Student Income Loans Transfer Wealth to Investors, Risk to Students

At more than $1.3 trillion dollars as of 2016, US student loan debt has become widely discussed in the media, the business press and academia as a new debt bubble with the potential to burst and trigger a global economic crisis that puts everyone at risk. The student debt bubble is regularly compared to the subprime mortgage debt bubble that resulted in the failure of banks, the great recession and the public bailout of Wall Street and the auto industry in 2008. Prior to the subprime crisis, high- and low-risk mortgages were packaged together into investment bonds so that when enough of the high-risk mortgages defaulted, the bonds that had been rated as safe collapsed. Similarly, one form of student debt investment security, Student Loan Asset Backed Securities (SLABS), is composed of pooled student debt.

A crucial difference between the subprime debt bubble and the student debt bubble is that the properties that comprised subprime mortgage securities served as collateral to the mortgage debt. If a homeowner defaults on a mortgage, the bank claims the property in its stead. Student loan debt has traditionally not been collateralized. In other words, if a student or former student defaults on student loans, there is no tangible asset for the bank to claim. However, since a great deal of student loan debt has been federally subsidized and especially reinsured, private banks that package student loan debt into investment securities have been able to sell these investment securities because they carry the full faith and credit of the federal government. Despite having no collateral, they have the federal guarantee.

In 2010, the federal government ended the Federal Family Education Loan Program (FFELP) that federally subsidized and reinsured private loans that formed the basis of most SLABS, opting to shift federally subsidized loans into direct federal loans issued through the Department of Education. Despite the end of FFELP, privately held student loan debt and securities based on it accumulated prior to 2010 remain a massive outstanding debt that is predominately serviced, managed and collected by a single for-profit corporation, Navient, that spun off from Sallie Mae. Sallie Mae was a public bank that lent to students and was privatized by the Bill Clinton administration. Navient faces criminal charges of illegal collection practices and defrauding borrowers and has come under fire most notably from US Senator Elizabeth Warren. With federal insurance and subsidy removed on these privately held FFELP loans as of 2010, Wall Street lost its enthusiasm for securitizing newly issued unsecured private debt, despite the fact that bankruptcy laws make student loan debt extremely difficult to discharge through bankruptcy. Enter the Student Income Loan.

After the end of FFELP in 2010, private investors developed Student Income Loans (also known as Income Share Agreements or ISAs), an “innovative” financing technique to expand private student loans and develop a new kind of student debt investment security. Several for-profit and nonprofit companies, such as 13th Avenue Funding, Lumni and Pave created Student Income Loans that provide tuition in exchange for a percentage of future income. These lenders pool the Student Income Loans into investment securities. The financiers have presented Student Income Loans as a service to students providing another avenue of educational finance and as an innovation in lending. Since the federal government does not insure or subsidize the loans, the private investors make terms that mitigate their risk while maximizing their profit. Profits can be enormous. The Wall Street Journal offers an example of a student ultimately paying $60,000 for a $15,000 tuition loan.

One key way these Student Income Loan banks limit risk and maximize profit is by restricting loan issuance to students who study subjects that are expected to result in high incomes, such as engineering, or by restricting loans to graduate students in select fields. This instrumental and vocational tendency of student income loans contributes to the rising clamor to defund elements of higher education that do not directly result in commercial benefits for business, such as programs in the humanities and the arts, the social sciences and even the abstract sciences.

Other new nontraditional private lenders post-FFELP cater to what Forbes calls “the indebted 1%” because they have “racked up pricey and prestigious debt.” These banks capture the lowest-risk student borrowers from the outstanding pool of the student loan debt that is eligible for refinancing — 75 percent of the $1.2 trillion in debt. Companies like CommonBond ($100 million refinanced) and SoFi ($1 billion refinanced) refinance student loan debt at lower rates than the federal government by cherry-picking the students and graduates who are seen as the lowest risk of defaulting on their loans. By creaming off the highest quality, that is lowest risk loans, Sofi and Common Bond are able to offer lower interest rates only to the minority of borrowers who have an average income of more than $130,000 yet raise the overall risk of other pooled federal student debt.

Another way Student Income Loans limit risk for investors is by pooling loans together in tranches (like subprimes). Some Student Income Loan arrangements pool debtors together and make the default by one debtor to cause the interest rates (percentage of future income taken) for all borrowers to rise. Lenders like to make these pools of debtors out of students from the same alma mater so that there is an additional sense of affiliation and moral obligation to fellow students. This arrangement adds a moral culpability onto the borrower in such a way as to counter the rationality of homo economicus that drives these projects. Why, after all, wouldn’t a rational economic actor seek to default on these loans in which the only collateral is their future work and good will? By linking the fate of other borrowers in the investment security, lenders levy on debtors a social stake in not defaulting (you, borrower, are screwing not just the rich greedy banker but also your fellow student who has a precarious situation like yours). Of course, the truly social act would be to dispense with the debt altogether and make the social obligation one for the entire society to bear rather than restricted communities of borrowers.

Student Income Loans and other new nontraditional private student loans represent not merely a new form of student loan financing but also: (1) a form of upward economic redistribution in the context of a broader assault on public institutions, particularly on public higher education, and a downward transfer of responsibility and risk onto youth; (2) a force for the neoliberal vocationalization and instrumentalism of higher education that participates in the broader trend driven by neoliberal privatization and corporate culture; and (3) a form of indenture that relies upon the fabrication of a specific form of restricted morality and the capture of future forms of associated living. I suggest that these three key elements of Student Income Loans need to be seen as a material and symbolic project of class warfare waged by the rich on the rest.

An Assault on Public Higher Education

Following the great recession of 2008 and the ensuing rightist push for austerity, states and the federal government significantly cut public higher education spending. Universities responded by raising tuition. As is common during recessions, university enrollments increased. As students assumed debt to pay for university, an effective redistributive transfer was accomplished whereby youth, among the most economically vulnerable citizens, absorbed the costs. A number of states not only cut higher education funding but also enacted educational privatizations and created slush funds for businesses. While spending has not been fully restored, students are shouldering the debt burden and banks are profiting.

Higher education spending cuts by states need to be seen as effectively an upward redistribution scheme, with tuition increasing by the same amount as public defunding, about 10 percent. Thirty-six percent of undergraduates take federal student loans and 6 percent take more expensive private loans. Forty-seven percent of public higher education revenue comes from tuition. The state defunding of public higher education is regressive, much like the shift from an income tax to a sales tax, in that it puts more of the burden on a smaller segment of the population while lifting the burden to pay for this public good through taxation off of those with greater wealth and income.

The federal government also cut education spending in the wake of the recession. To make matters worse the federal government “generated upwards of $100 billion in revenues from its student loan operations from 2008 to 2013.” To put this federal revenue generation in context, the money that students pay to the federal government joins a pool of money that in the age of austerity decreasingly goes to pay for the caregiving functions of the federal government but increasingly goes to pay for its punitive functions. Perhaps most perniciously, half of federal discretionary spending goes towards the military and military-related spending, while enormous amounts go to subsidize private industries, such as corporate agriculture and entertainment. In this regard, the shift of the costs of higher education onto students represents a kind of debt spending by youth to fund the military and corporations. This generational pillage is not just unethical but it represents an economic burden on future workers and consumers who will be spending to service debt to create bank profits. In addition to being a financial redistribution, it also represents a transfer of risk and responsibility.

As Andrew Ross explains, the transfer of fiscal responsibility from the state to the individual is a key aspect of higher education privatization. He points out that it would only cost $87 billion to federally fund every two- and four-year public college. This is a miniscule amount relative to the $1.22 trillion spent annually by the federal government on tax breaks and less than the current $102 billion federal outlay for education that represents just 2.67 percent of all federal spending.

Vocationalism and Instrumentalism

Student Income Loans further the vocationalizing and instrumentalizing trend that has been expanding with the corporatization of higher education. The American Enterprise Institute, an outspoken neoliberal advocate of Student Income Loans or Income Share Agreements (ISA), writes:

Because ISA investors earn a profit only when a student is successful, they offer students better terms for programs that are expected to be of high value and have strong incentives to support students both during school and after graduation. This process gives students strong signals about which programs and fields are most likely to help them be successful.

In this context, successful means students endeavoring to pursue the highest-paying fields that are the most directly commercializable. As Jeff Bryant of Salon writes, this will likely lead to students being pushed into academic programs that are “financially incentivized” by investors rather than towards programs that appeal to students’ imaginations, ideas or interests.

Bryant suggests that the dangers of the vocational tendencies of Student Income Loans may be harmful not only to the pursuit of meaningful, passionate and interesting work but that it may be harmful to business as well because “outliers” from the humanities often make important contributions to business. He emphasizes that unless the interests and desires of a young student are math or science, “a quest for personal development and intrinsic reward — becomes a lifelong liability regardless of personal attributes.”

Moreover, making majors in the humanities, arts and social sciences more expensive will result in the further gutting of these programs from universities and a reduction in the number of not just workers but citizens who are educated in the knowledge and habits of society and self-reflection grounded in traditions of culture and scholarly thought. There is more at stake than just individual economic opportunity. As Henry Giroux argues, the undermining of the humanities as part of the war on public higher education represents the production of civic illiteracy in that it deprives citizens of the intellectual tools to interpret and intervene in public problems as well as a form of “organized forgetting” as the history is flattened into a permanent present understood through acts of working and consuming.

These public and civic concerns expressed by Giroux seem not to be on the minds of the financiers behind Student Income Loans. McGrath writes:

“Not to be glib about it,” says Tom Glocer, former Thomson Reuters CEO and a CommonBond equity investor, “but if you’re coming to me for a loan and you’re a dentistry student at the University of Pennsylvania, I’ll be more willing to make a loan than if you tell me you’re an art history major at Texas Christian.”

Student Income Loans do not only allow the rich to own the labor of another, they also allow the rich to create investment securities out of these collected pledges of future time and work while supporting the institutions that have historically bolstered their own class interests. These speculative instruments then serve as the basis for additional future private lending and in turn, yet more speculation. Ultimately, Student Income Loans promote not only a strictly commercial way of seeing education and its social value and defund fields of study alleged to have little commercial value, they also create a financial incentive to avoid mass public funding of higher education while fueling a dangerous educational debt bubble.