Trying to address the countrys college debt crisis, President Obama this week signed an order that allows borrowers to cap their student loan payments at 10 percent of their incomes. According to the Federal Reserve, total student debt now exceeds $1.25 trillion. This is a dramatic increase from the $250 billion just 10 years ago. If trends continue, the total could exceed $2 trillion by 2020, and most student debt could be privately held by 2030.
The most immediate problem with student debt is tight cash flow, though the most enduring problem is the opportunity cost it creates. But there is a solution that can alleviate both of these problems for many borrowers, and it comes from an unlikely yet perfectly logical place: the world of patent royalties. The name of this solution: the anti-stacking rule.
Anti-stacking rules are sometimes found in patent license agreements. They allow licensees to reduce their original royalty obligations in circumstances where additional licenses are required. Anti-stacking rules help ease tight cash flow by reducing earlier payment obligations to accommodate later payment obligations. They solve for licensees a similar problem that student debt creates for borrowers.
Applied to student debt, the anti-stacking rule would require lenders to accept a reduced interest rate on the following terms: The interest rate would either be reduced by 50 percent or to the then-current risk free rate (10-year Treasury) plus 1.5 percent, whichever is better for the lender. All of the borrowers savings would be diverted toward investment in certain types of appreciating assets. The following assets would qualify: homes, mutual funds, ETFs, REITs, CDs, permanent life insurance, municipal bonds and treasuries. Each borrower could choose which assets to acquire. Whatever asset is chosen, the loan payment schedule should be modified in a way that maximizes asset growth potential.
Although this program would reduce upside profits for some lenders, it would also reduce their downside risk. The borrowers assets would collateralize the debt from which it was derived. Lenders would gain the rights of a secured lender. Borrowers could not liquidate or encumber the assets until the underlying debt is discharged. But they could roll over investments made in one type of asset into another. Lenders would otherwise retain most of their existing rights and remedies.
This program would be voluntary for borrowers. Original loan terms would apply for those who do not use this program. This is by design. The idea is to enable young people to invest in an asset that appreciates in value so they can start building future economic security and independence. Simply allowing borrowers to refinance debt may not promote this goal. This is not about freeing up discretionary income. If money is to be diverted from lenders, it should be to a responsible and mutually beneficial end.
The special nature of student debt justifies this program. Student debt is normally bankruptcy-proof, which means it is safer for the lender than most other kinds of debt. The lenders risk would be even further reduced by collateralization of the debt with the assets created by this program. This justifies the interest rate adjustment to the nominal rate suggested above.
Student debt is more compulsory than other types of debt because higher education is generally essential for higher wages. And student debt is usually the first major debt that young people incur, so its position as first-in-time naturally makes it the most proper category for subsequent adjustment. This program would restore balance to the lending risk-reward paradigm while treating all players fairly.
All players would benefit. Borrowers would have a chance to build an asset base, and years of directed investment would train many young people to develop good investing habits. Educational institutions wouldnt have to compromise the quality of education or plunder endowments. Governments would have reduced funding slack and additional liquidity through securities sales. Taxpayers would get a reduced likelihood and scope of student debt subsidization. Mortgage lenders, fund managers and life insurance companies would have more business. The public markets and the housing markets would get a liquidity infusion.
And even lenders would benefit because it would reduce their risk, give them more rights and avoid harsher alternatives with fewer benefits: loss of bankruptcy protection, partial debt forgiveness and/or refinancing with no collateral.