Student Loans: A New Initiative to Stop the Stifling of an Innovative Approach

M ajor changes in federal policy toward student debt have been in the news recently, chiefly with the Biden administration considering some amount of student-loan forgiveness. Meanwhile, very quietly, a more innovative, free-market solution to the student-debt crisis is being attacked. The Biden Consumer Financial Protection Bureau (CFPB) has been cracking down on income-share agreements (ISAs), an innovative solution popularized by Milton Friedman in a 1955 essay titled “The Role of Government in Education” that ultimately made its way into Friedman’s 1962 classic, Capitalism and Freedom. With income-share agreements, students have to pay back a fraction of their future earnings over a fixed amount of time, as opposed to the case with traditional student debt where students often have to pay back a fixed amount of debt payments.

Fortunately, in early August, bipartisan legislation, known as the ISA Student Protection Act, was reintroduced in the Senate by Mark Warner and Chris Coons, two Democrats, along with Todd Young and Marco Rubio, two Republicans. The legislation seeks to combat the Biden administration’s overreach in this area by providing a regulatory framework for such ISAs to exist without regulatory uncertainty and to take steps to eliminate predatory practices by lenders. By providing guardrails such as limits on how high ISA rates can be, the legislation in return exempts ISAs from usury laws and other state regulation, as well as from federal-agency regulation by the CFPB.

One main benefit of ISAs is that they enable students to diversify their post-college-earnings risk. For instance, if they were to graduate in a recession without a job and no income, they wouldn’t be on the hook for education-related payments. Meanwhile, the rates charged by ISA lenders will vary depending on how lucrative the major they are being asked to finance tends to be (e.g. accounting majors receive more favorable rates compared with humanities majors).

While the income-share agreements idea isn’t new, it started to come back in the mid 2010s with the rise of new education-finance start-ups and some schools such as Purdue (led by President Mitch Daniels), which created a form of income-share agreements as an experiment some years ago (which I wrote about at length back in 2016 for National Review magazine and at Forbes). However, as I discuss below, Purdue is now taking a pause as a result of regulatory pressure.

Things started to go wrong from a regulatory standpoint when in September 2021, the Consumer Financial Protection Bureau ruled against the income-share lender known as Better Future Forward Inc. (BFF), an ISA market leader that operates one of the first income-share-agreement funds (the BFF Opportunity ISA Fund). Regardless of the merits of that particular case, it’s worth noting that the Biden administration has been strongly opposed to innovative solutions to the student-debt crisis such as ISAs, favoring the more politically promising and costly approach of debt forgiveness (even for graduates with higher incomes). A government in power paying off student loans is a much easier way to win votes as opposed to the more difficult path of promoting innovative solutions for the poor and middle class through financing education that can produce better, more affordable, and productive outcomes such as ISAs.

Arguably, this was the reason the CFPB went after one of the market leaders in ISAs in, some suspect, an attempt to wipe out the entire ISA industry. The CFPB alleged that BFF “falsely represented that its ISAs are not loans and do not create debt” and “failed to give certain required disclosures and imposed prepayment penalties on private education loans,” thus arguing that these arrangements constituted violations of the Consumer Financial Protection Act of 2010. Better Future Forward subsequently went along with a consent decree.

Moving away from the specifics of that case, I’d argue that the CFPB’s approach is flawed, since ISAs have important differences from conventional debt. There is a somewhat philosophical and technical debate over what exactly constitutes “debt.” The Biden administration, CFPB, and loan-forgiveness advocates all say that any liability is “debt,” to create a broader definition of what falls under consumer-protection laws. Others, like myself, would argue that debt has unique features such as interest rates — fixed or variable — and principal.

With ISAs, there is no concept of principal (if you end up making $0 of income over the term of the ISA, you owe $0 to the ISA provider) or interest rate. A better analogy might be that ISAs are like voluntary taxes in that the obligation of how much one pays depends entirely on the amount of income earned by the borrower.

While this single CFPB action may seem isolated, various universities and lenders have been scared silly about the legal and regulatory risks of entering the ISA market.

Purdue — which since 2016 enrolled 1,900 students in ISAs and became the largest post-secondary-education ISA provider in the U.S. — just announced that it is now pausing originating new ISAs as ISA lenders. Vemo Education, which has served as Purdue’s ISA servicer since 2016, has been scared by the Biden CFPB attack on Better Future Forward Inc., and is walking away from the ISA-origination market until more regulatory clarity is provided. Part of the regulatory uncertainty has enabled ISA borrowers, in order to get out of their obligations, to sue servicers such as Vemo Education, arguing that their practice of saying there were no upfront payments were supposedly “deceptive.”

“After Vemo’s departure, [the Purdue Research Foundation] was not able to timely identify a suitable successor meeting PRF’s high standards for ISA origination activities in the coming academic year. PRF therefore decided to pause new ISA originations under Back a Boiler for the time being, while continuing to service the ISAs already outstanding under the program,” a Purdue spokesperson said in response to being unable to find a new provider of ISA finance.

Further, Purdue said its “expectation is that, as policymakers continue to provide greater regulatory certainty around ISAs and as additional market participants enter this space, more potential vendors will be available to support programs like Back a Boiler.”

This is just one example of how the legal and regulatory uncertainty being created by the Biden regulatory state may have put a complete halt to further development of a market (the Biden Commodity Futures Trading Commission is now shutting down the popular prediction-markets website PredictIt by revoking its no-action letter).

The best way to address concerns about the emergence of predatory practices in the ISA market could be for Congress to pass a safe-harbor-provision bill such as the bipartisan Rubio-Young-Warner-Coons bill. This would prevent arbitrary CFPB regulatory action and resolve the regulatory uncertainty keeping providers out of the ISA-origination market.

Focusing on innovative market solutions such as ISAs to solve the student-debt crisis is a better strategy than continuing to subsidize overpriced tuition at schools that, all too often, are failing to produce good student outcomes for poor and middle-class students who want an affordable, quality post-secondary education.