How to Profit

Citizens for Responsibility and Ethics in Washington, a progressive political watchdog group that’s lately become involved with issues affecting for-profit colleges, is asking the Department of Education to look into investment strategies surrounding proprietary schools.

According to a piece in the Chronicle of Higher Education:

[CREW] is asking Secretary of Education Arne Duncan to investigate the role that short sellers—investors who bet against for-profit colleges’ stock—are said to have played in crafting the Education Department’s proposed “gainful employment” rule. In a letter sent today, the watchdog group… says documents it obtained from the department “reveal the extraordinary degree to which Education has been captivated by outside groups in the development of its regulations.”

While many journalists and education advocates have pointed out the dilemma with people making money through the success of for-profit schools, it’s also, through short selling, possible to make money via their failure.

CREW argues that many of the people involved with crafting the “gainful employment” rules designed to prevent for-profit abuses were actually just interested in reducing the price of stock in for-profit education companies, because that’s how they make money.

Short sellers make money by selling borrowed securities. Basically it works like this: Profit University shares are trading at $5 a share. A person burrows 200 shares of Profit U and then sells them for $1000. And then, for whatever reason, Profit U shares decline. Profit U now trades for $1 a share. The short seller buys 200 shares of Profit U, for $200. He returns the shares to the lender, who gets those 200 shares back, though the seller has made $800.

The short seller makes money when the price of the stock declines. He loses money when the price increases.

The problem with this tactic, as far as for-profit colleges go, is that someone might have an interest in highlighting abuses and low quality at for-profit schools not because, say, there are abuses and low quality programs at for-profit schools, but because he would make money if people thought for-profit programs were going to close and the stock declined.

Whether or not the allegations of CREW are true, this highlights an interesting problem with for-profit colleges. The rules governing transactions involving such institutions cause people to behave rather oddly. Our basic understand of value would suggest that people make money on for-profit colleges if the colleges are good and people want to attend them.

The truth turns out to be a little more complicated.

Daniel Luzer

Daniel Luzer is the news editor at Governing Magazine and former web editor of the Washington Monthly. Find him on Twitter: @Daniel_Luzer