Other people’s money
By Berkeley law professor Steven Solomon has a curious piece in the NYT today on how and why the Thomas Jefferson School of Law managed to survive, for now, by working out a deal with its creditors after defaulting on its bond obligations this summer.
Solomon argues that it doesn’t make financial sense for private creditors of free-standing schools, or central university administrators of university-affiliated schools (90% of ABA law schools are in the latter category) to close down a law school, at least while there’s any reasonable prospect of bringing revenues and expenses into balance:
[A] closed law school is worth little, or most likely nothing, to creditors. The value is only in the revenue stream it produces and perhaps its building. (You could say the books also, but these are increasingly fewer.) And these days, that revenue stream is down 20 to 40 percent, meaning that if law schools were for-profit businesses, most would be failures.
A troubled law school is like Dracula: hard to kill. Creditors will not do so because even keeping a struggling school alive means there is some possibility of repayment.
Most law schools, however, don’t have huge bonds to service, or at least, the debt they have is borne by the university. For these schools, the calculus is even easier. If a closed law school is worth nothing and a nice big building without students is useless, then keeping it open remains the only option.
Shutting down a law school at a larger university also puts the administrators and others out of work, with few options for employment. They have every incentive to keep the school alive.
This explains why, despite forecasts that up to a third of law schools could close, even the most financially dire have not. Instead, law schools are doing everything they can to push down costs hard and fast. Reports of layoffs of professors, buyouts and job cuts abound even for those with tenure. For years, central campuses sucked money out of law schools. Now they are keeping them alive.
Solomon sees all this as evidence that “the market” is working, if somewhat slowly and imperfectly:
The failure of law schools to close may also simply be a recognition that the market is adjusting to today’s realities. The struggle is pushing down the costs of operating a law school, and law schools are still valuable to universities. It may be tempting to shut them in these difficult times, but it can cost tens of millions to open a new one. Better to invest and cut back on expenses for a while and see what happens.
The status quo is likely to remain as some are forecasting that the bottom is almost here for law schools. This is how economics works: Markets tend to overshoot on the way up, and down.
Stephen Harper, author of The Lawyer Bubble, points out what’s missing from this analysis:
Solomon suggests that creditors made the only deal possible and the school is the ultimate winner. He gives little attention to the real losers in this latest example of a legal education market that is not working: Thomas Jefferson’s students, the legal profession, and taxpayers.
In retrospect, the restructuring agreement between the school and its bondholders reveals that a deal was always likely. That’s because both sides could use other people’s money to make it, as they have since 2008.
According to published reports, interest on the taxable portion of the 2008 bond issuance was 11 percent. Tax-exempt bondholders earned more than 7 percent interest. Thanks to federally-backed student tuition loans, taxpayers then subsidized the school’s revenue streams that provided quarterly interest and principal payments to those bondholders. (emphasis added)
That attending TJSL turns out to be a life-wrecking disaster for a very large proportion of its students is, as Harper emphasizes “irrelevant” in this sort of deeply dysfunctional market:
Thomas Jefferson’s low bar passage rate [54% in 2012] made no difference to most of its graduates because the full-time long-term bar passage-employment rate for the class of 2013 was 29 percent, as it was for the class of 2012.
Meanwhile, its perennially high tuition (currently $44,900 a year) put Thomas Jefferson #1 on the U.S. News list of schools whose students incurred the greatest law school indebtedness: $180,665 for the class of 2013 [Note that this figure doesn’t include interest accrued during law school, so the average TJSL graduate has well over $200,000 in law school debt alone at graduation]. According to National Jurist, the school generates 95 percent of its income from tuition.
This invites an obvious question: How did the school survive so long and what is prolonging its life?
First, owing to unemployed recent graduates with massive student loans, bondholders received handsome quarterly payments for more than five years — much of it tax-exempt interest. The disconnect between student outcomes and the easy availability for federal loans blocked a true market response to a deteriorating situation. Bondholders should also give an appreciative nod to federal taxpayers who are guaranteeing those loans and will foot the bill for graduates entering income-based loan forgiveness programs.
Second, headlines touted Thomas Jefferson’s new deal as “slashing debt” by $87 million, but bondholders now own the law school building and will reportedly receive a market rate rent from the school — $5 million a year. Future student loans unrelated to student outcomes will provide those funds.
Third, the school issued $40 million in new bonds that will pay the current bondholders two percent. Student loan debt will make those payments possible.
Precisely.
Solomon doesn’t resist the urge to take a crack at certain unnamed critics of the law school status quo in America, who were supposedly enjoying “shivers of delight” at the prospect of seeing TJSL “keel over.” (Solomon links to an article in which I’m quoted using the latter phrase.) I’m not going to resist the urge to quote a couple of comments from the NYT site regarding his article:
Prof. Solomon’s stance in the face of this debacle is puzzling. He sardonically calls out the “shivers of delight” he attributes to critics such as Brian Tamanaha and Paul Campos who for years have been writing soberly and lucidly about these highly unethical operations that are just conduits of federal loan funds to overpaid faculty and administrators (the president/dean of Thomas Jefferson reportedly makes well over $500,00 per annum). Why Prof. Solomon feels called upon to defend this unconscionable system is a mystery.
To which another reader replies:
Yes, such a riddle wrapped up in an enigma why Prof. Solomon would support this money-printing operation. Someone please get the FBI on the case. We need answers, because I just can’t fathom why Berkeley law professor Solomon would support the Thomas Jefferson School of Law. It really makes no sense. I’m going to have to sleep on this one and see if I come up with some answers in the morning. Better yet, I’ll retain the services of an Ivy League consultant to perform an analysis on why Prof. Solomon would defend this institution. It’s a modern day mystery!