Human Capital Contracts: A Path Forward
By Charles Carter
In 1945, a man named Milton subtly proposed a new form of investment that today seems poised to disrupt the student lending industry. His sentiment was simple: “If individuals sold ‘stock’ in themselves, investors could ‘diversify’ holdings and balance capital appreciation against capital losses.’ Hidden in the footnotes of Income from Independent Professional Practice, Nobel Economist Milton Friedman created the Human Capital Contract.
After Friedman’s proposal, the concept of a human capital contract went dormant for half a century until a website called Myrichuncle.com picked up the idea and ran with it. The practice was revolutionary: lending firms and students were now on the same side, each with a mutual desire for the student to be successful in the workforce. These contracts were renamed Income Share Agreements (ISAs) in which students agree to pay a percentage of their income over a fixed number of years in exchange for tuition payments. While Myrichuncle.com stayed afloat for a few years, their unfortunate position between the fallout of the .com bubble and the era of Big Data gave the firm little opportunity to create meaningful algorithms to best determine who to invest in. By 2004, ISAs had vanished once again.
But firms adapt to changing demand. After the 2008 recession, investors and students began to realize that market volatility could be detrimental for individuals drowning in student loans. Since 2009, aggregate student loan debt has more than doubled to a staggering amount of $1.41 trillion dollars.
Determined to give students leverage in an evolving debt landscape, groups like Stride Funding, Blair, and even Purdue University have stepped up as leaders in the ISA industry. Stride CEO Tess Michaels “saw two main problems in the education market: 1) the risks are misaligned, where students pay schools up front and hope outcomes are good, and 2) there aren’t standardized ways to measure outcomes relative to expenses.” Income Share Agreements are inherently not predatory. They are guided by the premise that the better you perform, the better ISA providers fare. Loans are faceless; ISAs could never be. As such, ISAs offer flexibility that loans simply can’t through the fixed income percentage solution. 3% of your income during this current pandemic is likely very different from 3% of your income during the bull market just a few months ago, but both could be your payments for an ISA. If you lose your job, have a kid, or just decide to take some time off, ISAs have your back.
This is not to say that ISAs don’t have their critics. For those with high-paying post-grad jobs, individuals may pay more than they would have for a traditional loan due to their high income. That said, through an in-depth analysis of a student’s current situation, ISA groups are able to lower their payment percentage to accommodate those students.
With wide-scale news coverage, appealing outcomes, and federal attention, ISAs seem here to stay. As noted by James Surowiecki of The New Yorker, “The old way of borrowing was predicated on a world in which the job market was stable and everyone had a steady income. That world of work is changing.” The new way of borrowing may well be predicated upon the belief in human talent, modernized by the ISA.