A Better Measure of Financial Health

We stand on the precipice of an enrollment crisis in higher education, making it more critical now than ever to accurately assess the financial health of our universities. In 2024 alone, 16 nonprofit colleges and universities announced closures. A recent Federal Reserve report warned that in a worst-case scenario with a 15 percent decline in enrollments we could see as many as 80 additional closures annually.

This crisis is propelled by the much-discussed demographic cliff looming over higher education. A report from the Western Interstate Commission for Higher Education states that the total number of high school graduates is expected to peak this year and then decline steadily through 2041. This looming enrollment cliff threatens the financial stability of colleges and universities nationwide. As the pool of potential students shrinks, institutions will grapple with unprecedented challenges in maintaining enrollment levels, directly impacting their financial health.

Could this be the pivotal moment to overhaul the deeply flawed system we currently use to judge the financial stability of our educational institutions? Since its introduction in 1997 by the U.S. Department of Education, the Financial Responsibility Composite Score—FRCS—has standardized the evaluation of colleges’ financial stability through three main financial metrics. Colleges that receive failing scores must submit to additional oversight and may be required to post letters of credit to retain their eligibility to participate in federal financial aid programs. This system has drawn significant criticism for its inefficacy and has failed to protect students and institutions when they need it most.

Enter the second Trump administration. To date, its focus has centered on Department of Government Efficiency initiatives, including significant head-count reductions, with the stated goal of dismantling the ED. Yet the administration has not articulated a clear legislative agenda for the federal government’s ongoing role in higher education, nor has it explicitly called for eliminating the student loan program, which it instead wants to move to the Small Business Administration. So long as student loans and grants flow to institutions under the Higher Education Act, Section 498(c)(1) imposes a statutory requirement to maintain a system ensuring the financial responsibility of participating institutions—a mandate rooted in protecting federal funds and students.

Notably, the FRCS, the current tool for this purpose, isn’t enshrined in law but stems from 1997 ED regulations, offering flexibility for change. Practically, most would agree—regardless of political leanings—that the government must ensure that federal funds support financially viable institutions, allowing students to graduate and repay loans rather than face disruptions from collapsing colleges. The Trump administration has a unique opportunity to overhaul this flawed system.

Reflecting on historical analogues, the financial crisis of 2008 led to the enactment of the Dodd-Frank legislation, which mandates banks to undergo annual stress tests to evaluate capital adequacy under adverse economic conditions. Rather than merely reacting once a crisis has already occurred, the Trump administration has the opportunity to proactively address this issue of financial health in higher education.

The Flaws of the Financial Composite Score

The U.S. Government Accountability Office issued a report in 2017 finding that this metric only predicted half of college closures since the 2010–11 academic year. GAO identified three weaknesses of the FRCS:

1. It does not reflect up-to-date accounting practices.
2. It relies on outdated financial measures, and “does not incorporate new financial metrics that would provide a broader indication of schools’ financial health, such as liquidity, historical trend analysis, or future projections.”
3. It is vulnerable to manipulation.

My engagement with this issue deepened after co-authoring an article on this topic in 2019 for a think tank. Subsequent dialogues with higher education stakeholders have highlighted how the score restricts strategic financial decisions. College administrators often complain that the score doesn’t reflect the current market value of assets like real estate, leading to a focus on score management rather than genuine financial health improvement. Perversely, the FRCS incentivizes institutions to take on long-term debt to finance capital expenditures rather than using existing cash reserves. To be clear, through regulatory design, ED has effectively created a system where institutions benefit from incurring debt, which inherently introduces financial risk.

The treatment of debt within the FRCS illustrates its inherent complexity, as evidenced by ED’s regulatory adjustments over the past six years. In 2019, ED introduced new guidelines to clarify how long-term debt should be accounted for in the composite score, stipulating that debt associated with capitalized assets must be clearly identified in audited financial statements and that the debt must exceed a 12-month term. This was a direct response to historical manipulations by some institutions. However, confusion persisted with this guidance, leading to further clarifications in December 2024.

I encourage those of you reading this piece to dive into ED’s guidance, as you might feel like you are deciphering arcane text. The convoluted regulatory language highlights how much intellectual energy is wasted to patch up a fundamentally flawed system. This complexity is a boon for industry lawyers and consultants who capitalize on the FRCS’s shortcomings, turning the task of score improvement or explanation of the application of the rules into a profitable niche. Unfortunately, this means universities allocate scarce resources to navigating these regulatory mazes rather than focusing on what matters: maintaining a viable and sustainable institution that can serve learners.

Taxpayer resources are wasted with continual revisions to the FRCS, but meanwhile, in the real world, universities with seemingly robust scores still close down, leading to significant disruptions for students. Consider the following three universities that shut down this past year, all of which had passing financial composite scores (1.5 or above, with 3 being the highest obtainable score):

• Hodges University in Florida had a composite score of 2.7 in 2022 but closed after enrollment fell by more than half since 2017.
• Pennsylvania Academy of the Fine Arts in Philadelphia, with a score of 2.2 in 2023, saw enrollment drop from 273 to 126 students in four years.
• Notre Dame College of Ohio achieved a 2.1 score in 2022, but enrollment fell from 2,281 to about 1,050 over a decade.

A Proposed Solution: Third-Party Financial Analysis

ED created the FRCS in response to legislative edict by Congress (20 U.S.C. § 1099c(c)), which states that “if an institution fails to meet criteria prescribed by the Secretary regarding ratios that demonstrate financial responsibility, then the institution shall provide the Secretary with satisfactory evidence of its financial responsibility. “ Almost 30 years later, we have sufficient evidence that financial ratios aren’t sufficient to capture the complexities of an institution’s financial condition.

A more dynamic approach would involve evaluating universities’ financial health akin to how stocks or corporate bonds are rated.

The Trump administration should do away with the current approach in favor of hiring independent rating agencies like Fitch, Moody’s or Standard & Poor’s to provide ratings to institutions.

For example, these ratings could categorize institutions into groups:

• No risk of closure
• At risk of closure within five years
• Facing imminent closure

Institutions at risk would need to provide a teach-out plan and a strategy for credit transfer in case of closure. These ratings, along with the agencies’ research notes, should be disclosed to students before they enroll, ensuring transparency about the institution’s financial stability. Accreditors can align their own practices of institutional financial review with this new approach.

The issue of transparency received the most furious of responses when I circulated my proposal years ago to education stakeholders. Critics argue that such a system might accelerate an institution’s decline by deterring prospective students who might be hesitant to enroll in a college that might close. To be clear, this is a valid concern. Financial transparency could accelerate the collapse of institutions teetering on the edge of closure. But the current system leaves students and the public in the dark regarding a college’s tenuous financial footing, leading to sudden and disruptive closures. My discussions suggest that some in higher education prioritize institutional viability over student welfare.

Secretary of Education Linda McMahon has experience with the benefits of public scrutiny from her tenure as CEO of World Wrestling Entertainment. I know this firsthand. As a young analyst covering WWE stock more than 20 years ago, I met her at WWE headquarters in Connecticut. Within the first five minutes of our meeting, she expressed how management appreciated the transparency of being a publicly traded company and welcomed the scrutiny of third-party analysts. She said that becoming publicly traded was the best decision given increased disclosure requirements.

Critical Questions Analysts Would Ask

Here are key questions a third-party analyst might pose to assess an institution’s viability in a more nuanced way than the FRCS allows:

1. Enrollment break-even point: At what enrollment level does the university neither gain nor lose cash?
2. Enrollment trends and financial impact: Given current trends, what’s the risk of operating at a loss over the next three years?
3. Cash flow analysis: Does the university generate cash losses, as seen in cash flow statements?
4. Liquidity: How many years can the university fund operations with its current liquid assets?
5. Asset market value: What is the market, not just book, value of assets that could be liquidated for cash?

By shifting to a model supported by third-party analysis, we could foster a more transparent, predictive and protective environment for students and the broader educational community. This overhaul would not only align with the administration’s deregulatory stance but would also fundamentally enhance the integrity and accountability of higher education financial assessments.

Framing the Conversation

I recognize that in the vast arena of political priorities, an obscure metric like the FRCS will not capture headlines or be at the forefront of the Trump administration’s agenda. However, we cannot ignore the tangible, real-world repercussions of this outdated system.

The conversation should be framed around:

• Reducing the government’s footprint in higher education, by leveraging private sector expertise to evaluate the financial health of institutions that manage public funds through student loans.
• Preventing a crisis of sudden college closures, particularly those with shaky financial foundations, to protect the educational paths of students.

Given the language of the Higher Education Act as amended, what I am describing may require legislative rather than regulatory change. If so, I encourage both sides of the aisle to recognize the lack of partisanship on the issue of institutions failing due to weak financial health.

It’s conceivable that ED could initiate a new rule to contract agencies like Fitch or Moody’s, integrating their ratings into its oversight process. This shift could be executed through negotiated rule making, a collaborative process involving higher education stakeholders, where resistance seems unlikely. No participant—whether college administrators weary of the FRCS’s flaws, student advocates seeking transparency or fiscal watchdogs guarding federal funds—should object to this common-sense upgrade, as it promises a more accurate, market-driven gauge of financial health, aligning the interests of institutions, students and taxpayers without the upheaval of legislative gridlock.

If this proposal seems a bit too much, I urge those with decision-making power to at least update and enhance the methodology of the FRCS. The current state of affairs is unsustainable; it’s time to act decisively to safeguard our students and uphold the integrity of higher education.