that the price becomes decoupled from the people who pay it. Colleges effectively are getting their money from banks, not consumers, and banks in turn get their money from consumers. The problem with decoupling cost from buyers is that it changes how market forces work.

In a normal market, prices change demand. If you raise your price to be too high, people will stop buying your stuff. They’ll find cheaper alternatives or simply do without. As a result, you have a soft cap on how high your prices can rise before your business becomes unprofitable and you have to bring prices down, or competitors step in to take profits at slightly lower margins, forcing you to reduce prices.

In a third party market, if someone is paying the bills and passing the costs on, neither party has an incentive to control prices. Neither party benefits from regular market forces – in fact, quite the opposite. Both parties acting on behalf of the consumer have strong incentives to make things as expensive as possible as quickly as possible. A good example is real estate – if you had to pay cash for a house instead of borrowing, there’s a good chance that:

  • many people wouldn’t own homes
  • those who owned homes would have bought them for materials cost plus labor

Once you introduce a third party into the system that pays on behalf of the customer, prices and reality begin to dine at separate tables. It takes much, much longer for a price increase to change the consumer’s behavior when a third party is paying on behalf of the consumer, and as a result, prices rise at amazing rates.

The only way to get prices back down to earth on any third party system – healthcare, college, housing, etc. – is to remove the intermediate party and recouple prices back to the consumer. The consequences of doing so are drastic, possibly economy-breaking. Colleges would lose 80% of their students overnight until they adjusted pricing. Houses would sit empty for years, or possibly never be bought at all. Healthcare would be denied to everyone but the wealthiest at first. It’s this nuclear scenario that prevents us from making substantive changes that in the long term would benefit us, but in the short term would be incredibly painful.

There is one other option, one which holds more promise, and that’s revolution. Online marketing has made life very hard for direct mail marketers and other channels. Online forums have been the death knell for newspaper classifieds. Once the way of doing business is shattered by a completely new model, the old model becomes affordable as the market leaves for greener pastures or is rendered irrelevant. Education is headed this way rapidly: why pay $250,000 for information and skill you can acquire with Google, iTunes, and online learning? Eventually, colleges and education groups may realize their role isn’t the dispensing of knowledge, but the certification that you have it and can wield it. Certification comes at a much lower price tag than today’s current model.

What do you think? Is college worth it? What about home ownership or other third-party payee systems?

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