Tuesday, March 3, 2015

An Indecent Proposal?

I am in the process of reading a book entitled Your Money Milestones by Moshe Arye Milevsky, a professor of finance at York University located in Toronto. I am not sure I will recommend this book, but it is proving to be fun. The author likes to play “what if” games with his readers. One of these games is a different way to calculate your net worth. What if you calculate your future income and add that number to the asset side of your calculation? How might that change the way you view your net worth? In a way it is a reasonable proposal. After all you include the remaining balance on your mortgage on the liability side of your balance sheet. That is not the present. It is the future. Why not view your future earnings in the same way?

Professor Milevsky had a close relationship with a prize pupil. She graduated at the top of her class. She was accepted at one of the finest graduate schools in the United States. However, she discovered that she would need a quick $80,000 she didn’t have in order to attend this school. Milevsky offered the student an alternative to a student loan. He was willing and able to offer the student $50,000 in cash. In exchange the student would promise her professor 10% of her salary during her first ten years of employment following graduation. The professor guessed that her salary would start at approximately $100,000. Over the course of ten years he could reasonably expect to double his investment. This is roughly equal to a 7.2% loan. Initially I found this idea a little creepy. My mind came up with visions of a beautiful young princess chained to a fat alien slug.

But is this an indecent offer?

Actually it is a better offer than a comparable student loan because the lender is sharing risk with the borrower. Current student loans can not be discharged in bankruptcy. Sometimes they can not be discharged with the death of the student. Whether or not the student finds a good job or any job, that loan will be repaid according to the terms of the contract or it will ruin the child’s life for at least the next twenty years. In this case the lender will not be made whole if the student decides to join the Peace Corp or gets married and discovers she wants to be a stay at home mom.

While this idea of treating the cost of an education as an actual investment similar to shares in a corporation rather than as a corporate bond (loan) might work in close relationships. There is an obvious problem. There is no secondary market for such investments. If the professor needs some quick cash to buy his new mistress a Porsche or pay a retainer to an expensive divorce attorney he can’t call up his broker and sell his agreement with the student.

At this point I asked, “Why not?” I owner financed the purchase of my old house in Maryland. Companies try to buy that mortgage from me on a fairly regular basis. There could be a secondary market for this kind of security. If the student thought 10% for 10 years was too high, how about offering them 2% of their future income for their entire working life. Perhaps a percentage point could be translated into ten shares of Judy Jones, Inc. that could be bought or sold on the open market.

Why stop there? I believe one of the root problems of our current student loan crisis is the university. The school has no skin in the game. They get all their money up front. It doesn’t matter if the student graduates or ever finds a job in their field. The school gets all their money. What if the university shared in the risk? They could offer scholarships underwritten by major investment houses. These securities could be bundled in mutual funds and sold on the open market, lowering risk for the investors. Should I buy shares in the University of Alabama Theater Arts Program at a Price Earnings Ratio of 14 that pays a 4.3% dividend or should I buy shares in the Department of Electrical Engineering at the Massachusetts Institute of Technology at a Price Earnings Ratio of 60 that pays a 1.4% dividend?


It would be interesting to see what kind of scholarship money would be offered under what terms in such a world. If Judy Jones has the potential to become the next Wolf of Wall Street, major business schools might fight over her future value offering her better and better deals until she signed an offer sheet. If Percy Maltree, majoring in English Literature, wants to write a thesis on Suicide and the Young Artist in graduate school, what kind of offers would he get? Would you offer Percy any money? Under what terms? What if Percy dropped out of graduate school for a semester, because he found working for his Philistine thesis advisor—stressful? Could you sell your shares of Percy Maltree, Inc. for ten cents on the dollar?

Oh by the way, the actual Judy Jones turned down Milevsky’s offer. She thought it sounded too much like slavery. What if her professor had made a more, obviously, generous offer?

Then what would happen?

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