Changing the Financing Requirements for College

By Richard Vedder

All the student loan problems of the past year lead me to raise the question again: why don't we move away from a system where students finance their college costs largely by borrowing altogether? Why don't students sell equity as well as debt? (By the way, this does not eliminate the big lenders from Sallie Mae, it merely changes the products they market).

Student X goes to a upscale liberal arts college that costs $180,000 for four years. The school gives this student from a lower income family $80,000 in aid, reducing costs to $100,000. The student finances $30,000 of that through work and small family contributions, leaving a $70,000 gap. This is not an unusual scenario today. Yet the student graduates, faces a $70,000 loan debt, but wants to teach in a public school where she will make $30,000 a year, maximum, at the beginning. The costs of serving the loan annually are, very conservatively, $7,000 or $8,000 a year. This is today's problem. For most students, the problem is less --the loans are smaller, the initial earnings are greater.

Suppose the student as an entering freshman is approached by Sallie Mae and told --"you can borrow from us or you can sell us equity in your future earnings, or you can do a combination of both." In effect, the student is asked to sell a hunk of her or his "human capital" (to use a phrase that helped Ted Schultz and Gary Becker win Nobel Prizes as economists).

There are a variety of different ways it could work. Under one approach, a student might sell, say, 10 percent of all earnings above a subsistence allowance of, say, $25,000 a year, payable for 10 or 15 years. Under a variant of that, the same terms would exist, except that if a student had failed to pay back an amount equal to the initial cash capitalizaiton after the stated period (say, 15 years), the period would be extended until the payoff occcurred (but in no case longer than 30 years). That approach reduces risks to lenders dramatically, maybe even too much.

All of these gimmicks offer some marginal improvements over existing debt only financing arrangements. But the real problem remains: it costs too much to go to college for some kids. We should be do all sorts of things to reduce costs. Besides the standards things, we should be reconsidering the number of years that colleges takes and consider promoting year round schools more.

The problem may be, temporarily at least, receding at some of the top liberal arts colleges and universities in the wake of Harvard's (and possibility Yale's) recent decisions. Already many prestigious schools have followed Princeton's lead and eliminated student loans from the aid package of student (I believe that the financing of college should be divorced from the colleges themselves, so I have some mixed feelings about this). If that movement grows, the need for new models of financing may be small. However, as long as colleges are largely not-for-profit and are financed largely by third parties, I think we are going to have a huge problem in controlling college costs to society and, ultimately, to the students themselves.