Category Archives: Debt

Escaping the Student-Debt Trap

We need more national debate on this issue of student debt. Not just how to solve, but if it is the right solution to education at all.
Kate Bachelder – June 13, 2014 6:41 p.m. ET

Student debt in the U.S. now tops $1.2 trillion, spread among 37 million borrowers, 5.4 million of whom have already defaulted. Washington took notice this week, rolling out the usual non-solutions: On Monday, President Obama expanded a federal program that allows students to repay debt based on what they earn, eventually forgiving the balance. Taxpayers pay the rest. On Wednesday, Sen. Elizabeth Warren’s idea to tax millionaires to pay for broad student-loan refinancing stalled in the Senate.

But there’s one way to slow student-loan debt that didn’t make Washington’s agenda. What if a tool could help any student pay for college without a loan or government subsidy? If that sounds impossible, ask Miguel Palacios, assistant professor of finance at Vanderbilt University’s Owen School of Management. He’s the creative force behind income-share agreements.

“College is on average a good investment, but it’s a risky investment,” Mr. Palacios says. More than 40% of college students don’t finish in six years, and in 2012 45% of those who did graduate had jobs that didn’t require a degree, according to Federal Reserve data.

Here’s his solution in a nutshell: Suppose an industrious young person wants to get a degree at a top university but needs about $50,000. Under an income-share agreement, the student promises an investor a certain percent of his income over a fixed period in exchange for cash. The agreements are not loans, and there is no outstanding balance. Students who earn more pay more, and students who earn less pay less.

Mr. Palacios has seen these income-share agreements in action and thinks they can revolutionize higher education. The startup he co-founded in 2002 with entrepreneur Felipe Vergara, called Lumni, has funded nearly 5,000 students in five countries. In April Sen. Marco Rubio and Rep. Tom Petri, both Republicans, introduced legislation that would give income-share agreements the legal and regulatory clarity to flourish in the U.S.

At first handshake, Mr. Palacios seems easily typecast as an academic. He’s poring over spread sheets when I arrive at his Vanderbilt office. A dry-erase board behind him is scribbled with graphs and values of “x,” and the bookshelves are stocked with finance textbooks. Even the décor is industry-specific: On white walls hang two pieces of contemporary art, both using outmoded currency notes as a medium.

It’s quickly evident, though, that the 40-year-old scholar is part economist, part entrepreneur. “When you were starting college, did you know how much money you would make in the first 15 years of your life?” he asks in his crisp Colombian accent. No, and I still don’t.

Federal loan programs “encourage students to pursue any degree regardless of price,” he says. Students can borrow cash directly from the feds through Stafford loans. Parents have an even easier line of credit: Under the federal Parent PLUS program, mom and dad can borrow up to the cost of tuition after a credit check. “People are sometimes mortgaging their homes on what their kids will do,” Mr. Palacios says.

It’s not working. The Consumer Financial Protection Bureau estimated in 2013 that 22% of federal student-loan borrowers who have entered repayment are now in default or forbearance. More than 600,000 borrowers who graduated in 2010 had defaulted by 2012, according to Education Department data.

In response, the Obama administration has taken the “throw money at the problem” approach, as Mr. Palacios puts it, by expanding the Pay As You Earn program, under which students can curb their payments if their earnings don’t keep up. Those programs “do not help students make better choices about where to go and what to study,” Mr. Palacios says. The federal programs forgive loans after 20 years, 10 years if the borrower works in “public service” (government or nonprofit). But how long can the taxpayer bear that expense?

Mr. Palacios says income-share agreements, or ISAs, can mitigate the damage from what he calls the coming student-loan “train wreck.” First, they “send a strong signal about value,” he says. Want to get a peace-studies degree for $100,000? Be prepared to pay a hefty portion of your income for a really long time. ISAs give students much-needed information about which programs are more likely to lead to employment. Over time, colleges would be forced to lower costs and offer better value. Most important, ISAs take away “the risk of financial ruin,” Mr. Palacios says. If you don’t earn any money, you don’t pay any money.

Mr. Palacios explains that economist Milton Friedman floated the notion of buying a “share” in an individual’s earning prospects in the footnote of a 1945 paper and explored it more deeply in 1955 amid debates over financing higher ed. “The idea morphed into an income-contingent loan,” says Mr. Palacios, who calls himself “a liberal in the 19th-century sense,” and “not left or right” but “pro-freedom.”

Yet David Bowie, not Milton Friedman, first inspired Mr. Palacios. In 1997, the rock star announced that he planned to finance his next album by selling shares of future revenues. “I was intrigued.” he recalls. Working in Chile as a financial analyst, the 23-year-old Mr. Palacios thought: Why can’t bright, talented college students do something like the Bowie idea? In college, he saw “very brilliant people who just wouldn’t make it because they didn’t have the right funding.”

In 1999 Mr. Palacios moved to the U.S. to attend the University of Virginia’s business school, where he began researching how to implement human-capital contracts. In 2001 a friend introduced him to fellow Colombian Felipe Vergara, an entrepreneur who liked ISAs and “wanted to do it,” Mr. Palacios recalls. “That’s how Lumni was born.”

Mr. Palacios’s first boss chipped in capital, as did a few other investors. Then they needed students. “We had a spy,” Mr. Palacios confides. Messrs. Palacios and Vergara asked someone they knew attending university in Chile to identify good students who needed financial aid.

In October 2002, Lumni signed contracts with four Chilean university students for one year of funding, later adding two more to the first class. The investment totaled roughly $12,000. The students agreed to pay a small percentage of income—about 3%—for roughly five years. The students thrived: Gonzalo Labbe, for example, met his obligations and now manages corporate accounts for Hewlett-Packard HPQ -0.75% in Chile. The investors did well, too. “We had returns in excess of 10% and on the order of 15%,” Mr. Palacios says.

By 2009 the company had expanded to Colombia, Peru and Mexico and reached more than 1,000 students, funding many in community colleges and vocational programs. Nearly all of Lumni’s students come from low-income backgrounds, and most are the first in their family to attend college.

How has the fund held up? Pretty well. “The returns have been lower, by design,” Mr. Palacios notes. Investors can design the return they want within a certain range, and “many have simply liked the work we do and asked for little or no return.” Lumni has raised about $50 million from individuals, corporations and foundations.

In 2009 Lumni began offering contracts in the U.S., funding 27 students so far. Growth has not happened quickly, and here’s one major reason: There are lingering questions about the legal enforceability of the contracts. It’s also unclear how they’d be taxed or regulated, details that Lumni has mostly worked out in Latin America.

The murkiness has thwarted others interested in ISAs. In the mid-1990s, an entrepreneur named Roy Chapman started Human Capital Resources, seeking to do what Lumni does now. Chapman lobbied Congress for legal and regulatory clarity, and then-Rep. Lindsey Graham introduced a bill in 1999. It went nowhere. In the early 2000s, a firm called My Rich Uncle offered ISAs but soon gave up because, Mr. Palacios thinks, the founders realized that “raising capital for something risky in the regulatory sense is tough.”

Most recently, the lending platforms Upstart and Pave began offering the contracts. That didn’t last long for Upstart. “We’re still huge fans of income-share agreements,” company founder Dave Girouard wrote on Upstart’s website on May 6, but the startup feared it will “likely take many years” to sort out the regulatory issues.

Why so long? In part because ISAs are often portrayed by critics as indentured servitude. “Part of that is fear, and I think it’s completely misplaced,” Mr. Palacios says. “ISAs in no way tell anyone what to do. The contract can’t force anyone to work.” He maintains they are more liberating than student loans: “You have the same freedoms, but you don’t have the same worries.”

Others view ISAs as exploitation. Dave Bergeron, of the left-leaning Center for American Progress, told Reuters in April that ISAs are unfair to students because some would pay back “substantially more” than they borrowed. “That takes a static view of the student,” Mr. Palacios argues, noting some rich ideological inconsistency. “These people who talk about exploiting students have no qualms saying the 1% should pay much more of their income to the federal government. If that student has to pay a lot, it’s because that student became part of the 1%. To them, the right tax rate for the 1% is always just ‘more.’ ”

Do ISAs also encourage students not to work? Mr. Palacios suggests keeping payments as a share of income as low as a state income tax rate so students won’t be tempted “to go to the beach for the rest of their paying-contract lives.”

ISA funds also run the risk of adverse selection, as the best students might see federal loans as a better option. “That’s why we don’t offer everyone the same contract,” Mr. Palacios says. Pricing allows Lumni to be sure it can recoup enough of its investment. The firm also employs psychologists to evaluate whether students are being honest about their career intentions. “The concern that we’re going to end up with a bunch of French literature students who said they wanted to be investment bankers hasn’t panned out,” Mr. Palacios says, adding a playful apology to his wife, who teaches French literature.

The biggest hurdle might be Congress. The Rubio-Petri bill would give ISAs a chance by making them legally enforceable contracts, capping the percentage of income at 15%, setting a maximum repayment period of 30 years, with a repayment exemption for those who earn less than $10,000 a year. Contracts would be required to define what constitutes income, and not permitted to dictate career choices.

The bill may pass the House, but it would be dead on arrival in Harry Reid’s Senate. Mr. Palacios thinks it might fare better if Republicans retake the Senate in the fall, but then it looked that way for ISAs in the 1990s. Still, Mr. Palacios is bullish: “The momentum for ISAs has never been this strong.”

The momentum may reflect the moment. “At this rate,” he says, “student debt could be $2 trillion in five or six years.”

Lumni isn’t waiting around. The organization pledged in 2010 to fund 10,000 students world-wide by 2020, and Mr. Palacios says Lumni is on track to meet the goal. With a little push from Congress, more firms could jump into the market. ISA funds could be run someday by everyone from institutional investors to enthusiastic alumni.

ISAs are “a bright spot in finance,” Mr. Palacios says, because they better the lives of individuals and society. “How could anyone be against that?”

Ms. Bachelder is an assistant editorial features editor at the Journal.

The Weekend Interview: Escaping the Student-Debt Trap – WSJ.


What ‘Hard Work U’ Can Teach Elite Schools

Very solid model.
May 16, 2014 6:15 p.m. WSJ –  Point Lookout, Mo.
‘We don’t do debt here,’ says College of the Ozarks President Jerry C. Davis.

Looking for the biggest bargain in higher education? I think I found it in this rural Missouri town, 40 miles south of Springfield, nestled in the foothills of the Ozark Mountains. The school is College of the Ozarks, and it operates on an education model that could overturn the perverse method of financing college education that is turning this generation of young adults into a permanent debtor class.

At this college the tuition is nowhere near the $150,000 to $200,000 for a four-year degree that the elite top-tier universities are charging. At College of the Ozarks, tuition is free. That’s right. The school’s nearly 1,400 students don’t pay a dime in tuition during their time there.

So what’s the catch? All the college’s students—without exception—pay for their education by working 15 hours a week on campus. The jobs are plentiful because this school—just a few miles from Branson, a popular tourist destination—operates its own mill, a power plant, fire station, four-star restaurant and lodge, museum and dairy farm.

Some students from low-income homes also spend 12 weeks of summer on campus working to cover their room and board. Part of the students’ grade point average is determined by how they do on the job and those who shirk their work duties are tossed out. The jobs range from campus security to cooking and cleaning hotel rooms, tending the hundreds of cattle, building new dorms and buildings, to operating the power plant.

The college was founded in 1906 as the “School of the Ozarks” atop local Mount Huggins, named for brothers Louis and William Huggins from St. Joseph, Mo., who gave the school its first endowment. From the start, the school was run on the same work-for-education principle as it is today.

Just over 40 years ago, this newspaper made College of the Ozarks famous with a 1973 front-page story that nicknamed the school “Hard Work U.” In 1988, when he became the school’s president, Jerry C. Davis, started plastering the moniker “Hard Work U” on nearly every structure and piece of promotional material printed at the college. “We saw this as a huge marketing coup because it sets us apart from nearly every other school in the country,” explains the colorful Mr. Davis, who in 26 years as head of the school has brought to campus such luminaries as President George W. Bush, Margaret Thatcher, Tom Brokaw and Norman Schwarzkopf.

“We don’t do debt here,” Mr. Davis says. “The kids graduate debt free and the school is debt free too.” Operating expenses are paid out of a $400 million endowment. Seeing the success of College of the Ozarks, one wonders why presidents of schools with far bigger endowments don’t use them to make their colleges more affordable. This is one of the great derelictions of duty of college trustees as they allow universities to become massive storehouses of wealth as tuitions rise year after year.

In an era when patriotism on progressive college campuses is uncool or even denigrated as endorsing American imperialism, College of the Ozarks actually offers what it calls a “patriotic education.” “There’s value in teaching kids about the sacrifices previous generations have made,” Mr. Davis says. “Kids should know there are things worth fighting for.”

He says a dozen or so students will be taking a pilgrimage to Normandy in June to commemorate the 70-year anniversary of D-Day and the former College of the Ozarks students buried there. Amazingly, four of the school’s graduates served as generals in the U.S. military during the Vietnam War.

The emphasis on work in exchange for learning doesn’t mean the classroom experience is second rate. The college has a renowned nursing program, business school and agriculture program. As one who has lectured at many universities, I can attest that the many students I met on the campus are refreshingly respectful, inquisitive and grateful for the opportunity to learn.

These aren’t the highest academic status kids (the average ACT score is 21), but there is an unmistakable quest to succeed. To gain admittance, each student must demonstrate “financial need, academic ability, sound character, and a willingness to work.” Elizabeth Hughes, the public-relations director, says: “We don’t have a lot of rich kids . . . they have plenty of other schools they can choose from.”

That doesn’t mean the school is not in high demand. Unlike many small liberal-arts schools that are suffering a steep decline in applications, last year College of the Ozarks had 4,000 applicants for about 400 freshman slots, which makes this remote little school among the nation’s most selective.

All of this raises the question: To bring down tuition costs elsewhere, is it so unthinkable that college students be required to engage in an occasional honest day’s work? Many of the privileged class of kids who attend Dartmouth or Stanford or Wesleyan would no doubt call it a violation of their human rights. Others are too busy holding rallies for unisex bathrooms, reparations for slavery and an end to fossil fuels to work while in school. As the humorist P.J. O’Rourke once wrote: “Everyone wants to save the world, but no one wants to do the dishes.”

At Hard Work U, the kids actually do the dishes and much more while working their way through a four-year degree. Nearly 90% of graduates land jobs—an impressive figure, given the economy’s slow-motion recovery.

“If I were an employer, I’d take our graduates over those at most any other schools,” says Mr. Davis. “The kids at these East Coast colleges strike me as being a little spoiled. Our graduates don’t expect to come into the company as the CEO.” But they certainly join a company knowing the value of work.

Mr. Moore is chief economist at the Heritage Foundation.

Stephen Moore: What ‘Hard Work U’ Can Teach Elite Schools –


How Britain Returned to Growth

What could a Brit know ???

As the U.S. and Britain recover from the Great Recession, the question being asked of advanced economies like ours is this: Do we now face secular stagnation and long-term decline, so that it simply won’t be possible to promise the next generation better lives than our own?

Having met with policy makers and business leaders in the U.S. over the past few days, my answer is an emphatic no. Britain, the U.S. and others in the West do not have to accept defeat in the global race and resign ourselves to eroding living standards. The way to avoid this fate is to acknowledge two premises about the modern economy—and then take the necessary actions to surmount our nations’ economic problems.

First, we are not going to get richer by borrowing more from others in the world just so that we can buy the things they make. We have to earn our own way in the world, by making our countries attractive to overseas investment, better educating our workforces, and providing a climate in which our businesses are able to produce goods and services of sufficient quality that the rest of the world wants to buy them.

Second, our governments have to live within their means, and not pile up deficits and debts that will burden future generations with the taxes to pay for them. We have to reduce entitlements and drive value for money through government, so we can focus public spending on areas likely to enhance our productivity.

In Britain, we have been pursuing a long-term economic plan that seeks to achieve these two goals. The evidence is that our plan is working, although the job is not done.

When the coalition government came to power 3½ years ago, the United Kingdom’s deficit was forecast to be higher than any other country in the G-20. The International Monetary Fund estimates that the government has since achieved a 4.4% reduction in the structural deficit over three years, larger than any other major advanced economy. We’ve done it with a balanced program: 80% of the consolidation will come from cutting spending and welfare, and 20% from raising mainly sales taxes. The richest have paid the most. Yet we’ve protected key budgets, like science and schools, and increased planned infrastructure spending to invest in our country’s long-term economic success.

Some said that deficit reduction and economic growth were incompatible, predicting major job losses and another recession. Those predictions were wrong. The lingering damage wrought by the crash of our financial system, plus the eurozone crisis, dragged down economic growth in 2011 and 2012. But there has been growing economic momentum throughout 2013, with big improvements in credit conditions. As a result, in its latest forecasts the IMF revised up U.K. economic growth to 1.4% this year and 1.9% next year, the biggest upward revision of any G-7 7508.TO +0.27% economy. Jobs are being created at the rate of 60,000 a month, roughly equivalent to 300,000 in the U.S.

That doesn’t mean we can let up. While the deficit is coming down more quickly, stronger economic growth alone cannot be relied upon to solve what is a structural budget deficit. So the government will continue making difficult decisions, from reducing welfare entitlements and increasing the state pension age, to controlling public-sector pay. The aim is to run surpluses in good years to pay down debt. In other words, we’re going to fix the roof when the sun is shining.

We’re also reforming our tax system to make it more competitive, and to make sure that British people keep more of what they earn. The corporate tax rate is being cut to 20% from 28%. The top rate on income has been cut to 45% from 50%, while millions of the poorest won’t have to pay taxes at all. As a result, more international firms are moving their headquarters to Britain, and investment is flowing into our country. At a time when other European countries are thinking of introducing damaging financial-transaction taxes, we’re abolishing some of the ones that already exist. This will strengthen Britain’s reputation as the home of global finance—including new offshore renminbi markets and the first sovereign Islamic bond, or sukuk, issued in a non-Islamic country.

Our two countries have led the way in building a safer financial sector. In the U.S., this has been through the Dodd-Frank Act, and I welcome the new Volcker rule in your country. In the U.K., the Banking Reform Bill, which becomes effective this week, will end “too big to fail.” Both of our countries should also be tearing down trade barriers and opening up to investment from countries such as China. I’ve just been in Beijing to secure Chinese investment in a new generation of British civil nuclear power plants. Many Western nations lack the ambition to build such energy infrastructure, let alone encourage overseas investment in it. Not Britain.

The Transatlantic Trade and Investment Partnership, launched at the G-8 summit in Northern Ireland this summer, provides a huge opportunity to facilitate economic growth. A comprehensive deal to lower trade barriers between the European Union and the U.S. would deliver combined benefits to our economies of some £180 billion ($293.4 billion). That’s equivalent to $865 for the average American household, and $720 in the EU.

Negotiations will be tough, and compromises will be required. But neither the U.S. nor Britain can afford to turn their backs on the jobs and growth this trade agreement will bring. Nor can we afford to let our education systems fail the next generation. Neither country can be afraid to take on vested interests to drive up school standards and expand choice. That’s why in my financial statement last week, I announced that we would send more young people to college, lifting the cap on the number of U.K. students who can go to university.

Mr. Osborne is the United Kingdom’s chancellor of the exchequer.

George Osborne: How Britain Returned to Growth –