4 Surprising and Outrageous Ways Private Companies Are Fueling the Student Debt Crisis
In a society where crushing student debt is the new normal and markets are flooded with promissory riches long before they materialize, that popular refrain “our children are our future” may just be another business proposal.
“Investing in human capital makes sense as an asset,” says Reed Handley, head of Communications & Operations at Pave, one of several new companies that offer current college students and recent graduates income share agreements (ISAs). Income share agreements were first proposed by Milton Friedman, a man one as a general rule should not listen to, who suggested in his essay “The Role of Government in Education” that shareholders “'buy’ a share in an individual’s earning prospects; to advance him the funds needed to finance his training on condition that he agree to pay the lender a specified fraction of his future earnings.”
The model that Pave works with expands upon Friedman’s blueprint. Young people come to Pave looking for funding for a business proposal or higher education—essentially a long-term path toward financial success. If Pave likes their odds of becoming financially viable, which they determine using an algorithm (their own special recipe), they give the applicant a platform and encourage backers to fulfill his or her funding request, around $22,000 on average. Then, if the candidate gets funded, they sign a contract agreeing to pay their investors a certain percentage of their future earnings. And the applicant emerges from the chrysalis of their crowd-sourcing campaign as an asset.
Income share agreements (ISAs) have gained legitimacy in the past couple of years as a way for recent college graduates to jumpstart their careers and, in many instances, pay off their student loans early. Since 2013, companies like Pave, Upstart, CommonBond and Lumni—pioneers of these sorts of arrangements—have been covered by the New York Times, CNN, Slate and Vox.
Pave, which was founded by a former Goldman Sachs banker, argues that they serve as a healthy alternative to the junk loans many students are forced to rely on to fund their educations. “Interest isn’t at the heart of it,” said Handley, “you are sharing income, so there’s no principal amount that you’re paying back. Let’s say you raised $50,000 from 15 backers and pay back 5 percent. You only pay 5 percent of what you earn.”
“If someone is earning and willingly not making a payment,” Handley said, “we get in touch with them to make sure they haven’t had a lifestyle situation that’s changed that affects their income. If they willingly default then we can pursue standard methods of collection. But we haven’t had to do that.” Those funding their projects with Pave are not required to make payments at times when they are making less than 150 percent of the poverty line.
Pave also sets the minimum age requirement at 18 years. However young this cutoff may be, it’s an improvement compared to predatory student loans, debts that young people can take on long before they turn 18.
Still, there are many drawbacks to ISAs, some arising from the choices these companies are making right now, others built into the very ideology they sprang from. Here are four reasons why ISAs can’t reform our student loan crisis, but instead will only exacerbate it.
1. Invest In Your Ideology Today
At Pave, young people applying for or receiving backing are referred to as “Talent,” often with a with a capital “T.” One aspect that Pave likes to talk up is the personal touch afforded to Talent and backers alike. The backer, if they so choose, can act as mentors to their young investments, advising them, keeping up a regular correspondence, Daddy Warbucks-ing it up over Gchat.
“Backers all care that this makes financial sense,” says Handley, “but all of them also care about the pay it forward mentality and they care about making an impact. The very nature of what it is is you’re investing in the next generation, you’re investing in wages which is a low-volatility asset.” That sounds pretty good except for the whole equating the “next generation” to “wages” part.
But the thing is, investing in individuals isn’t all that Pave does—not anymore at least. In January Pave launched a project that allows backers to invest in groups of talent based on areas of interest. This new option, called “Talent Groups,” gives backers the option to invest in one of three categories of individuals: fields, professions or communities. Examples given on Pave’s website include “Technology,” “Entrepreneurs” and “Columbia Graduates” (easy way to weed out those kids who didn’t go Ivy).
The implication, of course, is that investors need not have contact with their individual mentees; they can bypass the relationship and access their interests directly. This isn’t to say that Pave backers will now suddenly invest irresponsibly, but it does mean that the human link between investor and Talent may easily be broken once the power of young ambition is harnessed into so many stock portfolios.
2. Nurturing the Next Generation of People Who Fund People
It is clear that many of Pave’s Talents are brilliant individuals driven by a strong social justice mission. Some are deeply passionate about sustainable farming, others make documentaries. But mostly this seems to be a case of like-attracts-like, of training a new generation in the art of producing surplus capital for individual gain. It’s not just that a few of the projects that get funded are lame corporate start-up ideas—it’s that a lot of them are.
Pave backers have invested in projects running the gamut from a line of designer neckties, to a start-up that helps users find the best deal on custom T-shirts, to a recent graduate who wishes to pursue a career in financial management. Darek Kaknes’ profile unironically reads, “I am using Pave to diversify my own human capital and finance my work at Prime Student Loan. I strongly believe that we are on the cusp of a revolution in consumer finance: the last 25 years have been about putting more debt on more individuals; the next 25 years will be about making individuals and consumer assets investable under equity-like terms.” In other words, Pave is creating spawn.
According to Handley, some 60 percent of the people who come to the Pave platform are pursuing some sort of business opportunity.
3. Diversity Is Not a Priority
One of the major problems with student loans is that the burden of repayment usually falls on the marginalized majority of students: people of color, LGBT people, people from low-income backgrounds and women.
There is no evidence to support the notion that ISAs do anything to correct this imbalance. Neither Pave nor Upstart collect information on the race or income background of their investees. Pave does have the numbers on gender and calculates that it funds an equal number of men and women.
Paul Gu, co-founder of Upstart, told Business Insider in February, “I think that while we think Upstart is solving a big problem for a lot of people and it’s adding tremendous value, we don’t pretend that it will solve the problem of funding or equality of opportunity in every sense.”
According to a 2013 article in the Village Voice, “[Pave co-founders Sal] Lahoud and [Oren] Bass say their market research has told them that a compelling personal story—of uncommon striving or overcoming adversity—might attract some backers as much as academic awards earned by a premed student at an Ivy League college.”
But while narrative is important, a Talent’s repayment rate and potential as an investment is determined by algorithms that take into consideration factors such as standardized test scores, education, credit history and job offers to predict future earning potential. According to Handley, Pave looks at “professions, earnings, income salary, education and builds a model based on an algorithm that calculates that someone with these broad characteristics is likely to get this amount of funding.” All are factors that, in America, are affected by so much more than natural aptitude, ambition, and, yes, even storytelling. Race, gender, sexuality and income background all play a role.
4. A Student Loan By Any Other Name
ISAs pitch themselves as an alternative to student loans, but companies like Pave have little incentive to dismantle a system that sends a steady flow of recent graduates to their websites. About half of Pave’s Talent uses the platform to refinance their student debt. “This alternative form of financing is unlikely to put even a tiny dent in the vast market for federal and private student loans,” wrote Tara Siegel Bernard of Pave for the New York Times in 2013.
Meanwhile, the federal government is doing what it can to feed the unchecked growth of ISAs. The Investing in Student Success Act, brought to you by Senator Marco Rubio and Representative Tom Petri, went to congressional committee in April. Its stated purpose is, “To provide the legal framework necessary for the growth of innovative private financing options for students to fund postsecondary education, and for other purposes.” The bill would support ISAs and give them rules to abide by, but these regulations are light at best.
The bill sets the maximum time such contracts can last at 30 years and the maximum income percentage investors can collect at 15 percent. Those numbers are bad, even by student loan standards.
Helpfully, the bill also formally states that an ISA is not a loan.
Petri said in a press release at the time he was proposing the bill, “These plans would help all students get the financing they need—including students from disadvantaged backgrounds—but without the anxiety that comes with traditional loans.” But, as we’ve already seen, there is no proof that ISAs help students from disadvantaged backgrounds, and contemporary corporate culture suggests that they will end up doing the opposite if left unchecked.
Rubio also had good things to say about his project, “The bill is designed to create a legal framework so we can encourage more entities, more investment groups to step into this field and help people with an alternative to the college loans that we currently have.”
“Investment groups” worming their way into young peoples’ lives to finance their student loans for them does ring a bell.
“[This is] no different than an investor who decides to invest in a company or in an idea and provide funding and capital for that to start up,” Rubio continued. There you have it.