Let's start with research by Dennis Epple, et. al.
We develop a new general equilibrium model of the market for higher education that captures the coexistence of public and private universities, the large degree of quality differentiation among them, and the tuition and admission policies that emerge from their competition for students. We use the model to examine the consequences of federal and state aid policies. We show that private colleges game the federal financial aid system, strategically increasing tuition to increase student aid, and using the proceeds to spend more on educational resources and to compete for high-ability students. Increases in federal aid have modest effects in increasing college attendance, with nearly half of the increased federal aid offset by reduced institutional aid and increased university educational expenditures. A reduction in state subsidies coupled with increases in tuition at public schools substantially reduces attendance at those universities, with mainly poor students exiting, and with only moderate switching into private colleges.
The paper is among the stack of projects to take on during the semester.  It's already being hailed at Phi Beta Cons as support for an assertion William Bennett made three decades ago.  Third party payments make price discovery noisy (what was that P. J. O'Rourke wisecrack about healthcare being even more expensive when it's free?), and it's a proposition usually well-understood by economists.  Hence Richard Vedder, in a guest appearance at The Washington Monthly.
The increased demand for higher education in recent decades partly results from the explosive growth of [government grants and loans]. They were originally intended to help poor people gain access to college, yet they have probably had the opposite effect, pushing up the sticker prices of colleges substantially. The easy money has helped fuel an academic arms race that provides amenities such as climbing walls and luxury student centers that entice kids from higher-income families but scare poor students away. The proportion of recent college graduates from low-income backgrounds has fallen since the federal student-assistance programs became large.
Yes, and a lot of that loan money might have gone into stereos and other amenities, that is, if it didn't get creamed off for debt service on climbing walls and five-star residence halls.

There's probably a research project to be written (perhaps it already exists) on how expanded federal loans and grants might have crowded out state operating subsidies for universities.  That adds yet another dimension to the broken-social-contract view recently retired Northern Illinois president John Peters took, when alerting faculty, staff, and students to the continued cutbacks and recissions from Springfield.

What comes as a bit of a surprise is that Rolling Stone's Matt Taibbi, someone whose name usually doesn't come up in the same sentence, or the same essay, as National Review or William Bennett or Richard Vedder, is fingering the dam-bankers but bringing in the federal programs and the university empire builders, forsooth!
For this story, I interviewed people who developed crippling mental and physical conditions, who considered suicide, who had to give up hope of having children, who were forced to leave the country, or who even entered a life of crime because of their student debts.

They all take responsibility for their own mistakes. They know they didn't arrive at gorgeous campuses for four golden years of boozing, balling and bong hits by way of anybody's cattle car. But they're angry, too, and they should be. Because the underlying cause of all that later-life distress and heartache – the reason they carry such crushing, life-alteringly huge college debt – is that our university-tuition system really is exploitative and unfair, designed primarily to benefit two major actors.

First in line are the colleges and universities, and the contractors who build their extravagant athletic complexes, hotel-like dormitories and God knows what other campus embellishments. For these little regional economic empires, the federal student-loan system is essentially a massive and ongoing government subsidy, once funded mostly by emotionally vulnerable parents, but now increasingly paid for in the form of federally backed loans to a political constituency – low- and middle-income students – that has virtually no lobby in Washington.

Next up is the government itself. While it's not commonly discussed on the Hill, the government actually stands to make an enormous profit on the president's new federal student-loan system, an estimated $184 billion over 10 years, a boondoggle paid for by hyperinflated tuition costs and fueled by a government-sponsored predatory-lending program that makes even the most ruthless private credit-card company seem like a "Save the Panda" charity. Why is this happening? The answer lies in a sociopathic marriage of private-sector greed and government force that will make you shake your head in wonder at the way modern America sucks blood out of its young.
It's another lengthy article on the stack of things to read (the weather right now is too good to be at this keyboard for much longer). Daniel Luzer, who edits the Washington Monthly college weblog, connects the dots.
During the middle of the last century, public university tuition cost about four percent of an average American family’s annual income. In 2010 it was 11 percent.

All of this is true, but he glosses over an important point, which is declining state support for public colleges, which about 80 percent of American students attend.

He’s very critical of colleges, as rightly he should be, but colleges are simply economically rational actors. It appears what happened was that colleges got less money from their states to operate (and as the costs of operations increased for normal reasons, since infrastructure costs money) and they figured if students were taking out loans for college, well, why not have them take out more loans? Then the colleges could charge even more and use the extra money to buy stuff.

For a time this strategy didn’t even look so irresponsible. College debt was gooddebt. Before the economy collapsed we just didn’t see student loans as a problem. Sure having college debt was annoying, but no one really seemed to have trouble paying it off. It just meant they had a little less money.
That doesn't completely settle whether the state legislatures broke the social contract by shifting costs to the federal government, or whether the universities broke the social contract by gutting core curricula and lowered standards in the name of access, or the universities engaged in expense-preference behavior.  The consensus, though, is that third-party payments matter.

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