A Venture Capital Alternative to Federal Student Loans

Now that they've taken over Congress, Democrats want to show that they can govern. That means pushing practical, incremental solutions that might actually avoid a Bush veto. (So no proposals to implement a Canadian-style national healthcare system or a return to Jimmy Carter-era income tax rates.)

Take their plans to improve college affordability. The House Dems' "Six for '06" campaign agenda called for halving student loan interest rates, making student loans deductible, and increasing federal Pell grant funding. Pretty basic stuff. I mean, if you want more kids to go to college and decrease the loan indebtedness of those who do attend, you flip more federal cash at them, yeah?

Another option, one that Republicans have pushed, is to try to punish colleges and universities who hit students with big tuition hikes. An unsuccessful 2004 GOP bill would have permitted the government to cut direct subsidies to colleges and universities that repeatedly socked it to students.

But there is a third option–one promoted by the recently departed Milton Friedman–that could in theory replace much of the current college financial aid system. (Indeed, there have been numerous studies showing that increased government financial aid fuels tuition increases to some extent.) The Nobel Prize-winning economist was in favor of "human capital contracts." As described to me by Prof. Gary Wolfram, a political economist at Hillsdale College in Hillsdale, Mich., a student in need of college financial aid would go to a venture capital market and obtain investors in his education. In return for that equitylike financing, the student would pledge a specific percentage of his future income–as opposed to a loan's fixed interest rate–over a specified period of time to be paid to the investor. Wolfram knows what this sounds like.

"It sounds like some sort of indentured servitude," he says, laughing.

But how is this different, in that respect, from taking out a federal student loan and having to pay back Uncle Sam? Eventually, human capital contracts could be combined into investment pools so the default risk could be spread over a large number of students. And as Wolfram explains in a study, "As the market for these contracts developed further, shares in the funds would be traded in the same way that individuals purchase shares in such things as real estate investment trusts. This would create an economically efficient way to finance higher education that would allow students to graduate without having to fear that their future earnings would not be sufficient to pay their student loans."

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