Over at the Roosevelt Institute’s “Next New Deal” blog, Mike Konczal summarizes an important New York Fed study on the effect federal student loans have on tuition prices. The Fed found evidence of the so-called “Bennett Hypothesis”: when the federal government raised the yearly cap on subsidized student loans, colleges raised their tuition 65 cents for every additional loan dollar. Konczal highlights the finding that while subsidized federal loans appear to have a strong effect on sticker prices, Pell Grants have a more modest effect.
He uses the rest of the post to discuss the implications of expanded subsidies versus expanded credit and argues that Income-Share Agreements or ISAs (private financing instruments through which investors front tuition money in return for a percentage of a student’s future income) would also cause tuition to skyrocket. Basically, Konczal posits that because federal loans and ISAs both allow students to borrow against their future earnings, and because the average return to college is high, the availability of ISA financing would have the same effect on tuition as the availability of federal loans.
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The point Konczal makes about loans versus grants is important. But if he thinks “virtually no coverage is catching this difference,” he needs to read more from conservative policy wonks. Andrew Gillen made this point long ago (and more effectively) in a paper for the conservative Center for College Affordability and Productivity; National Review’s Reihan Salam has cited Gillen’s paper a few times in his work on higher education. (Left-leaning journalists like Vox’s Dylan Mathews and Slate’s Jordan Weissmann have also discussed Gillen’s insight.) [1]
When it comes to ISAs, Konczal misunderstands the key difference between federal loan programs and an ISA. The former does not underwrite based on the expected value of postsecondary programs, while the latter does. The federal government gives out the same loans with the same terms whether you attend Ohio State or Ohio State College of Barber Styling. This sends no signal to prospective students about the value of different options and, worse, it allows them to enroll in programs that are much more expensive than they should be, given their low return. And because PLUS loans allow unlimited borrowing up to an institution’s charges, no program is too expensive for federal loans.
Now think of an ISA: investors only reap a return if a student is successful enough in the labor market such that the percentage of their income over the fixed time period exceeds the cost of the degree or certificate program. At a minimum, this means ISAs would limit the amount of financing available to programs offering a poor return. This alone is a significant strength relative to federal loans. It’s hard to imagine, for example, ISA providers financing students at the Florida Coastal School of Law— in contrast, federal loans willingly fund these types of programs.
But even for degrees with a positive return — Konczal’s main focus — ISAs would offer advantages in terms of cost containment. It is true, as he notes, that ISAs would offer more capital to programs that promise a higher return; whether that would have any effect on prices in a system already awash with unlimited credit is hard to say. The more important point is this: ISA investors have incentives to tailor the terms they offer students to the expected value of the different programs (value in this case being a function of the price versus the likely return). Thus, valuable programs that raise prices would not be doing so in a vacuum. It would change the value proposition, the terms of the contract, and open up opportunities for competitors to undercut them. And because ISA funding could finance a broader array of postsecondary options than can federal loans, the potential for competition is that much larger.
As such, ISAs are not designed to “expand the supply of credit” indiscriminately, as federal loan increases do. Instead, they spread the risk of investing across students and funders in a way that aligns their incentives and channels funding and people toward valuable programs. That is a very different world from the one examined in the NY Fed study.
Note:
[1] It’s also true that though colleges may not raise their sticker price in response to Pell Grants, economist Lesley Turner has found that selective private colleges give less institutional aid to Pell recipients, allowing them to effectively “capture” two-thirds of the federal money.
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