How Investors Are Turning Cash-Strapped College Students into 'Human Capital'

Have you heard the one about the dance/film/theater/Russian neo-realism literature major whose parents refused to contribute to her college education unless she chose a more practical area of study? It’s a story so common it’s become a cliche, almost as well-known as the cautionary tale of the starving artist. Higher education today is so expensive it far exceeds what many American families can afford, forcing students to take out loans they’ll potentially be paying off for decades. When well-intentioned parents balk at their kids getting “impractical” degrees, it's mostly out of fear their children will face poverty-stricken, debt-laden futures that aren’t worth the savings-sapping investment. Even if mom and dad aren't exactly right, their hearts are in the right place.

Now imagine the same scenario, in which the artsy student still needs money for tuition, but replace the concerned parents—and the loan agencies—with a business-minded private investor. This deep-pocketed funder offers what seems like a deal far better than your average lender: thousands in tuition dollars to be repaid, interest free, with a contractually designated percentage of her future salary. Of course, like any savvy financier, the investor will want to make a profit, and will be well aware that the earning potential of an arts major pales in comparison to an engineering major—one who, in this case, also needs tuition aid. Having assessed all risk factors, the funder may choose to fund one or both, but of paramount importance in the decision is the earnings potential of the students’ study areas. Whereas parents worry about their kids’ majors because they want what’s best for them, investors care because they want what’s best for the bottom line.

Income-sharing agreements (ISAs) may be the future of student lending, but they’re rooted in ideas that date back more than half a century. In 1955, economist and father of libertarianism Milton Friedman proposed that investors might “‘buy’ a share in an individual’s earning prospects,” underwriting schooling and training “on [the] condition that he agree to pay the lender a specified fraction of his future earnings.” With that founding principle, ISAs turn students into assets deemed high- or low-yield based on estimated career profitability and the graduating college’s track record in producing high earners. That means a Dartmouth business school senior is likely to get investors salivating in a way a puppetry major from the University of Connecticut would not.

Australia and several countries throughout Latin America have been receptive to ISAs, but they haven’t quite taken off in the United States. In part, that’s because Americans have been slow to embrace the concept of redefining students as “human capital” and treating them like stocks, an idea the free market may relish but actual human beings find justifiably weird. There’s also the issue of our exorbitant college costs, which require much larger influxes of funding than in other countries.

Laura Pappano of the Hechinger Report writes that Lumni, an ISA company that works primarily in South and Central America, has an average per-student investment of around $5,200, approximating the full cost of getting a degree in places like Chile, Peru, Colombia and Mexico. (Lumni has invested in 7,700 students in Latin America, but just 27 in the U.S.) Compare that with a recent survey that pegged average U.S. public and private tuition at $24,000 and $48,000 per year, respectively. As returns on ISAs remain largely untested in this country, investors in American students are often only willing to pony up a fraction of the tuition costs. ISAs essentially serve as gap funds, helping to make ends meet between parental contributions and federal loans, which the federal government restricts to $27,000 for four years of school.

Proponents argue that ISAs could help put a stop to out-of-control tuition hikes, a result of colleges attempting a cash grab as new federal loan monies have become available in recent years. (Forbes points to a 2015 study by the New York Federal Reserve Bank that finds “for every dollar of new subsidized loans, tuition went up by 65 cents.”) They cite the fact that the student debt crisis has reached $1.3 trillion, a figure that grows by $2,726 every minute of the day, according to MarketWatch. Average debt among students graduating with bachelors increased from $10,000 to $35,000 over the last two decades, and for many of those, payback sums will be even higher thanks to accrued interest. Americans are already in debt to their teeth as it is; wages have not merely stagnated, but fallen since the turn of this century. The result is that student loan default rates rival those of the subprime mortgage disaster.

In this environment, ISAs look pretty good on paper. Borrowers agree to fork over an annual percentage of their earnings until the specified time clock runs out, at which point payments end. There’s no interest on ISAs, so all that money goes toward paying down the actual debt. If the graduate fails to earn the predetermined salary minimum, repayment plans are suspended until her income hits or rebounds to the pre-set wage floor. Should she fall into financial hardship or decide to alter life plans in a way that lowers earning power—e.g., going on a bicycling trip around the world for a year—investors take the hit.

That definitely beats standard student loans, including the government’s income-based repayment plan, which forgives outstanding debts after 20 years. Federal loans can be put off for up to three years during lean times, but the government ultimately wants its money with interest, even in cases of bankruptcy. The most obvious downside of ISAs is that there’s no principal balance, and the terms of repayment are designed so that most students pay back more than they owe, and by a decent measure if their post-graduation pay exceeds expectations. This, of course, is what investors are banking on.

Late last year, Purdue University announced plans to contract with financial services firm Vemo Education to guide its new “Back a Boiler” ISA pilot project. Using funds from the university’s philanthropic arm, Purdue Research Foundation, students who are accepted to the program receive funding of $5,000 per year or more, with repayment slated to begin six months after graduation. An online calculator lets students enter their major to see how their ISA plan, complete with repayment details, will look. The school’s website presents the case of a hypothetical rising senior history major whose ISA funds total $10,000: “Based on an average starting salary of $36,000 in that field upon graduation, you would pay 3.92 percent of your salary for just over nine years.” In the end, the history grad would end up paying investors $15,845, or $5,845 more than the student borrowed.

It’s important to note, as Purdue does, that a “traditional, private loan” in the same situation would cost yet more. The site calculates that “$10,000 at 9 percent interest to a student with no cosigner would cost you $17,986 at the end of a typical 10-year term.” This is a clear advantage of ISAs over other lending sources. But with so much depending on what a student decides to study, what gets lost in the transaction? And if ISAs grow increasingly popula—and as the market would dictate, competitive—what message will students be sent about which fields of study are and aren’t worthwhile?

Purdue president Mitchell E. Daniels Jr. has been a champion of ISAs for some time, even penning a 2015 Washington Post op-ed in praise of them for their “student-friendly advantages,” boosting them as an alternative to debt-inducing student loans. He believes that the relative value ISAs place on students based on their future earnings, sorting them into investment-worthy and not-so-investment-worthy piles, prepares them for what awaits in the real world. “The minute they walk out the door of this university,” Daniels told Pappano, “they will be treated differently.”

At the risk of sounding idealistic —and I think there’s a lot of historical precedent for what I’m about to suggest—just because things are a certain way doesn’t mean they should be that way. Daniels’ answer neglects to address whether institutions of higher learning should be engaging in the same minimization of certain careers, and career aspirations, as society does. Colleges and universities are supposed to be places where students can indulge their curiosity about the world, studying what interests them in breadth until they find the subject they want to concentrate on in depth. In theory, campuses are spaces for intellectual growth and development, where students learn to be well-rounded and critical thinkers. Sure, college should prepare students for their future careers. But do we really want our institutions to place so much emphasis on job preparedness and churning out bankable human investments?

Tonio DeSorrento, cofounder and CEO of Vemo Education, says fears about investors overlooking graduates in less lucrative careers are unfounded. “The lower the likely income stream from an education investment, the lower the amount you would want to invest,” he told American Banker. “But every [course of study] is fundable. To cite an oft-underestimated course of study, poetry graduates don't starve. They aren't all professional poets, but they do something [else] that they like and that pays. But an investor might ask a school to deliver that degree less expensively.”

That last point seems a bit sticky. The idea that an investor, and the whims of the market, might literally dictate to a college or university the dollar worth of one degree over another seems wholly out of step with everything we prize about our institutions of higher learning, and learning itself. It implies that some knowledge is more quantifiably valuable than other kinds of knowledge, primarily because it turns a pretty profit. People fought long and hard for women’s studies, African-American studies and Asian American studies, to note a few examples, but it seems unlikely students working toward degrees in those areas will be first round drafts for investor funds.

Other academic disciplines where people of color and women are woefully underrepresented—STEM fields, for another example, which lead to well-paid employment mostly for white men—would command investor attention, creating a multi-tiered system where the top level is occupied by same dominant group it always is. Financial concerns already force many poor students to put aside their real academic desires to major in fields that guarantee a livable wage, while more affluent students can afford to study subjects like English lit and sculpture. If entire departments have their degrees devalued by educational gold prospectors, so to speak, we have to wonder what will happen to faculty and staff in those areas, how will funding to those divisions shift, and what are the chances some universities might shutter programs that don’t bring in investment dollars? Never underestimate the power of capitalism to destroy a good and necessary thing.

David Bergeron, former assistant education adviser to the Obama administration, who described ISAs as “icky,” has also questioned how ISAs might redirect the priorities of colleges away from what should be their primary mission. “[A]ll it does is provide an additional revenue stream for the institution over the long term,” Bergeron told Jill Berman of Market Watch. Now a senior fellow at the Center for American Progress, Bergeron added, “That seems to be doing something to benefit the institution and not really put the student first.”

Student happiness is placed even further behind. Studies find that college students who major in subjects they care deeply about get better grades than students who don’t. Cal Newport, of Georgetown University and the author of How to Win at College, points to the work of psychologists Richard Ryan and Edward Deci, and his own observations as a professor, for explanation:

[T]asks that are extrinsically motivated drain energy and willpower. Over time, they become harder and harder to continue…[S]ocietal pressure -- for example, a major being generally understood to be a practical choice -- can act as extrinsic motivation, making an activity increasingly hard to continue. Here’s what I’ve observed: Students who choose a major because it was expected or to please their parents are much more likely to burn out by their junior year...Becoming an engineer because your parents think the liberal arts are “soft” is a quick route to mild student depression and falling grades.”

He adds that “the slightly larger paycheck of the technical majors doesn’t justify majoring in these fields if you don’t love the subject—you’ll just go from hating college to hating your job.”

There’s another important point that’s often left undiscussed even in ISA skeptic conversations, one focused on the way the funds might exacerbate the already vast disparities in wealth in this country. Benjamin Studebaker of Cambridge University points out that while government loans are imperfect (I realize that’s a huge understatement), they at least do more than stuff the pockets of the wealthy class. ISAs essentially serve to facilitate yet more profiteering by the most-haves from the have-nots. “Student debt is mostly repaid to the state, and the state uses that money to fund many public services, from the university system to welfare to infrastructure,” Studebaker writes. “With ISAs, the surplus extracted from students is paid to wealthy investors, directly redistributing wealth from the bottom and middle to the top of the distribution.”

Studebaker also imagines the worst-case scenario if ISAs become commonplace and Wall Street begins to engineer ways to maximize profits. It’s all a bit what-if, granted, but if there are any lessons to be learned from the Great Recession, it’s that foresight is vital in these moments:

We have a student debt bubble, but unlike the housing bubble most student debt is owed to the government rather than private investors, and this limits the student debt bubble’s ability to damage the rest of the economy. ISAs could change that. Down the road, ISAs could be packaged by Wall Street into derivatives in much the same way that mortgages were in the years leading up to the 2008 financial crisis. ISAs in highly profitable majors like Engineering or Computer Science could be used to conceal large numbers of junk ISAs on students with low performing majors, encouraging the proliferation of subprime ISAs. Insurance could be sold on them in the same way that insurance was sold on mortgages. Eventually ISAs could become the foundations of a sequel to The Big Short, with utterly devastating consequences.

It’s unlikely that ISAs will have a real moment in the sun until consumer protections are put in place that allay investor fears and guarantee certain profitable returns. As of now, since ISAs don’t quite qualify as loans—the lack of a principal balance makes them hard to define—they don’t neatly fit into a regulated category. A spokesman from the Consumer Financial Protection Bureau told the Washington Post that the agency has been “closely monitoring” ISAs, so new laws might appear in the near future.

In 2014, GOP Senator Marco Rubio and Representative Tom Petri introduced the Investing in Student Success Act, legislation that would have more clearly defined ISA terms, but the bill was ultimately a no-go. (Chris Christie and Jeb Bush still remain fans, presumably.) Oregon is currently ironing out the kinks in its ISA program, called Pay it Forward, as it has been for three years. Each of these should probably be considered a sign that ISAs are slowly rising.

Here’s hoping we don’t look back at these early days with by-then-useless 20/20 hindsight.


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