There's an alarming new study that says charter schools are America's new subprime mortgages

The charter school industry — consisting of schools that are funded partly by tax dollars but run independently — may be heading toward a bubble similar to that of the subprime mortgage crisis, according to a study published by four education researchers.

The study, “Are charter schools the new subprime loans?,” warns of a number of factors that appear to be edging the charter industry toward a bubble premeditated by the same factors that incentivized banks to start originating risky mortgage loans.

With charters, school authorizers play the role of “mortgage originators.” They have the power to decide whether to issue a new charter school. There are a number of different types of authorizers from state education agencies to independent charter school boards. The majority of authorizers are local education agencies (LEAs).

“Supporters of charter schools are using their popularity in black, urban communities to push for states to remove their charter cap restrictions and to allow multiple authorizers,” one of the study’s authors, Preston C. Green III, told the Washington Post, where we first read about the study. “At the same time, private investors are lobbying states to change their rules to encourage charter school growth. The result is what we describe as a policy ‘bubble,’ where the combination of multiple authorizers and a lack of oversight can end up creating an abundance of poor-performing schools in particular communities.”

In both the subprime industry and charter schools, the authors of the study point to a change in business practices as the catalyst of the bubble (or possible bubble, in the case of charter schools).

With the mortgage crisis, loan origination changed from an originate-to-hold (OTH) model to an originate-to-distribute (OTD). The OTD model allowed banks to sell mortgages into the secondary market where they were bundled up and sold by the government-sponsored enterprises Fannie Mae and Freddie Mac.

Kipp charter schoolMichael Buckner/Getty ImagesStudents at KIPP Bridge Charter School in San Francisco, California.

In both the mortgage crisis and the charter industry, these business model changes essentially transfer the risk to a third party entity whose incentives don’t necessarily align with those of the originator.

The study also reveals a similarity they call the “Principal-Agent Problem” that exists in both examples. In the mortgage crisis, mortgage servicers emerged as a result of the OTD model. Servicers handled administrative tasks that originators used to carry out, such as collecting fees from late payments or foreclosures.

Again, the incentives of the servicers and the originators diverged, as the servicers were compensated to foreclose loans rather than find alternatives.

Mayor bloomberg at charter schoolWikimedia CommonsMayor Bloomberg at Explore Charter School

Charter schools have this same misalignment when it comes to management by third-party organisations, the study says. Many charter school boards hire private education management organisations (EMOs) to run the day-to-day administrative tasks of the school.

While charter school boards have the responsibility to follow the laws mandated of public schools, the incentive of EMOs is to increase revenue or cut expenses, the study claims. And that misalignment creates an environment that may discriminate against students the EMOs deem as “too expensive,” such as those with disabilities, according to the study.

The authors of the study acknowledge the necessity of alternatives to failing public schools, but they urge lawmakers to put safeguards in place to ensure a bubble doesn’t develop and impact the very communities they aim to help.

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