Last month, Lee Siegel reignited the debate on student loans with an opinion piece in The New York Times calling borrowers to simply default.
A lot of ink has already been spilled on the public policy side of the debate. Be it debt forgiveness, lower interest rate or longer grace period, in the end, it’s just a form of transfer from the state coffers to a specific social group.
While further questions of fairness, equality, and public access to higher education certainly merit discussion, I instead want to focus on two issues in the polemic that could be potentially solved by the private sector. Of course, no private industry alone can solve a $1.16 trillion problem. Yet, the government could perhaps learn from and adopt some practices from successful private ventures.
The first issue is fair risk-sharing. Post-secondary education is often compared to an investment. There are borrowers (students) who need initial capital they don’t have. Some time after receiving the loan, they start producing a steady stream of income (salaries) to pay off the creditors and become enriched.
However, investment to a degree differs crucially from other types: it is not allowed to fail. A college degree that produces a job in McDonald’s is akin to a business idea that turns out to be a dud. However, while a creditor to the entrepreneur may resign to recuperate a fraction of the principal through collateral repossession, the creditor of the student doesn’t.
A student loan cannot be cancelled in bankruptcy — in fact, the Department of Education in the US can keep collecting on defaulted loans from income tax refund and wage garnishment, potentially until the borrower dies.
This isn’t right. Lending money is a risky business and typical creditors always bear some default risks for investment failure. The government shouldn’t leverage its overwhelming ability to collect in an effort to make its lending risk free.
The idea that students shouldn’t be the only ones to bear responsibility for the failure of their investment in higher education is echoed in Elizabeth Warren’s “skin-in-the-game” proposal. She proposes fining colleges when its graduates cannot pay back loans.
This is a welcoming change, as it would fix the currently misaligned incentives in loan issuance. Right now, colleges could increase tuitions every year and simply encourage students to borrow more without ever worrying about how this loan can be repaid. But this proposal alone doesn’t solve the students’ problems — allowing discharge in bankruptcy will result in better risk sharing, but such straightforward policy is just begging for abuses.
Alternatively, accredited private investors could be encouraged to offer to pay a portion of the tuition in exchange for a pre-determined portion of the student’s future salaries for a fixed period. The students will feel less pressure to repay loans after graduation, but they could also end up repaying more than what they actually borrowed. In other words, risk is distributed more evenly.
In practice, this could be implemented as an Internet marketplace lender (also called P2P lenders) that connects student borrowers directly with retail investors. While, a quick Internet search reveals no such service exists right now, it resembles an idea Marco Rubio proposed in a recent speech on making higher education affordable again.
The second issue is sound loan issuance practices. In most bad debt stories, there is someone who gets a loan that should have never been approved in the first place, for example Greece. The student debt story is no exception. Currently, almost anyone can get a loan to go to college, regardless of their future ability to repay.
Some may question why governments continue offering loans, when it is no secret that degrees in some majors or from some colleges often lead to underemployment (and consequently, difficulty in paying back loans). However, the government has a responsibility to maintain universal access to higher education. As such, there is little room to advocate for the simple denial of government financial aid.
A private sector action may provide a more feasible solution. Internet finance start-ups could offer student loans based on factors such as reputation of the school, employment prospect of the major, GPA or previous work experience. Students, whom run serious risks of underemployment after graduation could see their loan requests refused or their interest rates increased to reflect the higher risks.
In turn, this will lower the number of struggling borrowers at the source. SoFi, a marketplace lender start-up that focuses on student loans, currently uses these factors to make student loan refinancing offers.
Fairer risk-sharing and better loan underwriting practices should be part of any solution to the student debt polemic. While focusing on public funding and government policy is necessary for any debate regarding student loans, it is important to remember that some solutions from the private sector could help as well.
Li Pan is a fourth—year student at Trinity College studying economics.