Risk Based Student Loans by Michael Simkovic
papers.ssrn.com
papers.ssrn.com
Compare this to private loans, which use the price system and mechanisms like futures markets to evaluate and distribute risk. Instead of one formula to price risk, many formulas compete and the information they contain is aggregated and summarized by relative prices. Risk is distributed among many lenders instead of concentrated in the hands of government.
The worst possible equilibrium seems to be the system in place now: price signals are distorted by subsidies that cover most of the loan market, while private lenders serve those whose educations are so expensive that they aren't covered by already-generous government subsidies. Private lenders encourage these students to take out risky loans, while strict rules on default shift the risk to borrowers.
There are all kinds of alternatives to student loans, but they will not be competitive while federal subsidies continue to distort the student borrowing market. One of my favorite ideas is human capital contracts (here's a good paper: http://www.cato.org/pubs/pas/pa462.pdf), which would work like equity instead of debt. Students could sell "shares" of their future earnings to investors in exchange for the start-up capital for an education. There are lots of potential pitfalls with this model, but I think it aligns the incentives of lender and borrower (or investor and future earner) in a much more positive way: investors would have strong incentives to help students succeed that do not exist under the current debt-based model. Unfortunately, big subsidies are a big barrier to entry: there's no reason to offer equity when one can easily obtain a subsidized loan.
I chose to attend a large state university on a generous scholarship and graduate without debt rather than attend one of the more prestigious schools where I was accepted and take on student loans. So far, I think it was the right choice. But if I had the necessary capital, I'd start a Y combinator for students: find students like me who would otherwise stay in-state and finance "prestige degrees" at an Ivy or other top university in exchange for a share of future income. The model would operate very much like a start-up incubator: providing mentorship and advice and placing students in well-paying jobs after graduation would have a direct effect on the profitability of the investment. It's just a matter of figuring out how to pick (or make) students who will succeed.
If the system is like the current loan system, where student debt can't be discharged even in bankruptcy, students run the risk of being settled with a tithe that will prevent them from making ends meet if they can't find a good job.
If you make less than x$/year you keep it all. On income above that, you pay y percent (but not more than z $ total). After w years, the contract expires.
So credit availability and interest rate is going to be directly related to what other people ahead of you studied in school and how well they settled the debt. Also:
> Educational institutions may have incentives to funnel students into areas that do not maximize students’ future incomes or employment prospects.
I guess they do. Unfortunately, the instituions are not even a factor. As far I can tell, the proposed solution is to deprive the student of the opportunity to get involved in that "low-value" field. Then, indirectly, we punish the institution by reducing revenues. Interesting.
It's an interesting read.
Easy credit for tuition has no doubt contributed to increases in tuition that are way out of line compared to overall inflation. This works to the detriment of everyone pursuing higher education, as you (or more likely your parents) are either spending a lot more than the education is really worth, or you're ending up deep in debt as you start your professional life.
As far I can tell, the proposed solution is to deprive the student of the opportunity to get involved in that "low-value" field. Then, indirectly, we punish the institution by reducing revenues.
Institutions need some price pressure. Tuition costs are out of control. Even state institutions are regularly raising tuition every year by the maximum allowed by their legislatures, and tacking on various other "fees" to raise the overall costs even more.
Have colleges charge a percentage of a student's future income. This aligns economic incentives for the student and the college.
Or I'm self employed and want to get another degree at night just because I can. Does a percentage of my income as payment make sense?
What if I studied art history, but the side project I was working on after classes was acquired by Google for $30 million and now they're paying me $200k/year as part of the deal. Does a percentage of my income as payment make sense?
That doesn't really answer his questions though.
Professionally, I work as a software developer and a farmer. If I had taken the percentage of future income option while receiving my CS degree thinking that's all I'd ever do, would the school be entitled to the profits from my farm too?
I didn't even consider farming until I was 26, so it's definitely in the realm of possibility.
I knew pretty early on that programming was my thing. That was where I put all my focus, getting my first part-time dev job in high school. Farming wasn't even a consideration in my mind. It was only after working full-time in the software game for a few of years, dad approached me and suggested that I take some of the money I had earned, find some land to rent, and buy some crop inputs with it. I agreed that it sounded like a good plan, and he helped me put it in motion.
My farm is strictly cash crop, so the work is highly seasonal. Right around this time in the spring and later in the fall there is a lot of work to do, but the rest of the year is fairly light on the time required of me. The second thing that made it work is that I was already telecommuting and my hours were flexible. There have been days where I've been in the field all day and working on code all night. Additionally, it's not completely unheard of to find me writing code from the seat of the tractor. Mobile internet access has been a lifesaver.
I hadn't really considered this to be an interesting topic to the HN crowd, but maybe I should write up a more detailed blog post about it?
Yes you should write more about this. It's fascinating.
And to answer your previous question about whether the college would get a percentage of your farm income, I would have to say yes.
The option of limiting their stake to a particular profession would introduce too many loopholes.
For instance I could get a math degree, and sign something giving them a share of all future earnings as a mathematician--then work as a programmer instead. That being said I'm sure there could be some sort of maximum.
Student loans already work somewhat similarly. There is an option to pay off loans based on a percentage of your total income, so you are in effect paying x percent of your income for y number of years.
some cs and engineering programs are shut down because they are the most expensive to run. this would reverse that trend.
seems kind of like VC applied to schools. but then the schools would have to be completely free: we are giving away a percentage of our company, we share in returns with our investors, but we sure as hell aren't paying them.
There is a bit of a naivete among college students, that having any degree from "X prestigious university" is enough for the big boys to respect them and give them a high paying job. As a consequence I know many graduates who end up working as waiters etc. Perhaps had this tradeoff been made more evident from the beginning, they would have made different choices.
The student isn't deprived of their opportunity to get involved in low-value fields, but that low value is more apparent, which should help their decision process.
And more high value graduates, with higher incomes and a better ability to donate back to the university would probably increase revenues in the long run.
Place all the information in the hands of students, including the estimated present value of anticipated future earnings, as well as statistical distributions.
Estimating default risk, completion of degree, and so forth should be child's play for analysts who are familiar with mortgages and credit risk. It would be great to apply similar risk comparisons to the higher education bubble.
The irony is that the rising freshmen who are actually numerate are probably already entering high average return fields (CS, engineering, sciences, business) and those who are innumerate (and thus can't interpret those data) are probably entering low average return fields (humanities, sociology, gender studies).
Do you really want our CS courses to be filled with people who have no chance of succeeding in the major? People who cannot pass college algebra wasting the time of the class? Who does that benefit?
The problem isn't statistics. The problem is not having an outlet for those drummed out of the sciences.
/sigh
Let me guess which groups: the ones you don't belong to?