Resolving The Student’s Loan Dilemma The Right Way

In the midst of the ongoing debate about the crisis that is student loans, one option that increasingly is floated, that was floated during the last elections is ‘free college education’.

I encourage you to hear me out, not freak out when I say introduction of free college education in the United States of America will in aggregate hurt Americans and the American economy.

First, introduction of free college education implies professors’ salaries likely are revised downwards. A downward revision to salaries implies loss of incentives for provision of high quality education. A decrease in quality of college education at a time when Asian countries have become intellectual threats to American interests or comparative advantages cannot in long run augur well for Americans.

Second, introduction of free college education means much smaller funding for research. Research is engine of innovation. Absent good research, America would not lead the rest of the world when it comes to innovation. In presence of much smaller funding for research, and lower quality of education, relative to the rest of the world, America is guaranteed to lose it’s innovation edge.

How does a country shipping manufacturing jobs overseas maintain any comparative trading edge if it loses it’s edge in research, innovation, and quality of education?

Introduction of free college education is the knee jerk, give it to the capitalists, socialist or communist response to the current debacle that is state of student loans.

An economy whose viability relative to the rest of the world resides in it’s innovation potential, and actualized innovation, which combined are essence of capitalism, cannot afford an education system rooted in socialist or communist ideology. So then while free college education sounds idealistic and can work for countries whose economies do not revolve around innovation, it is not a pragmatic solution for the USA. What we really need is a ‘Pareto optimal Capitalist’ solution.

A Pareto optimal Capitalist solution attempts to balance interests of all parties to a contract. Capitalism is supposed always to be rooted in Pareto optimal solutions.

A Pareto optimal Capitalist solution ensures college education is appropriately priced. If a student cannot afford the appropriate price, and exhausts all grants, the student takes on student debt for affording of college education.

On graduation, a person saddled with student debt receives notification of their minimum monthly payment for satisfaction of their debt. If the minimum payment is greater than 10% of their income, statutes passed by government empower the debtor to negotiate a monthly payment no more than 10% of income.

The creditor informs the debtor of the net increase in interest that reduction of the minimum payment will entail, and net increase in time to pay off the debt. If the debtor is comfortable with the increase in costs embedded in a more comfortable payment, the minimum debt payment is reset to the comfortable 10% of income level. With the increase in costs at back of the mind, the debtor has incentive, whenever opportunity presents itself, to make extra payments that help reduce the additional interest burden. Incentives are directed towards more payments, as opposed to less of payments and there is lower risk of intentional default on part of the debtor. This represents a win-win solution for the graduate and the creditor. A win-win solution that is better than the debtor having incentive to throw hands up in the air at injustice of an unaffordable monthly payment, resulting in intentional default.

The hidden risk in the mechanism described is the risk that debtors will not report permanent increases to income to creditors. If debtors’ incomes increase, but this is not reported to creditors, creditors are given the right based on objective evidence from tax returns to increase minimum payments to 10% of debtors’ incomes. In addition, and conditional on non-notification of permanent increases to income, if payments are not expected to extinguish the debt by age of 65, they earn the right to fix payments at level higher than 10% that ensures extinguishing of the debt by age of 65.

For debtors who faithfully report permanent increases to income, debt payments are not moored to extinguishing of the debt by age of 65. More on essence of non-tying of payments to guaranteed pay off at 65 later on in the post.

If a person saddled with student debt loses their job, they provide evidence of loss of income, are not charged with a default on their credit report, obtain a stay of payments.

The creditor offers a menu that encourages the debtor is encouraged to want to find another job as quickly as possible in the following manner. If the debtor obtains another job within three months, one month of payments is forgiven in entirety. If a new job is secured within six months, two months of payments are forgiven in entirety. If a new job is secured in one year, three months of payments are forgiven in entirety. This menu is not forced by government, rather encouraged. In presence of many players in the creditor market, and at least one participant who adopts such mechanisms, competition will render such offers ubiquitous within the market for student loans.

The mechanism outlined ensures debtors who lose jobs have incentive to resume debt payments in a timely manner, have incentive to secure a new job as quickly as possible.

At 65, a person who had student debt retires. If payments have been made faithfully over time whenever there was income, and if there still remains a balance on the person’s account, a law that guarantees creditors a minimum return on loans kicks into effect. Contract outcomes are presented to a government office responsible for dealing with creditors and the balance is taken care of by the government. If the creditor already earned more than the minimum, the account is closed, balance written down to zero.

Since payments go to Creditors who do not put the money into play until someone borrows, there does not exist any inflationary effect from this mechanism for subsidization of college education by the government.

Government subsidization that occurs in context of free education is guaranteed to introduce inflationary pressure into the U.S. economy. The mechanism proposed in this post does not portend any inflationary pressures.

If payments have been intentionally negligent, 10% of Social Security payments can be docked and paid to creditors directly by the government. If any balance remains unpaid at timing of death, the creditor can present a claim against the debtor’s estate and negotiate some lump sum payment that either resolves the claim, or at the very least reduces the unpaid balance. This claim on part of the creditor will be characterized as a senior claim that is pursued alongside any taxes owed the U.S. Government.

The mechanism outlined is a credible mitigant to intentional defaults. Typically, most Dads and Moms do not want their children thinking they were deadbeat with respect to their financial responsibilities. Do not want children to think all they passed down were liabilities.

The Government wins because it only subsidizes education for people who act responsibly subsequent to graduation from college. Students win because so long as they make payments on student debt faithfully, payments do not become a burden. Creditors win because under the assumption that most people are responsible, which is the case else the market for student loans already would have crashed, achievement of minimum returns on loans is quasi guaranteed.

What is the case for not adding the caveat that fixing of payments at 10% of income must ensure debts are extinguished by 65? This feature ensures people can pursue education without restricting themselves only to jobs that can pay off student loans.

A kid who would love to learn music at it’s highest level, who desires to live a kicked back life working in a bar post college, and playing gigs can get a good education, pay what he is able to afford based on his earnings, and the government subsidizes by paying off the balance left at age of 65 because it is beneficial for society that some people have flexibility required in order for arts and culture to enrich our lives.

If Michelangelo had student debt hanging over his head like a sword of Damocles, had to work as a curator in a museum so as not to default, maybe he does not have the time required for producing brilliant artworks.

If the United States creates more of such kids, saddling of society with commercial music as most ubiquitous option likely will be a thing of the past. Kids willing and now able to invest in creation of literary, as opposed to commercial music just might be able to give those commercial artists a good run for their money. A people no longer feeling oppressed by student loans also are more poised to appreciate literary music. Sounds like a win-win to me.

By the same token, a kid who obtains a degree in Economics or Finance from a top university does not feel under pressure to work on Wall Street.

If the kid would rather work with an NGO or a Charity or in some other not-so-high paying context, payments on student loans are commensurate with income.

The benefit to society is, brilliant kids can be induced into spaces which hitherto they did not have financial flexibility for consideration. Infusion of such spaces with brilliant kids can foster new innovations, induce increases to incomes within such spaces, with outcome maybe that kid pays off his loan almost as quickly as the kid on Wall Street because he innovates a space he never would have otherwise considered.

In aggregate idealistic? Yes.

But if we are going to change the student loan system, we might as well shoot for the most idealistic representations that we simultaneously are able to agree are economically and financially pragmatic.