The Morally Bankrupt Industry

| August 17, 2010 | 0 Comments

It’s barely been two years since the subprime debacle.

In fact, we’re still reeling from the financial crisis of 2008.  It’s one of the largest bubbles to burst in the history of the financial markets.  And we know the crisis was caused by the ridiculous excessive use of subprime mortgages (and related derivatives).

There’s an excellent book on the subject called The Big Short by Michael Lewis.  You can find it in any bookstore.

One of the main characters is Steve Eisman.  He’s become famous for betting against subprime mortgages.  People thought he was out of his mind.  Remember, he was betting against housing when it seemed house prices would never fall.

When the subprime market crashed, he made $1.5 billion.  No one’s laughing at him now.  In fact, he’s become a very popular, widely followed hedge fund manager.

Now Steve Eisman is already predicting the next market to crash.

You’ll never guess what it is…

For-Profit Education.

Check out this quote from Eisman.  I think it says it all…

“Until recently, I thought that there would never again be an opportunity to be involved with an industry as socially destructive and morally bankrupt as the subprime mortgage industry.  I was wrong.”

Wow.  Strong words coming from a hedge fund manager.

Why the harsh words?  What’s the deal with these for-profit education companies?

Let me explain…

For-profit colleges aren’t cheap.  But they always seem to have high enrollment numbers.  You see, the companies who own them spend a ton of money on marketing.  And they paint a rosy picture for perspective students… a better life with more money.

And who doesn’t want a better life?

The enrollment agents at the for-profit schools have an easy sell, particularly when they target the low-income demographic.  And low-income people are flocking to these schools.

But even average-income earners can’t afford the pricey tuition without help.  How can low-income students afford it?

Student loans of course.

Over 80% of the revenue for these for-profit colleges comes from federal student loans.  In fact, 25% of the nearly $90 billion a year of federal student loans are going to the for-profit colleges.  Keep in mind, only 10% of all college students are attending for-profit schools.  For-profit education is obviously sucking up a disproportionate share of the money.

But here’s the key point…

Many of these student loans never get paid off.  The default rate is climbing higher and higher.  And there’s no reprieve in sight.  Guess who gets stuck with the bill?  The taxpayer.

There are several reasons for this unfortunate situation.

First off, the education at many of these for-profit schools isn’t exactly top notch.  This is particularly true regarding the liberal arts degrees. Technical degrees can be valuable.  But it’s widely thought the more generic diplomas are not getting students into better jobs.  They simply don’t provide a lot of value to a potential employer.

More importantly, we’re in a recession.  There are plenty of people with advanced college degrees from renowned universities who can’t find work.  It’s even harder for the for-profit school graduates.

But that’s not even the scariest part…

There’s over a 50% dropout rate at for-profit schools!

Many students at the for-profit schools just don’t value the education they’re receiving.  Remember, a lot of these people were recruited by enrollment agents.  It appears many have no real desire to learn or attend classes.

But it gets even worse…

You won’t believe where some of the students were recruited.

According to Steve Eisman, enrollment agents recruit from homeless shelters and casinos.  Can you believe it?

Now I understand why Eisman used the term ‘morally bankrupt’ to describe the for-profit school industries.

Obviously, the companies running these for-profit schools are only concerned with higher revenues.  They know they’ll get federal student loan money.  The schools don’t care if students drop out.  They’ve already booked their profits…

Let me put this another way…

You and I are stuck paying the bill.

And the only people profiting are the corporate executives.

Because of Eisman and others like him, the government has finally taken notice.  Companies can’t keep using such unethical business practices. Eventually, it catches up to them.

As you read this, Congress is debating how to deal with the for-profit schools.

I don’t know what the result will be.  But, it’s pretty clear something will change.

The markets have taken notice.  The leaders in the industry have all taken a beating.  Apollo Group (APOL), Corinthian Colleges (COCO), DeVry (DV), and ITT Educational Services (ESI) are all trading lower in recent months.

But the window for lower prices isn’t closed yet.  APOL and ESI in particular still have room to drop.  Both stocks tend to be volatile.  The next time either of these companies gets a bounce higher, I’d recommend shorting the shares or buying puts.

The for-profit schools are in the crosshairs.  It won’t be long before changes are made.  The industry is sure to suffer from whatever happens.  And when the prices drop, we can be there to profit.

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Category: Stocks

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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