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Student loans in today’s papers

February 14, 2014

The Public Accounts Committee has published its report into Student Loan Repayments. It does not add much to the National Audit Office report from November and certainly lacks the colour of its student loans evidence session at which Margaret Hodge belittled the unprepared mandarins.

It’s worth drawing out the strongest point: the department for Business, Innovation and Skills is not in a position to make any robust assessment of the value of the loan ‘book’. This means that it has no robust way to assess ‘value for money’ in any sale of the income contingent repayment loans.

§9 We were told that the value for money of a sale would depend on a comparison of how much purchasers are willing to pay against an estimate of what the loans are worth. But to make this comparison, the Department needs a reliable and accurate forecasting model so that it can make a sufficiently robust estimate of the loan value in the first place, which it has not yet been able to do with any confidence.
The department has repeatedly overestimated annual repayments and it is not clear if this is due to macroeconomic conditions, other assumptions underlying the model or poor collection practices. The latter takes up most of the committee’s attention. On that last point, any sale of ICR loans would see HMRC and SLC continue to take responsibility for repayment collection before the sums were distributed to the private sector purchasers. As such there would be a ‘service agreement’ between those government bodies and the private sector, poor performance might then translate into compensation payments when targets are (likely) missed.
A new model to replace ‘Hero’ is scheduled for the Spring. In which case, why the unseemly haste to announce a planned sale?
Unfortunately, headlines may focus on some of the large figures on non-repayment in the report. The loan scheme was designed to make a loss – it is not a commercial initiative. The problem is not that the fair value of the loans differs from the face value so long as the accounts make allowances for that variance. If the estimated non-repayment loss is 35-40 per cent in net present value terms, but that is covered from elsewhere (and continues to be as new loans are issued), then it isn’t in itself a problem. Problems arise when the estimates move upwards as is happening at present – the official figure is now 40%, not that used by by the National Audit Office in November (and the PAC today).
In the previous years of the recession, the Treasury has provided £7billion of additional resource to cover such upwards revisions. It may not continue to do so and then there is a problem. The scheme appears to be unsustainable but we do not yet have an ‘£80billion black hole’.
One further thing to mention:
The Guardian has published a terrible article today on funding undergraduate study by securitising ‘promises to pay a certain amount of one’s taxable lifetime income’. 6 per cent on earnings made between 35 and 54 years of age is suggested. You have to concentrate quite hard to follow the cashflows and questions as to the capital funding of issuance and purchase are absent. The latter cannot be ignored if an investor is meant to be purchasing the ‘promises’ of university applicants but not seeing any return for 18 years.
The real problems though is studied ignorance.
The government, treasury and shareholder executive have been trying to introduce securitisation to higher education since at least 2007.  Indeed, the initial, biennial £6bn ‘sales’ were planned for 2009, but abandoned when the scale of the financial crisis become apparent. See Part 3 of my False Accounting? for a brief history.
In 2010, the Labour government put out the tender awarded to Rothschild to investigate ‘alternative routes to market’ because securitisation was no longer seen as the solution. You can see exactly what they proposed in 2011, now that False Economy has made the transcript available.
What’s clear is that the Guardian article misunderstands the challenges.

These promises would then be stacked together for each university class or cohort (for example, the class of 2018), securitised, and sold to investors at home and abroad. Through the securitisation process, investors would acquire an equity interest in the average income of the entire cohort. Because average income moves with inflation, these securities would be largely risk-free, and therefore would be very attractive to investors.

First, Rothschild are clear – investors do not want the risk associated with the ‘equity or junior tranche’ – they want a secure return, the ‘senior’ tranche which gets paid first from the cashflows. Indeed, Rothschild’s preferred piece of financial engineering would have seen the government pick up the ‘equity interest’. The Office for National Statistics rejected that proposal as it would not have achieved the aims of a sale – the loans would still be on the government’s balance sheet as they would be taking the risk of weaker than expected graduate earnings. On learning that, Rothschild made the alternative suggestion that universities, ‘in the private sector’, could be persuaded to underwrite private investors’s desire for secure returns.
Second, graduate earnings are not currently moving with inflation. Moreover, the current models for graduate repayment depend on those earnings moving at 2 per cent real. 
Under my proposal, no one would be forced to pursue high-income occupations in which they were not really interested for fear of being otherwise unable to pay their education debts.
So how are we going to guarantee returns to those buying the securities? There is no collateral underpinning student loans, such as houses (for mortgage backed securities) or cars (securitised loans).
Five years on from the financial crash you would think people would have a  basic scepticism  about financial engineering. But, no:

…  the securitisation process would offer the giant, insatiable, worldwide pool of private capital – currently out there looking for a safe place to go – a way to invest in the earning potential of the product of the nation’s public institutions of higher education. Instead of merely being used to create economic weapons of mass destruction, the advanced techniques developed by the financial services industry would now be able to be used for a far more constructive purpose – creating investment vehicles of mass education.

This is the danger of financialisation that I warn about in the final sections of my book, The Great University Gamble. As Rothschild makes clear, investors would need ‘complete and accurate data on individual borrowers’ to price such securities and that entails a fundamental transformation of education with graduates becoming the bearers of the unit of account. The author of the article is right, though, large funds do require new asset classes in which to invest. Their power underlies why Hyman Minsky talked about the contemporary economy being a ‘money manager economy’.

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