The Big Short: When the Education Bubble Bursts

Jack M. Jose

On September 15, 2008, the giant financial company Lehman Brothers, unable to meet its obligations to borrowers, completely collapsed, closing its doors and halting all transactions as it fell swiftly into unthinkably large debt. 25,000 Lehman employees lost their jobs.[1] The company would never re-open. In the same week, the largest banks in the United States all shared warnings of nearing a similar fate. This event was the primary public face of the start of the Great Recession, the greatest economic downturn in modern history. The US government stepped in to bail out the largest banks before they followed suit with Lehman Brothers, eventually spending trillions of taxpayer dollars to shore up our economy. The Lehman crash, and the bank crash in general, was connected with the bursting of the US housing bubble, where suddenly home prices crashed back from extravagant highs, costing homeowners billions in actual and unrealized gains in their personal net worth. In the end, billions of dollars of value of stocks, companies, and people’s homes and jobs were essentially vaporized. Even after 5 years of sustained job and economic growth following the official end of the recession in 2012, by some measures the United States has not yet unburied itself from this financial disaster.

There were many contributing factors to this economic crash, and many books and even movies helped to tell parts of the story. One best-selling book-turned-movie exploring the causes of this crash was The Big Short, by Michael Lewis.

“Wait,” you say. “This is an education blog. Why are you discussing the economy?”

Current conditions in the educational system in the United States, and particularly in specific states, resemble the situation that preceded the crash and Great Recession. A generation of reforms, from the Reagan-era Nation at Risk report to the transformative and bipartisan Bush II No Child Left Behind law to the Obama-era Every Student Succeeds Act, have eroded safeguards that tied tax dollars and community oversight to the education of our children. This has left our nation open to an educational crash, the sort of which has never happened, for which there is no roadmap or precedent, just as there was no precedent for the real estate and banking collapse in 2008. For many of us, just as for many experts in the banking industry, this collapse was a complete shock. Nothing could have prepared us for the long-lasting effects of the crash, and only in hindsight could we see all the signs of the impending crisis. Only a few people, generally well-read experts in the field who had proven willing to buck prevailing wisdom, were able to see the coming default. No one listened to them.

The Great Recession was caused by a number of related factors in the economy. One cause of the crash was deregulation. In a major windfall to banks and other lending institutions, Congress loosened restrictions on lending practices, allowing for larger and riskier loans, with fewer safeguards for borrowers. New companies, envisioning windfall profits, sprang up seemingly overnight and began competing for customers.  First time and repeat borrowers, excited for an opportunity to buy their first or their biggest house, flooded into the market, and found they had a wide array of companies competing to sell them a loan as cheaply as possible.

This deregulation combined with an extreme profit motive allowed for a second cause to emerge: predatory lending. With deregulation there came an expansion of banks, some of which became “too big to fail.” This phrase did not mean that they could not fail. It just meant that their failure would cause widespread economic disaster. The US government would, in this case, be forced to prop them up and to guarantee that their loans were covered. These institutions were assumed to be essentially unbreakable. Deregulation also meant such growth in the banking industry that new, non-bank companies got into the business of offering home loans and dealing mortgages. These new lending institutions looked and acted less and less like traditional banks, and they began enticing and even recruiting home buyers in the full knowledge that they would be unable to pay off the loans. This happened even while these institutions paid exorbitant salaries to CEOs, often with sales bonuses for the middle managers, creating incentives to make riskier and riskier loans.

Additionally, the oversight for these new kinds of banks, making these new kinds of loans, was essentially nonexistent. Traditional systems of measuring the effectiveness and liquidity of banks were overmatched by these new rules. The use of innovative and complex accounting, perhaps intentionally, made oversight of any sort more difficult. Specifically, the creation of credit default swaps and collateralized debt obligations made it nearly impossible to assess the riskiness of investments. It is hard to judge the risk inherent in buying something most people cannot understand or explain.

Finally, signs of an impending crash were ignored by almost everyone. Time and time again lenders and monitors alike allowed themselves to participate in what now is understood to have been “magical thinking”, the belief that these risky pools of unexplainable investments would somehow continue to increase in value forever. In fact, at times the warnings were so loud that Federal Reserve Chairman Alan Greenspan, who was notoriously reluctant to speak directly to future trends or concerns, made multiple public statements to dismiss these warnings. Bruce Bartlett, a former Treasury Department economist, catalogued many of those warnings in his first article as a regular columnist at Forbes Magazine.[2]

These factors have parallels in the current movement in education, as described below.

Deregulation – creating the bubble

In order to encourage the growth of the “ownership society” as espoused by President George W. Bush during his successful Presidential campaign[3], his administration and a Republican congress undertook several initiatives aimed at increasing home ownership. These were well-intentioned and broadly popular bipartisan acts aimed at placing more people in their own homes, and prompting them to be better citizens in general, because they would now have a stake in the success of the community. However, these enticements created unforeseen consequences. Homeowner down payment assistance and efforts to simplify home-buying drew in record amounts of new home owners. Some of these home buyers were not, according to traditional measures, a good bet to stay in the house and pay off their loan. Unscrupulous lenders capitalized on these eager new buyers, offering them larger and riskier loans than ever before. Folks with bad credit got loans, folks with good credit got larger loans than they could handle, all with the promise of future gains in the value of these houses.

The expansion of the charter school movement in the US parallels this change in the banking system, and seems poised to create a similar bubble. While a long-established system of education exists, with a history dating back to the first colonies on Plymouth Rock, and overseen by elected school boards in nearly every city and county in our country, recent deregulation in education law has created an expansion of school-like entities called charter schools. These schools often get permission to operate with a different set of rules than public schools, typically privileges to experiment with curriculum, seat time, salary scales, and more, often under the guise of being “laboratory schools”, free to experiment with ideas that might work better for education. These types of schools flourished under the Obama administration, and seem set to practically explode during the current administration. Just last week Florida approved $200M for a major expansion of charter schools in the Sunshine State.[4] In addition to brick and mortar schools, largely to save on costs associated with maintenance and transportation, charter schools have innovated and quickly expanded online learning. Ohio, California, and Pennsylvania, lead states in enrolling students in online schools, according to the National Alliance for Public Charter Schools (NAPCS). And the expansion has been accelerated through the use of novel, some might say experimental or even suspect, techniques for delivering education. In the 2014-15 school year, 38,500 students in Ohio alone took all of their classes on computers from home through an online school.  For the 2015-16 school year, Ohio paid online schools $267 million to educate those students — more than a quarter of what it paid all charter schools in the state. The Electronic Classroom of Tomorrow (ECOT) and the Ohio Virtual Academy (OVA), with 15,000 and 11,000 students respectively, are the largest online schools in Ohio. More on ECOT later.

In May of 2014, the New York City legislature created laws that they touted made New York “friendlier [to charters] than almost any other city in the nation.” By increasing the per pupil allocation allotted to charters, eliminating salary minimums for teachers and other staff, and by requiring public schools to offer up unused space at a significant discount, many charter schools are given advantages that would seem to tip the scale in their favor. It would be hard to argue that these private or public charters are indeed true laboratories for innovation of best practices, given the tremendous advantages they have over public or even private schools.

The US Senate’s Levin–Coburn Report concluded that the financial crisis was the result of “high risk, complex financial products; undisclosed conflicts of interest; the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street.”[5] Might a charter school bubble and resulting education crisis happen the same way? Might the leverage of a few powerful textbook and test printing companies create a system that is “too big to fail”? Might a pending educational crash similarly be the result of state and national legislatures failing to rein in the excesses of “Big Ed”, a conglomerate of test makers, book printers, and educational consultants profiting handsomely from the creation and amalgamation of more and more charter schools?


“Bundling”: Credit default swaps, collateralized debt obligations, and joining forces

One of the effects of deregulation was the creation of new ways to buy and sell groups of mortgages. One of the ways that the lenders protected themselves from economic trouble was by creating complex financial vehicles called credit default swaps (CDS). These CDSs could be created without collateral – that is, without proving that there was anything of value to be sold in case the investment went wrong – and thus they were at higher risk for a default. These junk bonds, accurately named because they were groups of mortgages that were without value (hence “junk”), were often quickly bundled with other similar loans and sold in large amounts to larger companies who were investing on the continued growth of the value of real estate in the United States.[6]

Just like the creation of new banks and lenders looks like the expansion of charter schools, so too does the creation of CDS look like the persistent closing and combining happening among charter schools. Time and again failing charter schools are merged into larger existing entities, in much the way Lehman Brothers sopped up smaller banks in order to bundle their mortgage assets.

The national White Hat Management group’s Cleveland experiment is an example of how deregulation and recombination make it difficult to monitor the effectiveness of individual schools. White Hat management ran into legal difficulties, accused of being beholden to particular publishers and vendors, rather than operating independently. Instead of amending their practices, they chose to sell major operations to a Pansophic education (founded by the same people who helped found the charter school system K12) which overnight became one of the largest charter school sponsors in the state of Ohio[7].

Other national vendors of charter schools, such as K12 and KIPP, have expanded through a combination of opening new branches and purchasing or absorbing existing charter schools. This makes it impossible to truly gage the effectiveness of the schools. In 2014, the law in Ohio called for charter schools to release their state report cards in their third year of existence. The average length of operation of a charter school in Ohio was 2.5 years. On average, schools chose to fold or divest rather than reveal their results. This has the effect of skewing charter school data to look better than it actually is. How? If, in any data set, you allow the option for the low-performers to opt out before being counted, the resulting data is inaccurate. This makes the data, which shows that charter schools tend to slightly underperform public schools on average, even more frightening.

Also in Ohio, the I Can charter school chain – started by former leaders of the well-regarded Breakthrough charter schools – has faced poor results and negative feedback from the public in Cleveland. The chain has additional schools in Akron and Canton and one in Indiana. In response to the poor results, the chain was turned over to Accel Charter School network. In their public statement on the transition, school officials explained that “running quality schools at the state’s $6,000 funding per student is too great a challenge and that they want to be with a larger network to save money.”[8]

“The teachers, the students and the parents will not notice a difference,” said I Can lawyer Jamie Callender, a former state representative for western Lake County.

It is hard to find these words reassuring, given that the transfer happened because of poor results.


Profit motive and predatory lending

Another contributing factor to the market crash and resulting recession was the large profit motive leading to predatory lending. Here is how it worked in the banking and mortgage business: mortgage lenders could bundle these mortgages (and the associated risks) and pass them on to banks and bank-replacements. They could – and did – adopt loose underwriting criteria (encouraged by regulators), and some developed aggressive lending practices.[9]

What might this look like in the education world? Much the same as it did in the mortgage world, it might look like charter schools targeting residents of urban areas and promising a new world of opportunities. It might look like glossy postcards and slick advertising campaigns, and promises of access to the internet at home for people who cannot afford it for themselves. It might look like promises of safety and order. It might look like colleges enticing students to borrow beyond their means in the hope of enhanced future earnings. 

It might look like dozens, maybe more than a hundred, for-profit colleges identified as having an unacceptable debt to earnings ratio. This ratio is “how much money typical program graduates are required to spend on student loan payments every year, and how much they earn in the job market two years after graduation.”[10] The administration of President Barack Obama labeled schools with unacceptably high ratios of debt as “profit mills”  – schools designed to create profit for themselves with little concern for their actual benefit to the students. A list of such programs was available at this Department of Education site at the time of publication of this article.

And there is big money to be made. One example of a well-paid executive in the charter school business is Ronald J. Packard, the CEO of K12 Inc. According to SourceWatch, a publication of the Center for Media and Democracy, Packard received compensation of over $19.48 million from 2009 to 20013, almost $4M a year. In 2013, he owned over 2 percent of K12, which had a market cap of around $1.25 billion in September 2013.

Education publication companies are already massive. Pearson, a textbook and testing company, has a market value over $4.5B. McGraw-Hill, according to Reuters, anticipated a valuation of nearly $5B when they offered an initial offering of stock in 2014. A third major educational publishing company, Houghton Mifflin Harcourt, currently is worth about $1.5B. The Chief Executive Officers of these companies are making major deals that will determine how our students and our schools are taught and tested, and their ability to work a deal that is good for the company will be a primary determinant of their value to the company, and the source of their compensation. They are even working in many states, as well as at the federal level, to create mandatory testing. Thus the law will guarantee that their product is purchased. They could be moving from free market salespeople to the sole deliverers of a multi-billion-dollar government mandate.

There is significant economic pressure to deliver a contract, especially a federal contract with billions of dollars.

Well-compensated CEOs, and multi-billion dollar publishing companies are sources of concern. But the mere ability to earn a major profit is not evidence of wrongdoing.

Profit-mill colleges are a bigger concern, but these do not, necessarily, rise to the level of wrongdoing or fraud. They are merely concerns.

However, actual wrongdoing was recently uncovered at Ohio’s ECOT school. This for-profit online k-12 school was cited this September by the Ohio Department of Education for charging the state for higher attendance than the school actually could verify. Online schools are very different from traditional schools, as students do not have to physically show up at school in order to be counted as present. They merely have to log in from home. The problem at ECOT was that they claimed compensation for 9,000 more students than they could prove they had.[11] With about 6,500 students verifiably enrolled, ECOT received an estimated $60M in funding that they did not merit for the school year. This fraudulent claim on taxpayer dollars should be a major concern for taxpayers.

Fortunately, this fraud was caught through oversight, and public records claims would help reveal the same information. Efforts to undermine the transparency of the system could create a system where such schools could hide their efforts to defraud states and taxpayers. In fact, reducing oversight seems to invite poor behavior.

Lack of Oversight

A final important cause of the 2008 economic collapse was that deregulation had led to a serious lack of oversight, which meant that important signs of impending collapse were ignored, or were never seen at all. “In 2007-2010 the lack of transparency in the large market became a concern to regulators as it could pose a systemic risk.”[12]  The Financial Crisis Inquiry Commission concluded that the financial crisis was avoidable and was caused by “widespread failures in financial regulation and supervision.”

In a revealing scene in the movie version of The Big Short, an investor approaches a woman he knows well and who works at the Securities Exchange Commission, which is tasked with overseeing the banking market. He learns she is still providing oversight to these companies, even while she is actually seeking a higher-paying job from them – whichever one will hire her. He asks if there are laws preventing her from moving from a regulatory agency directly into a position with a large bank she was supposed to be investigating. She shrugs. “Since we got our budget cut, we don’t investigate much.”

For now, it is unclear whether the level of oversight is up to the task of managing the level of attempted fraud and poor performance. In addition to the ECOT investigation in Ohio, the Charter School Commission also proved willing to take charters away from low-performing schools.[13] These are positive signs.

Despite these isolated reports of identified fraud, the national move has been to reduce the amount of oversight, rather than increase it. In fact, one legislator, Representative Thomas Massie of Kentucky, introduced a bill to end the Department of Education on December 31, 2018. And while this is likely just a symbolic gesture, the symbolism is not empty in a government with Congress and the White House under the control of one party. The House of Representatives recently scaled back implementation of oversight proposed under the new ESSA law.[14]  The new Secretary of Education, Betsy DeVos, made millions of dollars buying and selling charter school companies, and seems predisposed to favor charter schools over public schools. Just last week Bloomberg reported efforts by Betsy DeVos’ education department to take away protections for students taking out large loans to attend college, including the profit mills described above.


So these 5 risk factors, which set the stage for the economic meltdown of 2008, seem to exist in education today: deregulation, “bundling”, profit motive and predatory lending, and the potential for a lack of oversight. But what does that presage?

Just what does a crash in the educational system look like, exactly? It has never happened, as far as we know. And an education, unlike a dollar, is incredibly complex to track and measure. But we can speculate.

It could look like individual communities bilked out of hundreds of thousands of dollars, with state and federal dollars siphoned into the hands of a few corporations, who expand charter schools into additional markets, perhaps with the help of new federal laws. These communities whose public schools will be pitted against charter schools, already perpetually struggling to make ends meet, could find themselves over the next three years hit by a double-whammy of the loss of federal government support for individual programs and a federal hiring freeze, and the specter of funding a charter school system to run in direct competition with their own public system. Bankruptcy and receivership can mean the permanent fiscal end to a community, as inhabitants pack up and move away, or it can mean incorporation into a neighboring municipality.

The losses here, however, are perhaps as significant as they hard to measure.

On an individual scale the losses might be even worse than mere dollars and cents. Losing two or three years of a child’s education, as well-intentioned parents direct their children into profit-mill schools, can actually have a measurably devastating effect on a student. These schools often hire untrained and uncertificated teachers, or teachers who have been unable to find or keep work in other schools. We know that being assigned to an ineffective teacher for three consecutive years results in a 50% lower performance at the end of the three years than similar peers taught by the best teachers.[15]   We know that the lack of ties to a community that comes from answering to a private board rather than a public one can create a loss of identity for students and the community. What is the effect of schools that continually close, reorganize, and open again? How can they build continuity of relationships, standards and expectations, professional growth among teachers and administrators? What happens to students treated like widgets, or worse? What happens to the communities as these students grow up feeling a little less connected, a little less educated, a little less prepared for the future?

The housing bubble, and the resulting market crash, had devastating effects on people’s homes and lives. Billions of dollars were lost. The economy lost millions of jobs. People had to move from their homes. It was devastating. Money, however, can be earned back over time. The cost of thousands of lost educations, as corporations populate laboratory charter schools with our next generation, and those schools churn and change hands every couple of years, is incalculable.


[1] Sorkin, Andrew Ross. “Lehman Files for Bankruptcy; Merrill Is Sold.” Editorial. NY Times 25 Sept. 2008: n. pag. The New York Times. The New York Times, 14 Sept. 2008. Web. 16 Apr. 2017.