Monday, November 28, 2011

How to Fix the Student Loan Problem

Even if you declare bankruptcy, you can't be rid of your student loans. The rationale is that, unlike a car, your education isn't an asset that can be seized to pay your creditors. And, unlike other unsecured loans, appropriate interest rates (think credit card interest rates) would be politically untenable.

There is, however, a better analogy we could use. When a bank goes bankrupt, it also has few assets to seize. We could try the bailout approach or the good bank/bad bank approach, but neither of them are terribly effective or applicable to people. What you can do, however, is forcibly convert bonds to stocks. When this happens to a bank, those who loaned the bank money can either sell their bank shares for what they can get for them, or they can hold on to them in hopes of a recovery.

If you apply this to people, you'd convert the bond (the student loan) into a stock (a percentage claim on future income). For example, every $1,000 of student loans would be converted into a 0.2% claim on future earnings. If the student is holding down a full-time, minimum wage job, that $1,000 would earn $29 annual in "dividends," which is well below the interest they would have paid on the student loan--and that's assuming their employed full time. However, if the student gets a good job, earning $80,000, the $160 in "dividends" would be well above the interest rate available, so the creditor shares in the upside as well as the downside. And the student could take part in this as well, buying back shares of "stock" (though when prosperity struck the value would go up).

In order to have a worthwhile market for these, however, you'd have to have reporting requirements. Those who went through bankruptcy would have to disclose financial information so that they could be valued accordingly (though most of what they'd need is available on a tax form).

However, the real impact is on the front end. The banks who write the student loans would take a much closer look at what the student is studying and how they're doing--it would introduce market discipline into education. Students who were coasting along through college drinking and studying underwater basket weaving would quickly discover that loans were in short supply, and they'd better start cracking the books as well as the beer.


Blogger Noumenon said...

It's an idea with great appeal to me. Here's a marginal revolution comment thread about it.

3:24 AM  

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