On ISA's
Table of Contents
In recent days, there's been a flareup about student loans and student loan forgiveness, especially with the Democrats seemingly moving towards a student loan forgiveness plan via executive order. Beyond the possibilities of this or some kind of debt jubilee, one thing that caught my eye lately was the rise of ISA's, or income share agreements, where students pay a set percentage of their earnings for a set period of time in the future as opposed to taking out student loans.
Harper's magazine has a good article on this, so I won't recapitulate it here, but there are a few things I found interesting:
- A company called edly is largely behind this push
- Sketchy-but-accredited schools are already starting to use ISA's, on potentially onerous terms
- Purdue is the first major university to use ISA's (besides a small experiment at Yale in the 70's), and explicitly tied to major choice
- S 2114 attempts to provide a few protections on ISA's, senators such as Elizabeth Warren have called out ISA's for being predatory
- This field is growing, a company called Entity Academy secured a 10M funding round in September, MiTio, a medical education company secured another 20M yesterday.
1. Similarities to Mortgages
The key takeaway here is that the collateralized debt obligation vehicles (CDO) are definitely back: the resurgence of mortgage backed securities (MBS) shows that there's some significant appetite for these types of financial instruments. One thing that's key to MBS that has yet to develop fully in ISA CDO's offered by edly is the concept of tranching: some mortgages (considered to be more risky than others) are bundled together and classified at different risk/return levels. Lauren Marie Schachar at UPenn wrote a dissertation on the current tranching schemes:
When talking to investors about their internal rate of return, the PRF uses the Parent PLUS as a guide. To account for the different investors and their risk appetites, the structure of the second fund is bifurcated into two tranches. For the senior tranche, the stated interest rate is 4.5%, and a junior tranche interest rate is 7% (Purdue Research Foundation, 2018). The second fund has been split in a way that might make it more appealing for various investors with different risks appetites to invest in the Back a Boiler fund. If the second fund reaches its goal of $10 million, the hope would be that it would fund at least two full cohorts.
This is relatively underdeveloped, tranching in MBS has significantly more complexity to them, indicating that the ISA financialization market has much more to grow.
What's also interesting is the rate of growth: market research firm Career Karma predicts 500 mil in ISA's to be issued in 2020. Currently, private student loans account for roughly 130 billion out of the 1.6 trillion outstanding of student loans.
2. Preserving the University
2.1. Humanities
There's another discussion involved on the role of ISA's, student loans, and the university. The theory is that ISA best aligns the goals of the student, the university, and the lender because they offer better loan conditions for students of majors with higher ROI, thus lowering the risk to the lender, while pushing the university to move towards more "applicable" or "workplace-friendly" curriculums.
Arguments about the humanities are the natural response to this (and also displayed in the Harper magazine article): what happens to the humanities majors which have skills that aren't necessarily quantifiable to the financial markets? Unfavorable ISA terms for English majors vs computer science ones, for example, would further decimate the humanities, goes the argument.
This is largely a head-in-the-sand argument1. Australia is toying with a program that charges more to study humanities, Tanner Greer makes the argument that if you were to spend 80k on a humanities degree, you'd be far better off getting and education in the humanities via private tutoring. Universities are ultimately about signaling, but as the number of graduates increases and the number of faculty positions dwindles, how much is the usefulness of these signals?
The argument that ISA's would continue or accelerate this trend is largely facile, it's akin to saying turning on your bath will make the damages from the incoming tsunami worse. The humanities are shrinking, and ISA structures are unlikely to change or worsen any headwinds. There are larger structural problems endemic to the humanities: insane cost, mediocre signaling, lack of career paths out of academia. Only when you ignore them does the ISA begin to have any impact.
2.2. Scientific Freedom
The larger problem here is the potential decimation of "hard" scientific fields. Braben makes the argument that universities have become too large, and the competition for resources is fierce, resulting in proliferation of funding agencies and committees that oversee research. Important discoveries that were made as a result of research that had no clear goals in mind (maser/laser, photoelectric effect, Geiger–Marsden experiments, etc) did not come out of funding agencies, but rather the freedom and the resources for individual scientists to conduct whatever research they chose.
ISA's, by making future monetary value coincident with majors2 require people to believe in a shared future. In order to put a price on future earnings3, the future has to be quantifiable through a series of measurements. The danger here is that these measurements act as a semi-deterministic view on the future. In other words, the signals that are being used for ISA's right now, primarily being the students' choice of majors, makes for a poor forecast of what the student will do in the future. If anything, the ISA terms need to be more invasive and track the student's progress and earning potential, it's not hard to imagine an ISA with floating interest terms depending on GPA in the future, your loan terms are better when your GPA is higher, and get worse when your GPA is lower4.
Overall, ISA's seem to be neutral for the student loan market. They might slightly accelerate some trends that were already ongoing, but the biggest problem with them currently is the lack of oversight and the potential onerous terms students are signing up to.
Footnotes:
and I say this as someone doing a MFA in Near Eastern studies
there's also the concern that majors are not necessarily the best signal of future returns, since a student can take on careers outside of their major
to be exact, we're weighing the opportunity cost of investing in a percentage of a student's future earnings vs investing in anything else. Tim Mitchell has this concept of "economentality" in describing the notion of measuring the future as well.
Obviously this has all sorts of procyclical problems, such as punishing people who are already struggling,