I read an opinion piece recently from the New York Times with a unique approach to the issue of ever mounting student loan debt. Luigi Zingales, a professor of entrepreneurship and finance at the Booth School of Business at the University of Chicago, proposes that instead of using debt as a means to finance an education, venture capitalists could be the solution. Venture capitalists could interview prospective high school students and then provide funding for their education. In return they would receive a percentage of future earnings that the student made after graduating.
The problem of college funding
I do agree with the author that the current student loan process is a disaster that leaves many young people in bondage to their loans for much of their lives. This is a crisis that has the potential to bite our economy in much the same way the housing bubble led to the most recent recession. He makes a number of very good points about the problems with the current methods of funding college.
College tuition continues to skyrocket. While over the last 10 years the general rate of inflation in the U.S. has averaged around 2-4%, college tuition continues to increase at a rate of approximately 8% per year.
Federal and state programs like Pell grants and others have been created to assist those from lower-income families with paying tuition, but it becomes increasingly difficult for the grants to keep up with the increase in education costs. All this is coming at a time when many state governments, not to mention our federal government, are facing large deficits that make it difficult to fund even well-meaning programs.
Additionally, many student loans are guaranteed by the federal government. Why is this a problem? Well there are a couple of issues actually. Because the loans are guaranteed by the government, there is little incentive for lenders to make much effort to qualify potential borrowers. To the lender it makes little difference if they are lending to a student whose career path has the potential to make $20,000 or $2,000,000. This has negative consequences on the students years later as these loans will follow the student until they are repaid. Even bankruptcy can’t be used to wipe away government-backed student loans.
Clearly, the current process has some serious issues.
A radical idea
Mr. Zingales notes that part of the problem is that young 18-year-olds have very little collateral to offer and thus are somewhat at the mercy of a broken system. He notes that there is one major asset that these young people have and that is their abilities that will be honed and enhanced by their education, leading to the potential for increased earnings during the rest of their lives. He notes that this could be indexed in some way to the average earnings of someone without the education to quantify exactly what kind of value was provided by the education. Repayment to the venture capitalists would be tied in some fashion to those increased earnings.
He states that this would not be a return to indentured servitude, but instead a form of voluntary taxation. He even suggests that collections of these future earnings could be performed by the IRS with little or no added costs.
A good idea?
So is this a potential answer to our student loan issues? I will say in some ways I would prefer a system like this over the current college loan process. If the pay back was in some way indexed to their earning potential there might be some value to the process. For example the repayment made by a social worker would be much less than the repayment made by a neurosurgeon. I also give Mr. Zingales a lot of credit fo trying to “think outside the box” and find a solution to a serious problem facing our young people today.
That said I think this approach has some serious issues.
How would students be “qualified” for this process?
If I am investing my money I want to make sure I get the best return on my investments. Most venture capitalists aren’t going to be putting money in strictly due to them being nice folks. So how would the approval process work? Would I want to invest in that future social worker knowing my return at best may be only a few hundred dollars a year? Or would I be wanting to sponsor the future neurosurgeon where if all goes well I will be making tens of thousands of dollars on my investment? It would seem that this approach would make it very difficult for young people to pursue certain career paths.
Granted this could be construed as an advantage as well since it would force young people to consider the future value provided by their education. Some of the saddest stories I hear are of young people with degrees that lead to a $20,000-30,000 dollar a year earning potential that are saddled under a mountain of 6-figure student loan debt. Many of these young folk will literally spend the rest of their lives trying to escape these chains. I really question where their parents were in allowing an 18-year-old young person to make such a crippling decision.
Still the process defined by Mr. Zingales would likely make many of these career paths very difficult to pursue. To me this is one of the real problems with this proposal. That neurosurgeon with the high six figure income has the capability to pay back loans as well as to follow this process. It is those with lower income potential that are most burdened by student loan debt and they are the ones that would be least attractive to a venture capitalist.
How would the application process work?
Additionally, how exactly would a young person apply for this money? Young people are already often times under tremendous pressure to be accepted to the “right” school. Now we are adding to that the pressure of being interviewed by groups of venture capitalists to try to raise funding to pay for their education? Visions of an episode of “Shark Tank” for high school seniors comes to mind. I don’t think this is a healthy place to put our young people.
What if things don’t work out as planned?
What if the future earnings don’t pan out? Certainly part of the venture capital process is the potential of losing their money. If I fund a business startup and the business fails I might well lose my money. That’s how the process works. In the case of funding education there could be similar provisions built in.Suppose for example the student became disabled and was not able to pursue their chosen occupation, then the venture capitalist would just be out their money. But what if the student chooses not to continue with their planned profession? What if that neurosurgeon decides in a couple of years that he absolutely hates his job, and what he really dreams of doing is being an artist even though that means he will make a fraction of his current income? Or what if she loves being a neurosurgeon until she gets married and has a child and then wants to give up her career to be a full-time mom? Or what if 2 years into the degree the student decides to change majors to one with a much less lucrative potential? I’m not sure that venture capitalist is going to be very happy to see the person they invested in voluntarily choose to no longer pursue a career that provides the kind of return they agreed to at the start.
How about collections?
Lastly, Mr Zingales suggests that the collections process could be rolled into our current IRS system at no additional cost. I agree that the IRS would potentially be a good organization to tie this to, since they already have all the needed income data. But really? This could be done at no additional cost? I find it very hard to believe that any government program of this size could ever be implemented at no additional cost to the taxpayer.
A college funding solution or more repackaged servitude?
Mr. Zingales states that this program is not a new form of indentured servitude but instead a form of voluntary taxation. I would submit though that indentured servitude is exactly what he is proposing.
According to Merriam-Webster’s dictionary, indentured servitude is defined as:
a person who signs and is bound by indentures to work for another for a specified time especially in return for payment of travel expenses and maintenance
This sounds very much like what Mr. Zingales was proposing.
The problem is this is simply another form of debt. Proverbs 22:7 says that the “Borrower is a slave to the lender“.
That said as I stated earlier the student loan issue is a crisis that is in need of a solution. Check back in my next post I’ll suggest an even more radical approach to funding college.