There are advantages to living with less competitive pressure, and those advantages could more than offset the financial losses. Besides, students don't bear the full burden of those financial losses. As degrees become less valuable, colleges must cut tuition or lose enrollments. A college that can distinguish itself from the pack by maintaining high standards should be able to reap substantial rewards in the marketplace, because its degrees are worth more. Partly, it's because colleges don't assign grades.
Professors assign grades, and professors face perverse incentives.
Being human, they tend to take a special interest in their own students and are therefore tempted to give those students a boost at the expense of the anonymous strangers who signed up for someone else's class. Besides, easy graders are more popular on campus. Therefore the professor is biased toward leniency. The problem, then, is in the gap between the professor's interests and the college's. Any solution must involve narrowing that gap.