A Creative Combination of Philanthropy and the Capital Markets That Could Solve the Student Debt Crisis
Since I wound down my division of Barclays in 2017, I’ve had time to try new things and to learn a lot, including the best quick splint for a child’s broken wrist, how to convincingly fake Sirsa Padasana, and the right etiquette for accompanying my wife at her movie premieres. One new topic of thought and research for me has been student debt. What’s striking to me is how much ink is spilled over the problem, and how little is over any solution. This is my stab at beginning to tip the scales in the other direction. What I want to propose is a market-driven solution that capitalizes on philanthropic institutions to scale, a model of cross-sector collaboration that I think should be far more common in financial services.
In 2012, American foundations made grants totaling $52 billion — or a little less than two days’ worth of trading volume on the New York Stock Exchange and a little more than three months’ worth of federal student loan originations. Obviously, what foundations lack in scale capital they make up for in real contribution to society — absent them it’s not clear who would fill the gap with the same capacities, resources, and incentives. The novelty and utility in that is deploying those resources effectively to activate scale actors (i.e., government and the markets). A lot of foundations have operationalized this understanding as it relates to the public sector, utilizing (comparatively) limited resources to influence social institutions and public policy. I’m arguing for the same approach with the financial sector: using limited but unique resources to influence the direction of the market. Hopefully my premise will be a little clearer given an example of a specific financial solution that would benefit from it.
If you’re a regular reader of, well, anything — People Magazine, NBER working papers — you know between a little and a lot about the “crisis” of student debt. Despite the fact that foundations are deeply embedded in all dimensions of higher education, they’ve been oddly silent on the subject. It’s really not that odd. The vast majority of funds flowing into college tuition are public, and the nature and volume of those funds is ultimately dictated by the federal government. But I think there’s a useful role for the markets here.
The three most important words in education finance are “unmet financial need.” That’s the amount of money students need to cobble together to pay for college after exhausting grants, scholarships, and federal loans. In my adoptive home state of New York, the average unmet financial need for a student from a family making $30,000 a year or less is more than $10,000. And bridging that gap is where students are turning to a selection of financial products that range from unfortunate to wholly unsuitable. Federally-backed PLUS loans with stringent cosigner requirements, private loans with onerous interest rates and no dischargeability, credit cards at even higher interest rates, and consumer loans with parents’ retirement plans as collateral. This is a small part of the total picture of student loans, but it’s the most destructive for students.
The government could increase its own student borrowing limits and eradicate unmet financial need. I think there’s reason to worry about that, though. There’s the obvious question of cost, but also (and to me, more importantly) the question of how much we want to scale up the current incentive structure in student loans. Ultimately, the private education lending market is just that — a market. And I’d love to see the market solve this problem for itself.
It won’t do so without some prompting. There was $26 billion in nonfederal student lending in the 2007 academic year (25% of all student loans). The market troughed two years later, with just $8 billion in originations (seven percent of all student loans), but it’s slowly creeping back upward ($11.6 billion last fall). Who’s to lead us in a different direction?
Lately, I’ve been watching a new financial product emerge that holds promising commercial characteristics, . It’s inherently market-driven, not a financialization of government funding or grants. It has a massive addressable market, far larger, in fact, than that of private student loans. It has a clear, concrete, and quantifiable social dimension. And it’s aimed squarely at this messy but pressing issue of education financing.
Others have explained Income Share Agreements (ISAs) better than I can here. My shorthand for them is that they’re an equity-like financial product in a world of debt-based options. Investors provide upfront tuition financing in exchange for a defined portion of students’ future earnings. Ideally, the ISAs are pooled across a wide range of student characteristics (credit, academic performance, program, field of study, etc.) and have a relatively narrow band of eligible earnings (i.e., threshold to initiate payments, a cap on payments). Investors would underwrite the product on some stable, rich forecasting of future earnings. Servicers would collect based on W-2 filings or the like.
Structurally, ISAs are fairly intuitive and elegant. But their implications for education finance are widespread. At significant scale, one can imagine a couple of massively consequential features of an ISA-dominated education finance market. First, and foremost, access to high-quality education capital is dramatically increased, both because the risk of utilizing it is less (ISAs are income-contingent) and because it’s underwritten differently (chiefly on future earning potential). Second, education capital becomes substantially biased toward programs that generate a positive return on a student’s investment in them (a necessity borne of ISA fund economics). Third, education capital providers start to behave more like equity investors than debt collectors. My wife’s VC firm invests a lot of resource in expert staff, because doing so ultimately benefits their portfolio of companies and thus Anthemis’s bottom line. I think there’s an incentive analogy there to ISAs, where investors put up small amounts of short-term additional cash — emergency aid, living stipend for an internship, academic coaching — knowing that it has large amounts of long-term (social and financial) benefits.
I’ve been learning a lot from some early implementations of ISAs. My friends at the Jain Family Institute have helped structure several ISA programs that underscore the promise and premise of the model, most notably with Purdue University, General Assembly, and College Possible. I particularly like that Purdue’s program is funded by its own endowment, but all of the programs I’ve seen so far point to some of the larger implications I outlined above. General Assembly’s ISA builds in the extra student supports I mentioned. College Possible’s ISA is only available to students attending institutions with a certain Pell-eligible graduation rate. None of the programs underwrite on FICO, academic performance, or cosigners.
The broader social benefits that follow from all that likely go without stating. I’ll spare you a screed on greater economic mobility for poor students, increased numbers of mid- and high-skilled workers, and fewer predatory education providers.
I think ISAs have exactly the right mix of characteristics that plays to the strengths of the free market while delivering meaningful non-financial returns. How then do we get from a few small, exemplar programs to a large-scale market that remains exemplary? I think the pathway to scale for ISAs yields some instructive structural insight for the social innovation sector in general.
Philanthropy and finance both have a role to play in growing the ISA market. Finance should marshal return-seeking scale capital, and philanthropy should bring concessionary capital. Finance should provide quantity, and philanthropy should promote quality, using its more limited resources as risk protection that eases terms and reduces the cost of capital. In this blended arrangement, ISAs can quickly reach exponentially greater numbers of students without sacrificing social impact, and while producing the financial and reputational data that will eventually render the blending unnecessary. Freeing up philanthropy to provide the same risk capital to something else that’s new and potentially consequential.
This is a form of structured finance, widespread across a number of different asset classes, geographies, and industries, including development finance! It’s stubbornly not a fixture of social innovation in the U.S. though. At least part of the explanation here is that while sources of senior (scale) capital are many and centralized, sources of junior (concessionary) capital are few and decentralized. If ISAs and products like them are to flourish, this is a problem that philanthropy should commit itself to solving.
It’s fodder for another blog post, but I can imagine a number of approaches to this. One would be building a platform for concessionary capital that reduces barriers to entry for funders (i.e., philanthropy) and empowers investors to intelligently, creatively invest capital within the bounds of various social objectives. Something like a concessionary wealth fund powered by “revenues” from America’s most abundant natural resource — philanthropy!
The evidence-based policy movement — funding research to catalyze policy innovation — has been among the most prominent and consequential in the social sector. It’s high time for something analogous aimed at financial services, where pilots catalyze financial innovation. Too much of the connectivity between the private and philanthropic sectors (i.e., impact investing), uses the tools of the market but doesn’t use the market as a tool. But the real the promise of aiming private enterprise at alleviating social ills is marshalling efficient, highly scalable resources to address those moral tragedies that are also inherently market failures. There’s $36 trillion in assets under management in the United States alone. By putting resources and talent behind new financial products like ISAs, philanthropy can influence a significant part of it.