Karun Philip discusses a proposition that taking structured finance to the private skills-training industry can shorten the road back to global prosperity.
In this article I discuss the problems with the economic theory that claims that interest rate cuts will create money supply expansion that will re-start the economy, and then present a way that may help work around these problems.
Whom do we lend to?
On October 2, 2001 the US Federal Reserve cut interest rates once again to a 40-year low of 2.5%. In addition, private money is sitting on cash deposits in large quantities. There is now a large quantity of money in the banking system that economists claim will now be lent cheaply to successful companies, and this will stimulate new jobs and new demand. Great theory, but now look at the state of the successful large companies – they seem to be in no great hurry to borrow because they cannot see anything but decline in demand, and are lowering costs through layoffs, which will reinforce the reduction in consumer demand. There is plenty of capacity in the banking system to lend, but a lack of knowledge of where to lend it profitably and safely. And without growth in lending, there will be no economic growth.
The general consensus is that there will be a period of belt tightening that cannot be avoided. The debate is only whether it will be a short 6-month period, or a decade-long (and counting) experience like Japan’s.
In every major downturn in the US, people have tended to go back to school during a period where they have been laid off and are finding it difficult to find a new job. If we take a look at this simple wisdom of ordinary people, we can begin to see how an efficient supply of capital to people to retrain themselves with economically valuable skills can be both profitable and sustainable. But instead of looking to college education which is general purpose in nature, we need to look at schools which train people in practical skills – these are the schools that would tend to provide a more predictable return on an investment in training than conventional college degrees. These schools typically provide a large return on capital to their students, but are unable to charge the full value of their training because of the limited purchasing power of their clientele prior to the training.
But lending money for training can be a safe and profitable business only if we employ the techniques of structured finance. There can be no guarantee that every student given a loan will be able to get a job of sufficient pay to service the loan. But we can collect and analyze data. By forming partnerships with training schools, lenders can build databases on the effectiveness of various types of training, in various parts of the country, and for people of various prior skills. These data sets will lead to the determination of how much default is to be expected, and thereby determine the price of the pool of training loans. The training school will be incented to provide such information since once the data is established and funding becomes available, they may be able to even increase the amount they charge for training, as long as they demonstrate a clear return on investment.
The innovations from there can be endless. For example:
- Make the training schools hold the equity tranche of the deal so that they are incented to discover ever better ways of making their training more effective.
- Develop ways of credit scoring a training school and its prospective students to ensure that each type of person focuses on the type of career prospects that will maximize their particular aptitude.
- If the training is proven to be sufficiently productive, consolidate older consumer debt such as credit card debt of the borrower into a training loan by lending the cost of training plus the cost of paying off the older debt.
- Discover appropriate training schools for delinquent credit card debtors who can then pay back old debt as well as have the prospect of new earning power after the training investment.
- Provide an online reference check to employers to validate the courses and performance of students who apply for a job. Defaulters and delinquencies can also be flagged on this reference check.
- Provide an online rating of various professions, their average pay, the schools that train for that profession, and the banks that provide financing. This will enable people to find out what skills are most needed in the economy and how to acquire those skills.
Of course the standard tools of structured finance will also be applicable – pools of training loans can be split into waterfalls, interest-only pieces, etc. to tailor the supply of loans to the demand for risk and return in the capital markets.
The data collection needed for building such a ‘Knowledge Backed Securities’ (KBS) infrastructure into place presents quite a massive task. But once it is underway, the macro-economic effects of such data being collected and used as a basis for new credit issuance ought to be quite dramatic. Over time, there will be almost endless prospects for investment in areas that are proven to be effective. The greater the pace of technological change, the more will be the need for workers in an economy to upgrade their skill sets multiple times in a career.
The unemployment claims would become virtually zero because everyone would either be in a job, or at a training school (or not seeking work). The training industry could be the source and sink for labor, constantly measuring what types of labor and skills the economy needs, and then supplying that labor before shortages cause bottlenecks on the economy.
Training would become very competitive and only schools that provide the best and most effective training would survive the test of detailed data analysis from Wall Street. However, with the liquidity available for higher investments in training, schools would be able to afford the best salaries in the economy to attract the best talent as teachers. With a way to for those who have useful practical knowledge to monetize that knowledge, the ‘habits of highly effective people’ will emerge and spread spontaneously as the market seeks out ever more productivity in training.
The massive positive fallout of such a system should be sufficient for the Federal Reserve to encourage KBS to the extent of providing liquidity to AAA-rated KBS, much as it buys rated mortgage products. It could also provide limited reinsurance or lines of credit to pools of loans for the lower end of jobs, where defaults may otherwise be too high.
In general, by investing in market-based training loans, money supply injections from frightened investors or the Federal Reserve can be employed in a way that will rescue consumer credit, and set the stage for demand recovery in a newer, reconfigured economy after bad older investments are written off. The injection of market-monitored training loans into the economy will also stimulate capital investment from businesses that can safely assume that consumer demand will not retreat indefinitely into a shell. While this ‘new economy’ will continue to be one where no job is safe from redundancy, it can also be one where if one job disappears, many other potential jobs are sure to be around the corner. And if capitalism does its trick of increasing productivity continually, you can bet that the new jobs will afford a higher standard of living than the old ones.