Income Share Agreements Looking Up

The Federal Reserve Bank of Richmond has a good piece reviewing income share agreements, aka income-contingent loans, including a timely example:

ISAs provide students with funding to cover their education expenses in exchange for a portion of their income once they start working. Under a typical contract, recipients pledge to pay a fixed percentage of their incomes for a set period of time up to an agreed cap. For example, a student who has $10,000 of his or her tuition covered through an ISA might agree to repay 5 percent of his or her monthly income for the next 120 months (10 years), up to a maximum of $20,000. ISAs typically also have a minimum income threshold before payments kick in; if the recipient earns less than the minimum, he or she pays nothing. This means that ISAs offer students more downside protection than a traditional loan.

This downside protection is what attracted Andrew Hoyler to Purdue’s “Back a Boiler” ISA program, which launched in the fall of 2016. Hoyler, who graduated from Purdue’s professional flight program in 2017, signed up for Back a Boiler in his senior year. He received $21,263 in reduced tuition and flight fees in exchange for agreeing to repay 7.83 percent of his monthly income for 104 months, or until he had paid back 2.5 times the amount he originally received. Now a pilot for PSA Airlines, a subsidiary of American Airlines, he has been making payments on his ISA for about 30 months.

…Hoyler is particularly grateful to have that safety net now, as the airline industry is being rocked by the COVID-19 outbreak. “The ISA is giving me a sense of relief. If I find myself furloughed, my payments stop with zero interest,” he says.

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Equity sure beats debt, especially when it is capped and time-limited. Debt that cannot be discharged in bankruptcy is indentured servitude. The banks and pols that snuck that one by Congress when everyone was told to be afraid of terrorists must really hate the future generations of this country.

Some history; note the administration in charge with each ratcheting, save one. I expect it was the purchaser/bundlers of student loans most concerned, though banks like the origination fees.

https://www.savingforcollege.com/article/history-of-student-loans-bankruptcy-discharge

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State governments like California are more than happy to force their taxpayers into indentured servitude.

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It's tough to see why this has not taken off more widely. It's such an elegant solution to many of the issues that higher education is facing currently and creates a much better alignment of incentives among the educational institution, the student and the financing provider.

IDK. If the past is any guide, universities will respond by ...wait for it... raising prices. They'll justify the higher loan amounts on the grounds that this takes some of that risk away.

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It's got to be attractive to both sides, and here it's very much caveat emptor. You buy the wrong guy's equity and end up parted with your money. Due diligence is hard if your subject of analysis don't have much of a track record.

How is it any less or more risky than giving someone a loan?

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It's official. You've become a stock. The era of the i-IPO has come.

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Can we now finally drop the pretense that education is a public good?

What's so funny is that it fundamentally doesn't address the underlying reason for all these financial tools in the first place:

The cost of education itself. In a free market (yes...I know free markets are pretty much dead) competition - in the absence of regulatory capture (which is exactly what happened) - should be forcing prices down and productivity/results up.

If you're having to borrow either through a loan or by leveraging your future earnings, the cost of education is the problem, not the financial toolbox you're using to get it.

Education in the USA has become very much like healthcare: a black box.

No one really knows why it's so expensive, and no one will tell you, they will offer you infinite ways to pay for it, and you'll pay for it after you receive it without really knowing the prices in the first place.

It's one of those economic mysteries that not even academic economists can figure out!

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It's really not that much of a mystery why prices are so high, there was a lot of government central planning intended to increase the "accessibility" of both of those services, healthcare through providing incentives and later mandates for employers to provide health insurance and with education a basically unlimited, unqualified source of loans for education (which is part of the reason you can't default on school loans). Both of these increased consumers' ability to pay (shift in demand) and did nothing for the supply of either. Of course prices increase.

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"If you're having to borrow either through a loan or by leveraging your future earnings..." then maybe there is something to the Permanent Income Hypothesis.

If the model of the Japanese 'salary man' is any indication, jobs will continue to become less and less permanent and more transient. People even 10 years ago already adopted a mode of 'your actual job is searching for your next job'.

In other words, it's getting to the point where a guarantee of future earnings to a lender will/maybe already going to mean jack squat.

" People even 10 years ago already adopted a mode of 'your actual job is searching for your next job'."

No, nothing has really changed in the last 4 decades.

"The median number of years wage and salaried employees stayed with their current employer in 2018 was 4.2 years. In 2012 and 2014, the median tenure was 4.6 years. In 2004, the average was 4 years.
....
To put that into historical context, in January 1983, according to the BLS report for the year, the median tenure of workers was 4.4 years. The figures are clear: On average, people today stay in their current jobs about the same as they did in the past."

https://www.thebalancecareers.com/job-tenure-and-the-myth-of-job-hopping-2071302

@JWatts

"The figures are clear: On average, people today stay in their current jobs about the same as they did in the past"

In the US. But maybe this particular economic model is catching up in the rest of the world and the average tenure is going down.

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The only reference I saw in the article to privately held ISAs, outside of the context of programs linked to universities, coding programs, etc., was this passing remark:

"That kind of upside would be one way to incentivize schools or private investors to offer ISAs, but most ISAs today do have a cap on total payments. "

Why couldn't this all be structured as a purely private business, and why couldn't it be set up right now?

I could envision several vehicles, all of which would need to consolidate or at least assist investors in: (a.) evaluating students, (b.) contracting, and (c.) tracking and enforcing. A business devoted to these things could develop the expertise needed to reliably evaluate students and accurately track incomes and minimize the risk of deception.

Three models that come to mind:

1.) A clearing house, somewhat akin to the international micro-loan websites, but modeled also on impressive entrepreneurial ventures like Uber and AirBnB.

2.) Something akin to a closed-end mutual fund -- not to trade equity shares on the secondary market, but rather as a primary supplier that holds the shares till maturity.

3.) A large-scale privately or publicly held company that specializes in making these agreements as investments for its shareholders.

As investment vehicles, it seems that ISAs could be a good hedge against inflation, and might, in some cases (for students heading toward "non-cyclical" careers), provide protection even against recessions. It could even stimulate students to pursue solid careers, with good majors, rather than studying only garbage. In the good old days, before the inflation-loving monetary manipulators took over, driving everyone into risk-on gambling, one could buy short-term government debt as a primary source of investment income. Could a large private ISA market serve as a replacement?

As an added benefit, institutionalizing and scaling up a fully private ISA market could have the enjoyable effect of serving as a rebuke to government loan programs and the fools who created them.

Why couldn't this all be structured as a purely private business, and why couldn't it be set up right now?

It can be. You can draft a business plan, round up investors and start doing it next week. It doesn't happen because most education is superflous and hence unprofitable absent externalities and rent-seeking.

Well that and young adults have no assets, so they can easily bankrupt out of such an agreement.

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It's going to be hard to match the different sides of the market in the commercial sector. The people who want these loans are often going to be people going into lower wage or less stable professions, and the people you want to loan to are going to be higher earners in stable occupations. You'll have to weed through thousands of applications for future writers who will be waiting tables for 10 years.

Seems to be a feature, not a bug.

If people want to go to college for unstable, low earning jobs...maybe we shouldn't encourage them to do that.

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Huh. If he’s fortunate to make enough money to pay the full amount back, that would be $53,150, or an interest rate of roughly 25.7%. But if it keeps university professors employed, it’s a great deal!

The interest rate charge has nothing to do with tuition prices. It's got to be high enough to cover the overhead of all the people not paying back the full amount.

It's a normal high risk loan with little collateral.

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When one is furloughed because of covid 19 it is indeed comforting for one to know that one's student debt is suspended. But what if everyone is furloughed or fired at once, if debt default is occurring across the country and around the world, if public and private retirement plans are unable to pay benefits, if the global economy collapses, then what difference does it make if one has an ISA. https://www.project-syndicate.org/commentary/greater-depression-covid19-headwinds-by-nouriel-roubini-2020-04 The coming contraction in trade will make Smoot-Hawley seem innocuous. If there ever was a time for cooler heads to prevail, it's now. Yet, Trump and Pompeo are fanning the flames for short-term political gain. Read Roubini's very pessimistic forecast of what's ahead. Much of the conflagration will be attributable to the collapse of global trade, and we are rushing full speed ahead to the conflagration.

Nouriel has been permanently pessimistic his entire career. He looked pretty smart being so in 2007, when 2008 happened. But then he stayed that way, so was useless as things mended.

Now he will look smart again as long as things are bad and be useless again as things recover, as they always do.

Yes, and you can apply this to most public procrastinators

Ha, prognosticators

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The 7.83 percent of income plan would have been a terrible deal for me.

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I guess for Economist Alex incentives don't matter much for these students who, if they are successful, will face much higher "marginal tax rates" as economists define that term. As I pointed out in an earlier post on this subject, it will be very tricky for lenders to track income and borrowers will have even greater incentives to avoid the higher "marginal taxes" (including income taxes). Tax deferral schemes, income off the books etc., will become very tempting.

I should have better written "income deferral schemes" for the scheme will be to defer income so that it falls outside the term limits of the contract. In this respect, the "tax" is permanently avoided.

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The income sharing loan is on top of the loans paid. He didn't get a degree from the professional flight program for $22,000. If he had to finance the whole cost through this program, it would probably be paying 30% of his income or until he paid back twice the $80,000.

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Wouldn't selection effects be a big problem for these ISAs? I'd be concerned that students who don't anticipate earning a lot would be more tempted than those who expect a big pay day after graduation.

Maybe the ISAs have a way to manage that, curious if anyone knows.

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American Airlines decided to cut 30% of its workforce in an attempt to avoide bankruptcy. Interesting fact is that 30% cut affects management mostly. Good decision at the years of such crisis.

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