Thursday, December 11, 2008

Virtual Loans

I mentioned an idea in the last post about institutional loans. A better word might be virtual loans because the money doesn't really exist until it comes due. That is, it's a loan with no capital at risk. You'd think this would get the attention of a bank or two, but in these times who knows.

Direct loans from the government are limited in amount, and subject to other kinds of restrictions. Loans in general are likely to be harder to get for students in the current climate. I've argued that the easy money of the last decade has allowed tuition to rise in its own bubble along with housing, and that there will be a return to Earth in short order. Virtual loans are possibly a way to ease this pain.

Here's how it works. Most institutions give out institutional aid that is a simple discount from tuition. We don't ask anything in return for this discount, and it's used to get students with the kind of ability we want to attend, or (to a lesser extent) help students who can't afford the cost. For the latter group particularly, it's probably a good idea to tie the aid to student work. This helps alleviate the need for part-time workers, and gives the students a point of engagement with the institution that should help with their retention. But I digress.

Instead of a no-strings grant from the institution, why not ask for something? Work study is one idea, but there are lots of others. Future participation in alumni activities, recruiting, etc. are some ideas that could be the strings attached. Another one is repayment for a part of the total aid. That is, the institution "loans" the student money to make up part of the tuition instead of granting it directly. Since this money never really exists, the terms of what I'm calling a virtual loan could be quite generous. How about a zero-percent loan, deferrable two years after graduation, and paid out over 10 years? Even if many of these default, this program only has to pay for its own administration in order to break even, since there's no real capital at risk. The goal would be to provide a future revenue stream with no present capital outlay.

Even better would be to involve a bank in the processing of the virtual loan. Banks do loans all the time (well, they used to, and this will give them something to do). They have the regulatory infrastructure in place, and are set up to receive payment with no additional bureaucracy needed. This should lower the administration cost. If you know a banker, ask him or her on what terms would he or she loan money at no risk.

There may be some legal reason why this all can't happen. I should have opportunity in the near future to explore this idea with people who know more about the regulations than I, and I'll find out if this idea is feasible. Maybe someone is already doing it. The virtual loans wouldn't do anything to alleviate the current financial woes, but would start to create a new long-term revenue stream that would start to pay off in a few years. With judicious planning, an institution could be audacious enough to eventually offer these kinds of loans to the extent that they replace traditional loans, and thus secure a favored place in the market. That is, if the virtual loans were managed so that they push out more traditional loans, it would be very attractive to students because of the much lower interest rates. This could only happen by institutions weening themselves off of the interest-bearing loans over time, but in principle there's no reason for that to be impossible.

The fact that virtual loans are not ubiquitous seems to me to be an inefficiency in the marketplace. But it may be that the conditions for such loans are not favorable enough to warrant the administrative costs. If the default rate is near 100%, for example, it might create more problems with alumni (who often voluntarily give money) than it is worth.

No comments:

Post a Comment