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You may recall my number one U.S. higher education prediction (see The Year of the Rabbit) for 2011 was, “Early in 2011 cities and states that are broke now, operating with deficits, and projecting deficits through 2012, will begin to either default or furiously renegotiate their outstanding bonds.” I did not anticipate this prediction would begin to materialize on the fourth day of this year.

January 4 2011 Harrisburg, Pa. CNN Business Pennsylvania’s capital (city) owes $68 million in bond interest payments this year — $3 million or so more than its entire annual budget. The Harrisburg Authority, the governing body that issued the bonds to construct a state-of-the-art trash incinerator, has already been unable to make several payments, and now the county government, which footed the bill last year for a $775,000 swap fee, is suing for the funds. A combination of increasing bond rates and bad management led to this situation which is estimated to afflict over 400 tax-free bond borrowers nationwide.

And then just three days later…

January 07, 2011| Los Angeles Times The San Joaquin Valley town of Chowchilla — known for its dairy farms and prisons has defaulted on a municipal revenue bond, underscoring the tight times and drastic choices faced by struggling California cities.

If there are two economic activities that would tend to remain steady or increase no matter what economic conditions surround, are milk production and locking people up. What happened here?

I also projected that “At the same time, state’s contribution to higher education is expected to decline, precisely when demand from 18-24 year olds is projected to grow sharply (fueled in part by the nature of this recovery).”

So, three days after that…

January 10th SACRAMENTO UCNewsroom— Gov. Jerry Brown proposed a balanced, deficit-closing 2011-12 state budget today that relies on painful cuts in state services including a $500 million reduction in support for the University of California.

The 16.4 percent drop in state general fund support for UC would result in a historic shift in how California’s public research university is funded: For the first time in UC’s 143-year history, student tuition revenue will surpass what the state contributes to the university’s core operating budget. (Italics added)

California’s Governor Brown proposed state general fund budget that will return the UC system to the 1998 funding level when the system was 31% smaller (i.e., 161,400 students compared to today’s enrollment of 235,000 students or a difference 0f 73,600 students).

My prediction one continued…“This will exacerbate the financial issues already being faced by the whole of higher education, from decreased state contributions for public universities, to tapped-out Federal pools for loans and new requirements for additional reserves for private universities.”

The fiscal crisis in higher education did not begin with the mortgage securities crisis of 2008. Before then (much before then), Traditional Universities (TUs) failed to consider hidden operating cost and growing overhead costs as crucial fiscal factors.

Beginning in the 60’s, TUs administrative costs as percentage of all costs, began to take off. This rise in administrative costs were due to the following, (a) external reporting requirements newly imposed by the Feds and legislative demand for additional controls and (b) security, legal and compliance costs, born of the student protests of that era. These administrative costs were soon beyond budgetary control. One administrator begets staff to help her do her job and these make demands on budget.

The expansion of these costs continue today and little if any of it contributes to the productivity of the system, instead, even when the new administrative role is to create new sources of income, their contribution comes mostly from standardizing and controlling and is seldom developmental or entrepreneurial. This is where the hidden costs lie, in the organizational tradition of TUs that new things are addressed by minimizing the risk they might bring.  Most often this risk is imagined.

During good economic times, legislatures all over the United States signed blank checks to TUs, both in their direct contributions and in permission to raise tuitions. However, during bad economic times legislatures rescinded their financial support. Regardless of economic times, tuition always rose.

In my years of experience with TUs in fiscal crisis, I have encountered first-hand the difficulty in teaching TUs that operating costs matter. I don’t mean that TU’s do not care about costs, they do and they have been cutting budgets by eliminating costs as States cut back. But the costs ingrained in the inefficiency of their operating system is much less evident (and harder to see) than the budget adjustment. Ironically, the School of Business faculties with their experts in cost reduction and containment would unlikely advocate the TUs current financial policies. But more than likely, these Business School faculties have never been asked by their TUs to apply their skills to their own institution’s survival.

Commenting on my blog in November 2010 a former faculty member at UC Berkeley wrote:

A competent Chancellor would have been on top of identifying inefficiencies in the system and then crafting a plan to fix them. Competent oversight by the Board of Regents and the legislature would have required him to provide data on problems and on what steps he was taking to solve them. Instead, every year (Chancellor) Birgeneau would request a budget increase, the regents would agree to it, and the legislature would provide. The hard questions were avoided by all concerned, and the problems just piled up to $150 million of inefficiencies….until there was no money left.

Inefficiency (a) prevents the TUs from taking advantage of opportunities, (b) diverts money away from strategic purposes, and (c) frustrates staff and faculty who desire to accomplish more. Inefficiency also (a) featherbeds those staff and faculty looking for comfort, (b) maintains the status quo, and (c) provides a shelter for those administrators who prefer not to “make waves”. The commenter continued:

It’s not that (Chancellor) Birgeneau was unaware that there were, in fact, waste and inefficiencies in the system. Faculty and staff have raised issues with senior management, but when they failed to see relevant action taken, they stopped. Finally, Birgeneau engaged some expensive ($3 million) consultants, Bain & Company, to tell him what he should have been able to find out from the bright, engaged people in his own organization.

Change will come to TUs regardless of the institutions’ unwillingness or inability to cope with their financial crisis. But they won’t like it. For example, Governor Jindal of Louisiana proposed a study last week on merging Southern University at New Orleans with the University of New Orleans and then admitting both into the state system.  This will be the first of many forced mergers that the fiscal crisis and years of bad management has wrought. But that’s another prediction.