Month: February 2022

Promotion for book on centrist policies on student debt, pensions and health care.

Ideas on how pragmatic, politically feasible centrist policies can make a real difference.

Brief Discussion of Centrist Policies in a Polarized World:

Free Monday February 28 and Tuesday March 1, 2022.

Many Americans are experiencing increased financial stress even though the economy has performed well in the last several years. Student debt levels and the number of overextended borrowers continue to increase. Health Insurance premiums in state exchange health insurance markets are unstable and many state exchange markets have few providers. People are paying more for out-of-pocket for health care. High debt levels and the lack of funds for basic emergencies have persuaded many Americans to delay or reduce contributions to their retirement savings plan. 

The policy debates on student debt, health care, and retirement income in Washington follow a similar pattern. Conservatives offer a free market approach – reduction of financial assistance to student borrowers, repeal of the Affordable Care Act, and private accounts inside Social Security. Liberals offer expanded government programs – free or debt-free colleges, Medicare for all, and expansion of Social Security. In most cases, the conservative proposals would increase household financial risk while the liberal proposals are often unaffordable and poorly designed.  This book analyzes and compares conservative and liberal approaches to student debt, health care, and retirement income. 

The book also outlines a centrist economically feasible policy agenda in each area, with the goal of reducing household financial risk.  The centrist agenda on college costs and student debt targets financial assistance and debt relief to students and borrowers in greatest need.  The centrist health care agenda fixes problems with the Affordable Care Act and reduces distortions caused by high out-of-pocket costs and the most expensive health care cases. The centrist agenda seeks to expand health insurance and retirement benefits for contractors and workers at firms without employer-based benefit plans. The centrist agenda changes rules governing 401(k) plans and IRAs to facilitate increased savings by people with high debt levels and very little cash saved for emergencies. The centrist agenda includes an honest discussion on Social Security, which will likely infuriate both the left and the right.

The case for broad economic penalties on Russia

Targeted sanctions have not deterred the Russian invasion of Ukraine. Broader economic penalties outlined here – including a 100 percent tariff on all exports from Russia, the prohibition of all foreign direct investment, the eviction of Russia from the WTO, and severe restrictions on travel to Russia — are needed.

Introduction: 

In 1980, I had the privilege of asking Nobel Prize laureate Milton Friedman a question.

I asked why it was appropriate to prohibit virtually all trade with Communist countries while allowing substantial trade with non-communist authoritarian regimes.  

His response — that political change was possible in some authoritarian countries but impossible in countries that controlled the means or production — must be reconsidered.  

The Russian aggression in Ukraine teaches us that combatting communism is not the only reason for broad prohibitions against trade. 

Sanctions targeted towards the Russian elite is a grossly insufficient response to the current aggression.  

Money is fungible.   All funds obtained by Russia from exports, foreign direct investment, and tourism fuel for this invasion.

Analysis:

The Russian economy despite the size of the country is relatively small 

  • GDP $1.48 trillion
  • Exports around $332 billion, around 22 percent of GDP. 
  • Around $10.8 billion of these exports are purchased by the United States.

A decision by all countries sympathetic to Ukraine to put a 100 percent tariff on all exports from Russia would have a major impact on the Russian economy.  The tariffs can be phased in by some countries that are dependent on Russian oil and gas but countries that are not dependent on Russia for energy can implement the tariffs immediately.  

Russia entered the World Trade Organization on August of 2012 and was not expelled because of the 2014 invasion of Crimea. 

Ironically, WTO advocates claim that the WTO helps promote peace.   Seriously, this was listed as the number one benefit of the WTO. This time around Russia should be expelled from the WTO. 

The Russian economy is still receiving positive net foreign direct investment from the rest of the world. Interestingly, the United States is tied with China as the third largest source of foreign direct investment into China. 

Several restrictions on foreign direct investment could be implemented.  President Biden can probably immediately prohibit all foreign direct investment to Russia from the United States without legislation from Congress.  The President has broad authority with respect to foreign affairs and national security.  

Sanctions could be imposed on countries that continue investing in Russia.

Around 24.6 million foreigners visited Russia in 2018.  Foreign visitors contributed 3.8 percent to Russian Gross Value (GVA) added.  The Trump Administration imposed several restrictions on travel to Cuba.  The Biden Administration and America’s allies should now do the same for Russia.

Concluding Remarks:  Putin has prepared for the case of targeted sanctions by building up international reserves.  He has not prepared for large tariffs on all exports from Russia, the elimination of most foreign direct investment, the eviction of Russia from the WTO and the loss of funds from tourism.

Student Debt Proposal #4: Reducing tradeoff between retirement saving & student debt repayment

Reforms centered on increased use of Roth IRAs would better balance saving for retirement and student debt repayment than the Secure Act 2.0 reforms.

Introduction:   Tax and financial incentives are more generous for contributions to 401(k) plans than for the repayment of student debt.

  • Workers are allowed to to save untaxed dollars in a firm-sponsored retirement plan or an individual retirement account.
  • Firms can match employee contributions to the 401(k) plan. Two common 401(k) matching formulas are 50 percent of the dollar amount contributed by the employee up to 6.0 percent of the employee’s salary and 100 percent of contributions up to 3 percent of the employee’s salary. 
  • Student borrowers can deduct up to $2,500 of interest on student loans.  
  • The student loan tax deduction pertains exclusively to interest while the entire 401(k) or IRA contribution is exempt from taxes.
  • There are no matching contributions for student loan repayment.

The decision to prioritize 401(k) contributions over student debt repayment does not always work out well as discussed in a previous post.  Potential consequences include:

  • Higher total loan payments associated with selection of longer loan maturities.
  • Higher borrowing costs stemming from higher debt levels and lower credit ratings.
  • Early disbursements of 401(k) funds leading to penalty and tax payments.
  • Increased likelihood of having debt obligations in retirement.

Student borrowers who quickly repay their loans would increase saving for retirement, realize lower borrowing costs, start the process of paying off their mortgage and would basically be much better off.  

There is general agreement that student debt significantly impedes saving for retirement by young households.  There is, however, no real consensus on how to fix this problem.

Proposed modifications to 401(K) plans in the SECURE Act 2.0, which would induce some student borrowers to begin saving through a 401(k) plan, don’t solve this problem. Expanded incentives for the use of Roth IRAs by student borrowers would be far more effective than expanded incentives for 401(k) contributions.

The Secure Act 2.0:

Wall Street favors and greatly benefits from incentives for 401(k) investing. The Secure Act 2.0 maintains the high priority attached to 401(k) saving and facilitates participation in 401(k) plans by student borrowers.  

The Secure Act 2.0 has the following features:

  • Requires automatic enrollment of employees in 401(k) plans
  • Requires all catchup contributions be designated as Roth contributions
  • Allows designation of matching contributions to a Roth account 
  • Delays mandatory distributions
  • Reduces waiting period for 401(K) contributions from 3 to 2 years for part-time workers.
  • Authorizes 401(k) matches for student borrowers even if they do not participate in a 401(k) plan.

The general purpose of the Secure Act 2.0 is to expand investments through 401(k) plans.

Many people who rely on high-cost 401(k) plans often end up paying a substantial portion of their savings to Wall Street. Go here for a discussion of the impact of 401(k) fees on retirement. 

The proposal only benefits student borrowers at firms with 401(k) plans, workers at firms with plans offering matching contributions, and workers eligible for the 401(k) plan.  

Many student borrowers will not benefit from this provision in Secure Act 2.0 including:

  • Self-employed workers and people employed by firms not offering a 401(k) plan.  Only 53 percent of small and mid-size firms offer a 401(k) plan.
  • People at firms with 401(k) plans that do not match employer contributions. Around 49 percent of all firms do not offer an employer match.
  • Employees who are ineligible for the firms-sponsored 401(k) plan.  Around 24 percent of firms require one year of service for entry to the firm-sponsored 401(k) plan.
  • Employees eschewing 401(k) plans due to  vesting requirements.

It is reasonable to anticipate that increased 401(k) contributions by young adults with student debt will fail to increase retirement wealth because, as evidenced by this CNBC article, around 60 percent of young adults end up raiding their retirement savings earlier in the career.

An Alternative Proposal, Incentives for Increased Use of Roth IRAs:

A more equitable and efficient way to balance the goal of saving for retirement with rapid repayment of student debt is through incentives to increase contributions to Roth IRAs instead of 401(k) plans

This could be accomplished by modifying the SECURE Act in the following fashion.

  • Mandate automatic contributions to Roth IRAs instead of automatic contributions to 401(k) plans 
  • Mandate automatic use of low-cost highly diversified IRAs unless person opts for a different investment strategy
  • Allow employers to match contributions to Roth IRAs or contributions to 401(k) plans
  • Allow employers to give employer matches to holders of Roth IRAs even if the student borrower does not contribute to the Roth IRA.
  • Prohibit distributions from investment income inside Roth IRAs prior to age 59 ½. 

A strong case can be made that many workers should maximize the use of Roth IRAs instead of traditional IRAs even under current law.

  • There are substantial tax savings in retirement from the use of Roth IRAs from two sources. First, the distribution for the Roth IRA is not taxed during retirement.  Second, the Roth distribution does not count towards the income limit leading to the taxation of Social Security benefits.  Households that rely primarily on Roth distributions in retirement often do not pay any tax on their Social Security benefits.
  • Distributions from Roth contributions prior to age 59 ½ are not subject to income tax or penalty.  This feature benefits young adults who tend to raid their account prior to retirement and pay taxes and penalty.
  • The Roth account does not allow 401(k) loans, a feature that causes people to distribute funds and even close the entire account prior to retirement. 

This proposal encourages student borrowers who are ready to save for retirement to choose a Roth IRA instead of a 401(k) plan.  The change will increase retirement saving for several reasons

  • Some firms without a firm-sponsored retirement plan may provide an employer match to an IRA because there should be no administrative costs imposed on the firm for this type of contribution
  • The automatic selection of a low-cost IRA will usually result in lower fees and higher returns compared to the default 401(k) option. 
  • The restriction on distributions from investment income until after age 59 ½ prevents people from distributing all retirement assets and closing the retirement plan prior to retirement. 
  • The IRA could receive matching funds from multiple employers.

Both the Secure Act 2.0 reforms and the alternative one presented here favor Roth accounts over traditional accounts.  The use of Roth accounts favors low-income student borrowers because their marginal tax rate and deduction for contributions to traditional 401(k) plans is low.  

The use of Roth accounts by low-income low-marginal-tax-rate workers facilitates diversion of some assets for debt repayment because the holder of the Roth requires less wealth to fund a sufficient retirement.  

Concluding Remarks:  Wall Street and financial advisors consistently advise their clients to prioritize 401(k) contributions over rapid repayment of student debt.  This approach is not leading to a secure financial life for many student borrowers who are paying more on student debt over their lifetime, incurring high borrowing costs on other loans, having trouble qualifying for a mortgage and raiding their 401(k) plan prior to retirement.   The use of Roth IRAs and rules allowing employers to match contributions into a Roth rather than contributions into a 401(k) will help student borrower better balance student debt repayment and retirement saving.

The more rapid repayment of student debt might also be facilitated by a partial discharge of student debt after around 60 on-time payments as describe in this post.

A list of student debt post presented here will be updated with new articles when available.

Overview of student debt reform proposals

Most discussion on student debt involves debates over the desirability of free college and large-scale debt discharge programs. The proposals listed here involve a wider range of policy levers.


Student Debt Proposal #1: Eliminate First-Year Debt

The reduction of student debt taken on by first-year students through a combination of additional first-year financial assistance and restrictions on first-year loans would be an effective way to reduce total debt incurred by student borrowers.  This policy would also provide large benefits to students susceptible to payment problems because they did not finish their degree.  Go to this post for a more thorough discussion of a proposal to eliminate or substantially reduce debt incurred during the first year of college.

Student Debt Proposal #2:  Potential modifications to student loans

Existing programs designed to provide student borrowers debt relief are ineffective. Proposed reforms including — a relatively quick partial discharge of federal student loans, the elimination of interest charges on the maturity date of the loan, and the conversion of outstanding student debt at loan maturity to a tax liability collected by the IRS — would benefit both student borrowers and taxpayers.  Go here for a description of problems with existing student debt relief programs and my proposed reforms.

Student Debt Proposal #3: Facilitating on-time graduation

Students who fail to graduate on time take on high levels of student loans; hence, policies that improve on-time graduation rates would reduce student debt burdens.  There are multiple reasons why students fail to graduate on time and multiple ways to increase on-time graduation rates including — improvements in education prior to college, changes in college academic policies, and efforts to assist students dealing with hardships. Go herefor a description of polices designed to facilitate on-time graduation.

Student Debt Proposal #4: Reducing tradeoff between retirement savings & student debt repayment

Reforms centered on enhancing Roth IRAs and increasing incentives for the use of Roth IRAs would better balance saving for retirement and student debt repayment than the Secure Act 2.0 reforms that center on use of 401(k) plans. A first draft of a paper opposing the Wall Street view and suggesting new incentives can be found here. 

Coming Attractions: Forthcoming work on student debt includes — discussions of problems with public service loan programs and income based replacement loan programs, evaluation of potential regulation of private loans, the use of PLUS and parental PLUS loans, and treatment of student debt in bankruptcy.

Student Debt Proposal #1: Eliminate First-Year Debt

A combination of increased financial assistance for first-year students and restrictions on the use of student loans by first-year students would substantially reduce financial burdens associated with student debt.

Specific Proposed Policy Changes:

  • Design and provide funding and incentives for creation of financial assistance packages leading to a debt-free or tuition-free first year at both community colleges and four-year institutions.
  • Eliminate federal student loans until students have 9 credit hours of college credit from AP courses, community colleges or accredited on-line programs.
  • Provide federal, state, and private funds for programs that increase college-level work prior to college.
  • Increased incentives for quick transfers from community colleges to four-year institutions.

Comments:

  • Students who take out loans and do not complete college are around 3 times more likely to default on their loan than student borrowers who get a degree.   The reduction of first-year debt will reduce the debt burdens of people who leave school early and are most likely to experience payment problems.
  • The stipulation that people complete some college level courses prior to full-time college will reduce initial access to higher education by low-income and minority students.  However, these groups with higher student debt burdens would gain the most reduction of first-year debt.
  • The stipulation for some college level experience prior to full-time college would better prepare people for college and would reduce dropout rates.
  • The elimination or reduction in debt among people who leave college after a year or two could facilitate reentry to college after people get some job experience.
  • Low-income and minority students also stand to benefit the most from new programs that increase access to and use of higher education courses prior to full-time college.  For some students, access to a community college or high-quality on-line course would be preferable to access to an AP course with a high fail rate.
  • Universities would be encouraged to increase off-semester admissions to facilitate the admission of more students after a single semester at a community college.
  • The proposed increase in financial assistance at both four-year and two-year institutions will allow more qualified students to choose a four-year alternative.  By contrast, the Biden Administration free-community college proposal would encourage some qualified applicants to delay or forego four-year options.
  • Private schools and historically black colleges could also benefit from changes in financial assistance packages depending in part on the incentives tied to use of federal funds.
  • The changes in financial assistance programs could differ across institutions depending on the level of tuition and the level of state or private support.

Concluding Remarks:  Many people are unprepared for full time college and the burdens of student debt immediately after graduating college.   The proposals outlined here would help many young adults become better prepared for higher education before taking on any debt. 

Student Debt Proposal #4: Creation of incentives for more rapid student loan repayment

Financial incentives favoring contributions to 401(k) plan over rapid repayment of student loans make many households worse off financially. Programs and incentives encouraging the rapid repayment of student debt would lower future borrowing costs, facilitate the purchase of homes, and allow many households to increase saving for retirement.

Introduction:   Tax and financial incentives are more generous for contributions to 401(k) plans than for the repayment of student debt.

  • Workers are allowed to to save untaxed dollars in a firm-sponsored retirement plan or an individual retirement account.
  • Firms can match employee contributions to the 401(k) plan. Two common 401(k) matching formulas are 50 percent of the dollar amount contributed by the employee up to 6.0 percent of the employee’s salary and 100 percent of contributions up to 3 percent of the employee’s salary. 

The subsidies for 401(k) contributions are substantially higher than the subsidies for student debt repayments.

  • Student borrowers can deduct up to $2,500 of interest on student loans.  
  • The student loan tax deduction pertains exclusively to interest while the entire 401(k) or IRA contribution is exempt from taxes.
  • There is no matching contribution for student loan repayment.

The decision to prioritize 401(k) contributions over student debt repayment does not always work out well as discussed in a previous post.  Potential consequences include:

  • Higher total loan payments associated with selection of longer loan maturities.
  • Higher borrowing costs stemming from higher debt levels and lower credit ratings.
  • Early disbursements of 401(k) funds leading to penalty and tax payments.
  • Increased likelihood of having debt obligations in retirement.

Student borrowers who quickly repay their loans would increase saving for retirement, realize lower borrowing costs, start the process of paying off their mortgage and would basically be much better off.  

There is general agreement that student debt significantly impedes saving for retirement by young households.  There is, however, no real consensus on how to fix this problem.

A Congressional Proposal:

Wall Street favors and greatly benefits from incentives for 401(k) investing.   Current proposals to assist student borrowers favored by Wall Street and financial advisors maintain incentives for 401(k) contributions over rapid repayment of student loans.

The Secure Act 2.0 would expand incentives for 401(k) contributions.  One provision would allow student borrowers who are enrolled in a firm-sponsored retirement plan to receive a matching 401(k) contribution for funds used to pay off their student loan.  

It is not clear an act of Congress is needed to implement this proposal because of a previous IRS ruling.

The proposal should allow the employer to contribute an employer match to the employee’s 401(k) plan up to the smaller of the student loan payment and the maximum allowable match on the 401(k) plan.   The student borrower repaying her loan would receive the employer match even if the student borrower did not contribute to the 401(k) plan.

The proposal only benefits student borrowers at firms with 401(k) plans, workers at firms with plans offering matching contributions, and workers eligible for the 401(k) plan.

Many student borrowers will not benefit from this provision in Secure Act 2.0 including:

  • People at firms with 401(k) plans that do not match employer contributions. Around 49 percent of all firms do not offer an employer match.
  • Employees who are ineligible for the firms-sponsored 401(k) plan.  Around 24 percent of firms require one year of service for entry to the firm-sponsored 401(k) plan.

This proposal and other aspects of Secure Act 2.0 favor higher-cost 401(k) plans over low-cost IRAS.  People who rely on high-cost 401(k) plans end up paying a substantial portion of their savings to Wall Street. Go herefor a discussion of the impact of 401(k) fees on retirement.

Moreover, the use of traditional 401(k) plans instead of Roth IRAs substantially increases tax burdens in retirement. A strong case can be made that workers should maximize the use of Roth IRAs instead of contributing to traditional plans.  

A more equitable and efficient approach might provide additional retirement subsidies for people without access to 401(k) plans or might provide additional incentives for the more rapid reduction of student loans.

An Alternative Proposal: 

The current system, which incentivizes saving for retirement over rapid repayment of student loans, does not work for many households.  This is evidenced by a CNBC article that found that nearly 60 percent of young adults have taken funds out of their 401(k) plan.

The alternative proposal presented here incentivizes the more rapid repayment of student loans over saving for retirement.  Under the alternative approach, the government would discharge 25 percent of the original balance of the federal student loan after the student borrower made 36 full-time payments on a 10-year loan and 60 full-time payments on a 20-year loan.

The alternative approach levels the incentives for rapid repayment of student debt and saving for retirement. Students who delay making full payments on their student loan would also delay receipt of the partial discharge on the student loan.  

The more rapid repayment of student loans and the partial discharge of the student loan frees up monthly payments and allows student borrowers to increase savings for other objectives including saving for retirement and a home purchase.

The alternative proposal would benefit all student borrowers including borrowers working at firms that do not have a 401(k) plan, borrowers with at firms with 401(K) plans that do not have employer matches and workers ineligible for their firm-sponsored retirement plan.

The alternative proposal does not favor high-fee 401(k) plans over low-fee IRAs.

The alternative plan does not encourage workers to stay at a job where they might be unproductive and unhappy to claim matching funds.

The partial discharge on student debt reduces demand for Income Based Replacement IBR loans and Public Service Forgiveness Loans (PSFL), both costly programs for taxpayers.

Concluding Remarks:  Wall Street and financial advisors consistently advise their clients to prioritize 401(k) contributions over rapid repayment of student debt.  This approach is not leading to a secure financial life for many student borrowers who are paying more on student debt over their lifetime, incurring high borrowing costs on other loans, having trouble qualifying for a mortgage and raiding their 401(k) plan prior to retirement.   A quick partial discharge of student debt would allow highly leveraged students to increase saving for retirement.

Student Debt Proposal #3: Facilitating on-time graduation

Policies that improve on-time graduation rates outlined here will substantially reduce lifetime student debt burdens.

Background:  

Most of the focus of the discussion on student debt burdens is on proposals to make college debt free and proposals to forgive student debt.  The previous work on student debt published by this blog looked at the possibility of eliminating student debt for first-year students and potential modifications to student loan contracts that would offer limited debt relief. 

The discussion in this post examines whether student debt burdens could be improved through improvements in on-time graduation rates.

This CNBC article states that only around 41 percent of undergraduate students graduate within four years and 59 percent of undergraduate students graduate within six years.  On-time graduation rates are lower for people who start college at a community college and then transfer to a four-year institution.   

People who graduate on time tend to borrow less because of annual limits on student debt.

  • A dependent undergraduate student graduating in four years can take out a maximum of $27,000 in Stafford loans.  
  • The maximum Stafford student debt for dependent undergraduates is $31,000.
  • The overall Stafford debt limit for independent students is $57,500.  People who take longer to graduate are more likely to become independent students and qualify for the higher limit.
  • People who spend a longer amount of time in school may be more likely to take out a private student loan.

A couple of years ago I examined data from NCES on the relationship between amount of time it took for undergraduate to graduate and student debt outcomes for students graduating in 2012. 

  • 73.3 percent of students taking five or more years to graduate incurred debt compared to 62.6% for students who graduated in four or fewer years.
  • Average student debt for students with debt was $31,639 for students taking five or more years to graduate compared to $25,528 for students taking four or fewer years.

These figures understate the impact of duration in school on debt totals because everyone in the sample graduated and the debt totals do not include private loans or PLUS loans.

Improving on-time graduation rates:

Three policy levers designed to improve on-time graduation rates are considered.  The first set of policies involves programs attempting to better prepare students for college.  The second set of policies involves programs and rules impacting students in college.  The third set of policies involves attempts to mitigate the impact of unanticipated events and circumstances, including economic hardships and sexual assault.

Improving preparedness of students prior to college:

Some students are better prepared to succeed in college and graduate on time. The need for remedial courses often increases the amount of time spent in school and the total debt incurred.  

Costs associated with remedial education are not exclusively incurred by low-income or community college students.  One study reveals 45 percent of student taking remedial college work are from middle-income or upper income households and that nearly half are enrolled in four-year public or private colleges.

Several programs are proposed to better prepare students for college including:

  • Efforts to improve early education outcomes: Go here for a study on the importance of early education programs.
  • Efforts to increase access to AP courses and improve AP scores.  The programs discussed heretarget communities with low AP participation rates and attempt to improve both access and performance.
  • Increased access to community college courses while still in high school: The California Dual Enrollment program is an example of a program that allows high school student obtain college credit in high school.
  • Increased early access to camps and courses related to computer programming and coding:  It would be useful to survey people obtaining a CS or STEM degree to more fully evaluate the impact of early access to CS and success in the field.

Polices adopted by colleges:   

Colleges differ substantially in their on-time graduation rate.  Part of the difference is explained competitiveness of the college. Part of the difference is explained by college-specific policies, starting with transparency about on-time graduation rate and other performance metrics.

  • Greater transparency on on-time graduation rates for the university by area of study:  Some information on on-time graduation rates, debt totals, and starting income for universities can be obtained from the College Scorecard.  It would be useful to have more information for schools and for different departments in schools along with an overall rating.   
  • Better monitoring and Increased incentives for students to maintain on-track for on-time graduation:  Some students often enroll in fewer than the 15 credits per semester needed to graduate on time. Go here for a Cal-State article on why students should take 15 hours per semester. A policy requiring students who are behind schedule complete some on-line or summer course work before receipt of additional student loans might be useful.
  • Standardizing AP credit policies:  Some schools and some departments do not give credit for students who pass some AP exams.  Any student who gets a 4 or above on an AP test should get some credit if the institutions is processing federal student loans. The academic issues created by this change could be mitigated by having the department create a new course that overlaps but builds on the AP course. 
  • Reduce loss of credit by transfer students:  This article points out that student lose around 40 percent of their credits by transferring and argues for the acceptance of more transfer credits.  It would also be useful for students to transfer earlier in their career when fewer credits are at stake.
  • Increase access to courses for people needing certain credits for graduation or completion of a major:  Some students fail to graduate on time because they cannot enroll in a course needed for their major or for graduation.  Colleges need to rectify these types of problems and evidence should be reported to the College Scorecard or other Internet sites.
  • Increased Use of on-line courses:  The increases use of on-line courses can be an efficient approach when students are falling behind track for on-time graduation and when students need only a few courses to complete their degree.

Unanticipated Events that could lead to reduce on-time graduation rates:

Economic hardships and sexual assault undermine academic performance and delay the completion of academic programs.

  • On-time graduation would improve if more resources were available to assist students with housing and food.  This study found that economic hardships including lack of stable housing and lack of sufficient food impacts the ability of students to do well in food.
  • On-time graduation would improve if sexual assault was reduced and if resources were used to assist victims.  One study here discusses retaliation by perpetrators and institutional response.  This studyfound evidence that victims of sexual assault were more likely to experience a decrease in GPA and/or quit school. 

Concluding Remarks:  The ability to graduate on-time is a major determinant of the amount of debt a student takes on.  Policies and programs that better prepare people for college, that create incentives for colleges to helps students graduate on time and programs that assist students in difficult circumstances, would improve on-time graduation and reduce lifetime student debt burdens.

Student Debt Proposal #2: Potential modifications to student loans

Proposal considers partial discharge of loans after 4 years and complete elimination of interest charges at or near the maturity date of the loan. Future work will show these proposals are more effective an equitable than existing programs and proposals.


Introduction:

The current cohort of students is entering the workforce with substantially more debt than the previous cohorts of student and the growth of both the number of people with student debt and the average debt level have been consistently upwards. High student debt burdens are leading many student borrowers to forgo saving for retirement, delay starting a family, or put off purchasing a home.  

Some Democrats have urged President Biden to cancel up to $50,000 in student debt for all people with student loans.  Most economists believe that a widespread cancellation of student debt would be an inefficient and regressive subsidy.  Many student borrowers with debt could repay their loan without financial assistance and an indiscriminate loan relief program would allocate resources away from other pressing concerns. Most economic analysis supports the view that indiscriminate student debt cancellation programs would do very little to stimulate the economy.

Several papers including one by the New America Foundation one discussed in Inside Higher Education and my own work published by NASFAA have focused on reforming Income Driven Repayment Plans.  Current Income Driven Repayment (IDR) programs offering debt relief and linking debt payments to income have many problems.

  • The programs may incentivize some students to increase the amount they borrow.
  • Some students that commit themselves to an income linked loan may have been better off with a traditional loan.
  • Some student borrowers enrolled in IDR programs struggle to meet other financial priorities despite the benefits of the programs.
  • A large portion of applications for loan discharge have been rejected by the Department of Education as discussed in this CNBC article.

The memo presented here discusses ways to provide meaningful debt relief through modification of standard loan agreements instead of expansion of IDR loans or the creation of indiscriminate loan discharges.

A Proposal:

  • Discharge 40 percent of the initial loan balance after receipt of 60 monthly payments on 10-year loans and 72 monthly payments on 20-year loans.
  • Encourage partial interest payments for people in economic hardship rather than total payment forbearance.
  • Eliminate Interest charges on all loans on the scheduled loan maturity date.
  • Allow and facilitate collection of outstanding student loans after maturity of the loan by the IRs through federal tax returns.

Benefits of the Proposal:

The proposal presented here eliminates many of the uncertainties and problems associated with current programs offering student borrowers debt relief.    It offers students some assistance early in their careers allowing households to save for other priorities.   It does not create an incentive for students to increase the amount they borrow and contains incentives to facilitate quicker repayment of student debt.  The partial discharge of debt and the elimination of interest charges should reduce the number of people entering retirement with outstanding student debt.

  • The current system does not provide any loan forgiveness for 10 or 20 years.  The earlier debt relief in this proposal allows borrowers to pursue other financial objectives and may facilitate refinancing to lower-interest rate loans.
  • Many borrowers are unaware of any problems with their loan for 10 or 20 years when they apply for loan forgiveness.  The revised program will uncover problems with loan forgiveness applications after 60 months of payments for 10-year loans and 72 months of payments for 20-year loans.
  • The current system incentivizes many borrowers to pick the IDR program as soon as they leave school even though this choice can lead to higher lifetime loan payments if circumstances change.   The revised program assists borrowers with standard loans reducing reliance on IDR loans.
  • IDR plans create an incentive for some people to borrow more than they otherwise would because they anticipate low life-time loan payments and complete loan forgiveness. The alternative loan forgiveness terms presented here will always result in higher repayments for people who borrow more.
  • The loan discharge offered in this program occurs earlier for people making all payments on time, creating an incentive for student borrowers to prioritize student loan payments early in their career.
  • The existence of financial assistance for student borrowers with 10-year loans will reduce an incentive for borrowers to take out long-term loans and will speed repayment to the Treasury.
  • One study found the number of American over 60 with outstanding student debt quadrupled between 2005 and 2015. The elimination of interest charges at loan maturity proposed here should reverse this trend.
  • The elimination of all interest at the loan maturity creates an incentive for borrowers to allocate payments to other debts charging interest.  This problem is mitigated by requiring a minimum payment on student debt outstanding after the loan matures collected by the IRS through the federal tax return.

Concluding Thoughts:

Student debt is creating financial hardships for many borrowers and existing IDR programs often fail to provide meaningful debt relief.  Problems associated with student debt will worsen because of the growth of debt.  Most student borrowers can repay and manage their student debt with limited financial assistance.  An indiscriminate large discharge of student debt would impose costs on taxpayers and divert funds from other pressing priorities.

The program outlined here provides limited quick and efficient debt relief to student borrowers without the distortions caused by existing programs or proposed large-scale debt discharge proposals.

Lessons from the fall of ARKK

ARK funds are in free fall. Is there a better way to invest in high-risk startups?

Introduction:  ARKK, the ARK innovation ETF had fallen 58 percent from its all-time high by late January 2022.    The fund is experiencing massive outflows.  

What could Cathie Woods have done differently? 

Is there a way to create a fund that targets the most innovative companies but takes on less risk and does not experience this type of massive decline in value when things turn south?

Analysis:  Two Problems with the ARKK Investment Approach:

There are two problems with the ARKK investment model that led to this debacle.

The first problem involves an incorrect perception of the extent of diversification of the ARKK fund.

The ARKK fund, despite having 153 holdings, is not highly diversified.  The ARKK holdings have similar characteristics.  The firms are young, innovative, and risky. 

When risk appetites fall, as they are currently these firms fall in tandem.   

A portfolio manager could have a reasonably diversified portfolio based on either 153 randomly selected firms or 153 firms selected from different sectors of the economy. Much less diversification is obtained from a 153 similarly situated firms.

(It is sort of analogous to a person applying to all IVY league schools thinking one acceptance is in the bag because of the law of large numbers. The number of applications is not determinative when all institutions have similar decision rules.)

The tech fund could increase diversification of its holdings by holding 20 percent to 40 percent of its assets in a market portfolio perhaps through a Vanguard S&P 500 fund like VOO.   Alternatively, the tech fund could consider putting 20 percent to 40 percent of its assets in more stable value stocks, live VOOV, a fund that is uncorrelated with the startup sector.

A fund investing in high-tech startups needs to hold substantial funds in the general market or better yet invest substantial funds in the market that is not high tech.  A fund that invests 50 percent in innovative firms and 50 percent in startups would be able to reallocate assets when tech prices are elevated and make additional purchases during market downturns.

This approach is similar to the approach used by FBALX, a fund that balances stocks and bonds to provide more stable income in one fund.  The FBALX fund did well during the 2008 market downturn.

An ETF with both a tech portfolio and a market or value portfolio creates a better risk-return tradeoff than a pure tech startup portfolio.   The professional portfolio manager would reallocate assets from the tech component to the value component when tech was high and purchase tech assets when prices crash.

The person managing a combined tech/value ETF would probably be picking tech stocks at bargain prices right now rather than dealing with panic-driven withdrawals.

The second problem Impacting the risk of ARKK involves the existence of some very large positions inside several companies and a general lack of transparency exhibited by most ETFs (not just ARKK) on overall risk.

It is not accidental that Michael Burry, famous for the Big Short, was the first investor to highlight potential problems with ARRK.   Michael Burry is famous for looking at the quality of investments inside an ETF. 

I quickly looked at some of ARKK holdings.  My analysis for this post was limited to 10 holding found on the third tab of a listing by ZACKS.  The 10 holdings I looked at were – Fate Theraputics, 10 X Genomics, Docusign, Robinhood, Pacific Bioscience, Pager Duty, Iridium Communications, Tusimple Holdings, Gingko Bioworks, and Twist Bioscience.

My quick analysis found many ARKK ventures were highly speculative and were in the red.

Furthermore, ARKK had extremely large positions in some firms.

  • None of the 10 funds had positive earnings; hence, the PE ratio is undefined for all 10 firms.
  • The ARK management group was the largest shareholder for 4 of the 10 firms, was the second largest shareholder in one firm, was the third largest shareholder in two firms, was the fifth largest shareholder in one firm and the seventh largest shareholder in another.

ARK is a relatively small fund manager compared to firms like Vanguard, Fidelity, Blackstone, and T Rowe Price. ARKK is a relatively small fund compared to other tach and small-firm growth funds offered by larger firms.

Withdrawals from ARKK leading to the sale of company stock could exacerbate downward pressure on stocks when ARKK had an oversized position.

The recent withdrawals from ARKK and other ARK funds could have and likely did result in additional selling and downward pressure on stocks where ARK had a large position.

In a rational market the fundamentals of the stock prices determine the value of the ETF.  My concern is that selling by a risky ETF could spill over and impact the price of certain stocks.

Concluding Remarks:   The ARK funds allow investors to get exposure to innovative firms without taking on single-stock risk.  However, the amount of diversification offered by ARKK is not as large as some investors believe. The high stakes held by ARK funds likely exacerbated selling and downward price of some tech firms and the innovative company sector. 

One additional lesson from this post is that just as one should not judge a book by its cover one should not judge a fund by its profile.