Venture Capital to Buy Equity in Purdue Students

Danielle Douglas-Gabriel at the WashPost writes that Purdue is going to run an experiment with income contingent loans.

This week, Purdue University [partnered]…with Vemo Education, a Reston-based financial services firm, to explore the use of income-share agreements, or ISAs, to help students pay for college.

Through its research foundation, the school plans to create ISA funds that its students can tap to pay for tuition, room and board. In return, students would pay a percentage of their earnings after graduation for a set number of years, replenishing the fund for future investments.

The Federal government already offers an income based repayment program for student loans but private plans would likely be more flexible and generate more useful information.

Douglas-Gabriel makes a useful point:

Say a student agrees to pay five percent of her income for five years on a $10,000 agreement. If that student lands a $60,000 job after graduation, she could pay $15,000 by the time the contract is up, more if she gets raises along the way. Yet if that same graduate loses her job during that time, she wouldn’t be forced to find the money to pay.

But then concludes with an odd criticism:

Either way students would have to be pretty informed about the earning potential in their field before signing up.

What the example illustrates, however, is that being unlucky or uninformed is less damaging with an income share agreement than with a traditional loan. Loans have the greatest burden when a student overestimates their potential earnings and is poorer than expected. Thus, the loan offers no relief when relief is most needed. In contrast, payments under an income share agreement fall when income falls. An ISA does cost more than a loan when a student underestimates their potential earnings but in this case the student is richer than expected and can easily bear the extra burden. Thus, ISAs offer income insurance.

Douglas-Gabriel also writes:

Some observers worry that students pursuing profitable degrees in engineering or business would get better repayment terms than those studying to become nurses or teachers.

Actually, that is part of the point. An ISA is about improving idiosyncratic risk sharing. To the extent that engineers are reliably expected to earn more than nurses, they should pay a smaller share of their income so the total payment for an education is about the same for both engineers and nurses (fyi, business is not a profitable degree).

Indeed, one of the prospective benefits of ISAs is that differences in prices will better reveal which are the degrees, programs and schools that most generate value-added.

Hat tip: Kevin James.

Addendum: See previous MR posts on this topic.


AT, you're the real MVP. *sniff*

How enforce these contracts?

Seems plenty of ways for borrowers to game this system.

Lenders hope to reduce their risk via enforceable contracts, but exact terms of contract and efficacy of future enforcement "system" matter much. How are borrowers evaluated before contracting with them?

Credit history and/or a co-sign from a credit worth parent? What do you mean by "plenty of ways for borrowers to game", can you give me a for instance?

File for bankruptcy shortly after graduation.

Odd that they pick on nurses and teachers as those are still middle class jobs - even upper middle class jobs in union strongholds.

yes, i was really expecting to see the usual puppetry major cited there.

Don't knock puppetry, bub. It was around before most of your "approved" university majors and will be around after they go into the ash heap of history.

Nurses are probably the highest earning of the four majors they mention, then teachers, then engineering, then business. Small gap between teachers and engineering, depending on where and what type of engineering, but considering teachers only work 9 months of the year and not for the entire work day, can't be fired in most places after their probation period, cushy state benefits etc. All four are reasonable careers though where you can easily work up to good pay. Not like communications, sociology, grievance studies, etc.

We graduate massively more Education majors than become teachers though: "87 percent of education majors not teaching 10 years later"

really, think about that from an efficient markets perspective

Wow I had no idea. What the heck are they doing? Moved into the more lucrative administrative side? Or flipping burgers? That's the question I guess.

To let my cynicism fly, who cares, right?

Students (and university staff) followed their dream, colleges were funded, loans were made.

Who cares that the achievement was shallow, that loan repayment will languish, when value networks were satisfied?

They are being pushed aside by the high wages and requirements enforced by the unions... this is basic union-effects as discussed in intro textbooks

At the top level, business education is insanely profitable. A University of Chicago MBA has a ten-years-after-graduation median total compensation of $400,000. Other top-10 B-schools are similar. While this discussion is (primarily) about undergraduate education, MBAs need undergraduate degrees which are, for them, also very profitable.

A University of Chicago MBA is to a business education as a specialist MD is to a biology education.

I find it difficult to believe that a starting teacher makes more than an engineer just out of university.

Or over their career. Teacher's salaries hit a top fairly quickly while good engineers (at least where I live) make considerably more.

Cliff, anything to back this up? A quick google tells me that list is possibly backwards.

I agree with what you say, however, when you factor in teacher pensions the gap narrows. Teacher pensions for most districts are equivalent to 10%+ of their salary. Most teachers are going to draw 50%+ of their last years salary after 30 years.

The possibilities for wealth transfers (upward) are endless. Today's NYT has a story in the business section about a high school teacher who incurred over $400,000 in student debt - Lend with a Smile, Collect with a Fist. Oh, my! The hollowing out of the middle class marches on. In my generation upward mobility for children of middle class parents was both expected and not very expensive. I attended two large public universities in my state, one for undergraduate and the other for law, and finished with no student debt. None. Zero. Sure, the cost of living (rent, food, utilities) was less back then (I'm nearly old), but by far the largest increase in cost is for tuition. I never paid a $1,000 in a year for tuition, including for law school. Today I couldn't afford to go without borrowing hundreds of thousands of dollars (the annual tuition at my law school is now almost $40,000). It's absurd. What's often ignored are the consequences that flow from this. My first job out of law school was with my state's best law firm, where the starting salary was $18,000. Yes, $18,000. When tuition spiked, law firms had to raise starting salaries to accommodate the student debt incurred by the new associates. Indeed, there were instances where the starting salary exceeded the compensation for second and third year associates, which caused something of a riot. Raising the starting salary required increases in compensation up the line, which resulted in outrageous fees charged clients for the work of novice lawyers and compressed the compensation of more senior associates and partners. And compression of compensation of partners caused a mass exodus of some of the best mid-level lawyers (age 30 to 40), as they sought better terms elsewhere. The entire culture of law changed (for the worse) because of the spike in tuition and student debt. Nothing stays the same, but treating higher education as just another opportunity for hollowing out the middle class is a mistake of gigantic proportions.

Given that education is largely signaling, what then is the problem? You got to spend money to make money, and if you can't afford it, there's always a trade school or community college you can attend... speaking as a graduate of a private school and a member of the 1%, semi-retired and living large in a Third World country with a girl less than half my age. Peace!

To Hell with you, scum

A trade school or a community college or any public university or any private university that is willing to give you a good deal... I mean, you really have to make a series of bad decisions to end up with anywhere near that student debt with an employment position that doesn't nearly compensate for it.

@rayward- you started at $18k in a law firm? My god, that must have been in the early 1960s... anyway, I doubt first year associate salaries are the cause of law firm's having problems, more likely it was increased competition and bad clients, though I do recall this law firm making exactly your argument (as an excuse):,_Phleger_%26_Harrison

It was quite a shock to me when they closed (I'm not a lawyer but I sometimes play one on the internet).

I started at $13,200 in a consulting firm. That was in 1977. You are underestimating past inflation. That was a just-below-median salary for a Chicago MBA.

In the late 1960's, I was able to get through a private college with monies from a NYS Regents' Scholarship and pay from working part-time and summers. High tuition inflation made such self-funding practically impossible. How can a 19 year-old earn $40,000 working part-time and Summers?

But, I only have sons.

There are different definitions of "equity." Here I see a debtor/creditor relationship, with embedded options - no cap upside, no floor downside - more like an equity kicker attached to a loan agreement.

Equity is ownership, is permanent/perpetual, is noncumulative re: missed dividends, is residual interest, and is available to absorb losses.

The debt/equity hybrid that was described is a pretty good approximation of an equity position in a student, given the 13th Amendment which outlaws the buying and selling of people. If I were a student I'd consider it.

Veritas aequitas

"On a $10,000 agreement... she could pay $15,000".

We are dealing with morons that don't know DCF analysis stands for discounted cash flow analysis, aren't we?

Under ZIRP it's the same.

'Indeed, one of the prospective benefits of ISAs is that differences in prices will better reveal which are the degrees, programs and schools that most generate value-added.'

Of course, any German engineering exchange student from Karlsruhe going to Purdue won't be included in such 'equity' arrangements. German universities are free, as is the exchange program in terms of tuition for German students.

But then, apparently, Purdue is pretty much second rank in terms of the quality of its engineering programs compared to what is expected from a German mechanical engineering student, proving again that when it comes to an American university education, the cost exceeds the benefit. Unless someone else is making the profit, of course.

Which, unsurprisingly, is the point that Prof. Tabarrok highlight as 'useful.'

Germany traditionally did not have college for everyone, they had that apprenticeship track, which allowed university to be less common, free, and hard.

Where the American left screws that up is in thinking we can apply that to the bottom half of high school graduates as well. That doesn't work. What we get, as we see in my link, are ever greater numbers failing at college. Here, expensively.

I went to school for a while in Australia. University places there are allocated purely on merit (SAT equivalent) the government covers the total upfront cost and money is deducted from your salary when, and only when, you are earning above $30,000. Even then you don't pay the full cost. This is a great system* but is under threat from the same thinking as here (that everyone should go to university). Basic university funding is also under threat as more and more crappy institutions emerge and the existing pool of funds is distributed between all of them.
Students don't live on campus.

Sorry $54,000. See comment by Matt below

The American left hasn't screwed up. That 1 trillion dollar student loan behemouth is money that has already been paid to an apparatus of the American left - and now they are blaming that trillion on markets and corporations and demanding the government pay it all back so students are free to give more to the higher-education wing of the left...

To spread guilt a bit, private lenders, packagers, servicers of student loans are at the trough. For profit universities proved to be for profit before all else, burning private and public tuition funding for little return, for students or society.

If anything they reinforce that this is a pandemic of greeed and self-interest, of the kind that can't be solved by "one side."


differences in prices will better reveal which are the degrees, programs and schools that most generate value-added.

For some definitions of "value-added."

"Arum, Roksa, and their colleagues tracked more than 2300 students enrolled full time in four-year degree programs at a range of American colleges and universities. Their findings are alarming: 45% of students demonstrate no significant improvement on a written test of critical thinking called the Collegiate Learning Assessment (CLA) after two years of college, and 36% improved not at all after four years. And the average improvement on the test after four years was quite small."

Part-time indentured servitude.

I was going to say the same thing.

Also, somehow I suspect they are going to limit eligibility to students in more lucrative fields. At least exclude the psych majors.

But paying back a mortgage or a car loan is not indentured servitude?

If you borrow money, you have to pay it back.

Owing money is debt, it may be usurious, but the obligation is knowable.

This scheme involves equity, a part ownership of the "borrower".

Agreeing to pay 10% back on your first 5 years is pretty knowable. It's at least as knowable as signing a 5 year exclusive contract with an agent who gets paid 10% of your contracted earnings during that period.

Why not promote policies that support real wage growth so that students/parents can pay for college easily? Several decades ago, it only cost a few hundred bucks per semester to pay for college. Why promote these sort of debt schemes instead? Is it because a population that earns high real wages is not going to waste its time at colleges like GMU?

Isn't there a law against indentured servitude?

Come now, don't you think some of those free market proponents at the GMU econ dept. aren't working to get rid of this very restriction on the freedom to more efficiently exploit workers?

Average is over.

This isn't indentured servitude which requires the indentured servant to perform tasks required by the contract holder. If the students don't want to work they and the venture capital get less money. This has been done for some sports stars.

All Australian university students are eligible for income contingent loans, which are indexed to CPI on an annual basis. The loans are administered by the Taxation Office, and amounts are withheld along with PAYG tax each pay period.

Repayment rates start at 5% of gross income for people earning over ~$50,000, and gradually increase to 8% of gross income at ~$100,000 pa (median full-time salary is around $65,000).

This is obviously a good deal for students. It's relatively difficult to avoid making repayments - or at least only as easy as lying to the Tax Office about your income, which is getting harder and carries large penalties. There is a small but significant proportion of unpaid debts, mostly from people who move overseas (foreign income is not assessed) and people who die (student loans are not recovered from deceased estates). Overall the scheme costs the government quite a bit of money, but (I think) does a reasonable job of enabling people from poor backgrounds (who are likely to be debt-averse) to attend school.

In my opinion, this is how teachers could be compensated. At least partially. Especially with regard to retirement this would be a very fair component.

(The game doesn't have to use money/income as success measurement. It could be a different medium like happiness or altruism, if you know how to measure it.)

Interesting approach but in the end how much different is this approach frmo simply getting rid of the special "no bankruptcy protection" in the current student loan industry?

You can't get rid of the “no bankruptcy protection” clause without restricting who qualifies to get a loan to a much greater degree than the US currently does. And that's not politically obtainable.

Someone should have studied this a long time ago. No surprise that Purdue is led by an ex-Gov. who took risks privatizing roads, introducing public service employee HSA's, and a whole lot of innovative policies free markets advocates claim to love. And yet, I can't recall many times MR and other libertarian-leaning websites supported him or his initiatives while in power...

Agree to 10% if working. What happens when they decide they don't want to work? Or as someone said above, can this be discharged with a bankruptcy right after graduation??

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