More on the higher education bubble

In an earlier post, I quoted at length Megan McArdle's argument that colleges and universities appear to have gamed the system in order to extract for themselves as much as possible the economic benefits of higher education that used to go to students in the past.  Political Calculations' post seems to add to this:

We didn't set out to go looking for it, but we couldn't help but notice what would appear to be a really unique correlation between the average annual tuition at a four-year higher education institution in the United States and the total amount of money the U.S. federal government spends every year.

First this chart:

Notice the jumps compared to the median household incomes.

The argument here is that when household incomes did not grow much at the median level, and when state governments decrease their allocations for higher education, then one would expect adjustments in the service provision that would try to hold the costs constant, or at least hold the increases to a minimum.

But, that hasn't happened. Why?  We might not immediately think of the federal government's role in subsidized loans to students ... it is not that different from how low interest rates led to higher home prices during the real estate bubble times.  I recall even my realtor making this point eight years ago.  Realtors and mortgage brokers know this all too well because they operate with a clear sense of how much monthly payment the potential homeowner can take on. To them, that monthly payment is a critical variable in the process.  So, when interest rates are held low, it makes it possible for buyers to go after larger-value homes.  But then the homeowners and their advisers also sense this, and home prices are correspondingly adjusted upwards.  Pretty soon, the later entrants to this crazy market do not realize that such a system will only help those who are already homeowners, and are we to be surprised that those who joined this game towards the end are the ones "underwater" now?

In this case, colleges and universities then correspondingly adjust their tuition upwards.  Increasingly, students are like the late entrants to the real estate bubble.

Back to Political Calculations:

This correlation suggests that the U.S. federal government is directly behind the bubble we observe to exist in the cost of U.S. higher education, with federal spending during years of recession effectively insulating U.S. colleges and universities from the nation's economic circumstances by subsidizing their operations.
These subsidies, delivered at times of recession, free U.S. higher education institutions to set the price of their tuition independently of their students' ability to pay based upon their or their family's current household income.
The only limiting factor for U.S. higher education institutions then would be the actual growth of U.S. federal spending. This would be why the average cost of college tuition in the United States would appear to have come to track the total level of federal government spending so closely.
As a result, the cost of college tuition has skyrocketed with respect to the typical family's household income. Consequently, when a student attends college today, they must increasingly rely upon subsidies from the federal government that fill the gap between what their institutions charge and what they must pay for out of their own pockets.

How does all this translate to a typical student?  Here is a classic statement:

"I get financial aid but I get less because more goes to tuition," said Tiffany Webster, 22, who lives on campus. "It just seems like it is getting too high for a Cal State school. It should be affordable."

Which is how we end up with a scenario like the one in this graph from "Carpe Diem"'s Mark Perry, who adds that maybe, just maybe, students--like American consumers now--are not that excited to take on debt like they used to.  Perry notes that:

After remaining stable at about 11-12% of median household income between 1994 and 2001, student loans as a share of income climbed to more than 18% in 2006, before declining to 15.5% in 2007 and 13.6% in 2008.