Entitled Borrowing + Entrapment Lending

On my back patio with a group of vaccinated but still socially distanced friends, we covered the usual gamut of complaints and concerns addressing our country. At some point one of us mentioned Senator Elizabeth Warren and other politicians advocating for the U.S. government to forgive student debt. That topic lit up with strong options from across the political spectrum of our group. Student debt forgiveness is a popular notion right now in some circles. Those circles seem to comprise primarily those saddled with debt they willingly took on as gamble against future earning (their own or their children’s), and those politicians who think this is a good strategy in support of their agendas.

I offered my perspective, which springs from my lived experience and social location as a first-generation Cuban American whose college funding was pay-as-you-go. I surprised the group when I said I graduated from college thirteen years after taking my first college course. They were less surprised when I said I met my goal of graduating debt free. I wasn’t complaining nor did I reveal my undergraduate marathon because it’s a point of pride. Just the opposite. I would have appreciated a shorter ride but those are my facts. Drawing from the lessons learned during that time, including the value of setting and living within a budget and choosing to spend time and money on endeavors with the likelihood of a reasonable ROI, I argued against forgiving student debt without any requirement of payback.

Don’t misunderstand. In my view no one should be saddled with untenable debt. Nor do I harbor any kind of martyr or sadistic “I suffered so you should too” or “it was good enough for me so it’s good enough for you” attitudes. Indeed, my wife and I worked hard to ensure our daughter graduated her private college in four years without debt for any of us. But for the U.S. government to bail out student debt, especially without addressing the underlying abuses of entitled borrowing and entrapment lending, simply rewards and perpetuates the harmful behaviors of entitled borrowing and entrapment lending.

Photo Credit: Ehud Neuhaus on Unsplash.com

In Better Capitalism we acknowledge the problem of burdensome student debt and offer an intriguing solution based on partnership principles. In Luigi Zingales’s A Capitalism for the People, he proposes financing education through equity rather than loans. Funding to a student would be given by an investor in exchange for a portion of their future income for some number of years, or better yet, for a portion of the increase in their future income due to the education funded.

Equity financing for higher education is now being implemented in some places, so the idea is being put to the test and refined in practice. One notable example is Purdue University, which has an income sharing agreement (ISA) that started in 2016. More broadly, there is an ISA marketplace called edly (www.edly.co and www.edlystudent.com) that connects schools and their students with investors in this new “asset class.” The idea is gaining traction and prominence among schools and news outlets. As is to be expected with any innovation that threatens the status quo where large amounts of money are involved, not all the attention is favorable. Nevertheless, we see this as a viable and sustainable alternative if not a transformative initiative built on partnership principles.

That approach creates significantly better alignment in incentives and informed decision-making across all participants—partners—in the educational enterprise. In the current debt-based approach, poorly informed and inexperienced young students bear the full weight of the decision to get a loan, and well-informed lenders always give the loan—regardless of the type or quality of education it may fund—because the government (taxpayers) guarantees them. Those lenders either get a fixed repayment or, if the student defaults, taxpayers are left holding the bag. In an equity financing model, the lenders are incentivized to actually advise students on educational investments that will generate good future value (helping the students) and provide funding where it offers increased value and not where it doesn’t (helping the funders and students and society generally). These aligned funders and students will exert pressure on educators to deliver increasing value (helping the funders and students and educators and society generally) rather than continue in entrenched methods that have guaranteed subsidies to the lenders regardless of the student's future earnings and ability to repay.

The equity approach also transfers risk from government (taxpayer backed) loans, decided on by young students and handed out by intermediaries with little skin in the game, to equity funders exercising informed investment decision-making with their own money. If a student’s investment doesn’t pay off, the cost will be borne by the equity funder rather than taxpayer subsidy (bailout). Similarly, reward is transferred from being based simply on making the most loans (regardless of quality or ability to repay) to making the best funding decisions with both cost and benefit considered. Current incentives favor behaviors that involve poor decisions and increase taxpayer risk and burden; the equity method would give greater rewards to superior performance and put risk for poor performance on the poor performers rather than on taxpayers.

The parallels between the current approach to financing student education and government-subsidized housing loans are striking. We should not too quickly forget the painful lessons learned when those poorly informed, mis-incentivized loans went bad on a large scale beginning in 2007. Equity financing presents an opportunity to mitigate the growing bubble and perhaps avoid collapse across student debtors (parallel to mortgage takers), colleges (mortgage-issuing banks), and government guaranteed subsidizers (Sallie Mae and Fannie Mae).

The crisis of unsustainable student debt cries out for a partnership approach to a thoughtful plan and decisive action, all without undue delay. We advocate for solutions and actions, such as proposed by Zingales, that resolve the debt for the student and eliminate this plantation system variation on indentured servitude that permits the creation of unsustainable debt in the first place.

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