Friday, April 18, 2014

Privatizing student loans

Vanderbilt Owen finance professor Miguel Palacios pinned a WSJ oped earlier this week where he advocated a new approach to finance student loans.  Money quote:

If you thought mortgage-underwriting standards were lax right before the housing crisis, wait until you take a closer look at student loans. Borrowing for a house at least requires an appraisal of the property and an assessment of the borrower's future capacity to pay. Student loans require neither. Instead, students and families are encouraged to invest in any program at any price.
Palacios argues for Income share agreements (ISAs), contracts between individuals and investors.  The investor pays for school in return for an agreed-upon percentage of future earnings over a given time period.

This is a marked contrast to the usual student loan, in which the student borrows a given amount and faces a predetermined income stream.  Under ISAs if students earn more than expected, the investor collects more than expected and vice versa.

Apparently this approach has been tried with some success in Latin America.  It would face some obstacles here.  Capital markets require accurate and timely data to operate efficiently.  There are plenty of data on stocks, bonds, housing and cars -- not so much for earnings by school and major.  Property rights and regulations also would need to be drafted and approved.

Then there is the question of how such loans would co-exist with the existing federal student loan programs, open to all comers.  I doubt private investors would support students in degree programs with limited labor market opportunities, so the feds would end up with a worse risk pool than now.  

I do support Palacios' basic point that some underwriting standards need to be developed and applied to student loans but, as always, the devil is in the details.

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