The dramatic rise in college tuition might have you asking a lot of questions. Costs associated with obtaining a college degree have gone out of control.  Surprisingly, the trend of increased college tuition hasn’t decreased during the worst economic downturn in recent history. With the unemployment rate currently standing at 10.20% tuition has still managed an  increase of 6.50% in the fall of 2009. Worst of all, many of the reasons students have been given for rising tuition simply aren’t accurate.

In a free market college tuition prices are a product of supply and demand. Unfortunately, these free market forces aren’t allowed to play out because of government interference. All of the programs designed to help students pay for college have caused prices to skyrocket. Grants and guaranteed federal student loans are the main reasons for out of control tuition costs. That’s right, the very programs designed to help students are actually hurting our pocket books.

Guaranteed Student Loans

If students couldn’t borrow money through government guaranteed loan programs fewer students would have money for college. Private institutions would never loan this money out for fear of going broke from loans in default. When more students have access to guaranteed financing through government loan programs, demand for college placement increases. This results in a situation where students compete for a fixed amount of college positions with federal money.

Universities know this is taking place and can increase prices accordingly. They no longer have any incentive to control costs and reduce wasteful spending. Consequently, the gap between actual teaching faculty and administrators has shrunk. Along with the ever growing amount of Assistants, Directors, Deans and Heads comes supporting staff and office facilities. Throughout history the answer has always been increasing tuition prices, but never eliminating non-core expenses. This process starts a cycles of wasteful and unnecessary programs.

At public colleges, tuition has generally been driven up by rising spending on administrators, student support services, and the need to make up for reductions in government subsidies, according to a report issued by the Delta Cost Project, a nonprofit based in Washington, D.C. – Kim Clark

The chart above shows the ratio between average incomes and tuition at Stanford University at various points in history. The data shows a clear deterioration to just 1.53 in 2009. The average college student must work more than two thirds of a year (full time) to pay for just one year of tuition at Stanford. This is compared to just one-fifth of a year to pay for one  year of tuition in 1960. With increased government sponsored loan programs and other entitlements no reason exists for this trend to change in the future. Adding to that Ben Bernanke and the Federal Reserve sponsored inflation and you have rapidly rising costs.

Anytime our government interferes with free market systems costs go up and quality goes down. This is caused by moral hazard through guarantees and decreased competition. Colleges know they can charge higher tuition prices because of guaranteed loans. At the same time a greater amount of students are pursuing higher education so colleges don’t compete for enrollment as much as they use to. Instead prospective students fight for acceptance at universities. This is a recipe for skyrocketing tuition costs and a massive burden of debt for young academic Americans. The average college student is $20,000 in debt by graduation. Worst yet, many acquire consumer debt through credit cards and mortgages soon after. This certainly doesn’t sound like a good start to achieving financial security.

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Poor personal loan portfolios in a weak economy equals a lot of trouble. Couple that with a presidential administration completely against your specific business model and things go from bad to worse. These are the current circumstances surrounding publicly traded payday loan companies. The risks associated with many of the these companies are shocking – including  the complete elimination of the payday loan business model as we know it. The negativity doesn’t end there. Most of of the payday loan companies target citizens in “vulnerable” financial condition with many practices being borderline abusive. All of these areas add up to one huge problem in the consumer finance sector sparking widespread reform and lawsuits.

Let’s first take a look at the business models of most of these companies without mentioning specific names. A typical payday loan company deals with individuals in “high-risk” financially distressed situations. These types of loans are usually advertised for people with emergency or unexpected expenses. Most of the companies use “installment” based loan payment systems that are heavily front-loaded and uncollateralized. This implies a certain tendency for “extended credit” to be given to individuals already behind on their current loan through refinancing. People inside the system know this as “loan flipping”. While it seems like a nice gesture, all it really does is ensure an individual will get deeper into debt. Being financially “trapped” by payday lenders is brought about through triple digit interest rates – something many people never recover from. Well over half of loan portfolios of most of the payday lenders fall into this category.

In a strong economy with high inflation this type of business model works great. In a credit strapped economy with high unemployment, high-risk “payday” loans, refinanced many times over is the worst place for money to be. In strong economies these types of loan practices often “fly under the radar”, but when the economy is weak people get into real financial trouble. Then important people really start to take notice. Things have turned so sour that the Obama administration has taken notice and responded with potential new policy suggestions – in turn sending payday loan operators down double digits in recent trading sessions.

• Payday Loan Lenders Struck By Virtual Reality
• Payday Industry In Danger Of Default

“BARACK OBAMA’S PLAN TO STRENGTHEN THE ECONOMY FOR WORKING FAMILIES”

Cap Outlandish Interest Rates on Payday Loans and Improve Disclosure: In the wake of reports that some service members were paying 800 percent interest on payday loans, the U.S. Congress took bipartisan action to limit interest rates charged to service members to 36 percent. Barack Obama believes that we must extend this protection to all Americans, because predatory lending continues to be a major problem for low and middle income families alike. Obama also believes that we need to ensure that all Americans have access to clear and simplified information about loan fees, payments and penalties, which is why he’ll require lenders to provide this information during the loan application process…

…Barack Obama will work with his Secretary of Treasury and the Federal Deposit Insurance Corporation to encourage banks, credit unions and Community Development Financial Institutions to provide affordable short-term and small dollar loans – and to drive the sharks out of business.

These words have surely sent chills down the spines of payday lenders. A President who calls payday lenders “predatory” and “sharks” definitely means business. At the very least payday loan companies will face restrictions on interest rates. This will severely weaken current business models and lead to the destruction of market share. Industry giants like Well’s Fargo who also offer payday loan service will take current loan sharks to the cleaners. Worst of all, the attention given to the industry will put lending practices under a microscope, exposing potentially illegal loans. Several payday loan companies like First Cash Financial (NASDAQ: FCFS , FREE Analysis) , World Acceptance Corp (NASDAQ: WRLD, FREE Analysis) and EZCORP Inc (NASDAQ: EZPW, FREE Analysis) reside in the state of Texas. Coincidentally, the lone star state has some of the most lax and unregulated lending laws in the United States. The list of lawsuits against payday lenders is virtually endless. A simple search on google brings up pages of indexed lawsuits against the aforementioned companies.

• Attorney General Darrell McGraw Sues to Enforce Subpoenas and Enjoin Predatory Practices of 12 Internet Payday Lenders and Collection Agencies – 2009
• Payday lending lawsuit can proceed, court says Plaintiff OK’d as class representative – 2009
  
• Lawsuit Filed Against Payday Loan Companies – 2007
  
• Cordnyn Files Suit In Austin and Mcallen Against “Payday” Lenders – 1999
  

It is our belief that the business model of payday loan operators may be near the end as we know it. President Obama’s recent policy release may in fact be “the drop of water that makes the jar overflow”. Recent attention given to potential policy revision will most likely open the floodgates for predatory loan lawsuits by affected citizens. If lawsuits succeed in highly unregulated states like Texas, loan companies will no longer have a place to hide.

Consequently, much of the inherit downside risk associated with publicly traded payday lending companies may not be sufficiently factored into share price at the present time. We believe businesses engaged in payday loan operations may face substantial and potentially catastrophic loss during the Obama presidency – or at the very least, until the US can reinflate the credit bubble. One of the highest risk payday lenders is World Acceptance Corp (NASDAQ: WRLD) due to their specific loan business model. While many companies operate pawnshops, World Acceptance Corp engages exclusively in uncollateralized loans, putting them at extremely high risk in the present economic environment.