| Friday, April 27
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Who's 'gaming' with student loans? |
Like many other readers of The Philadelphia Inquirer and The Triangle, I have been puzzled and distressed by reports of the relationship between Drexel and a company making student loans, especially the recent revelation that the Attorney General of New York intends to sue Drexel on behalf of Drexel students from New York State. The assumption behind any such lawsuit is that the relationship must be against the interest of Drexel students in general, including those residing in New York State. But is this so? The reported fact that Drexel has devoted the payments from the loan company to scholarships would at least mitigate any such negative impact on students as a group. But, of course, that is not the whole story.
I asked myself, as an economist and game theorist, is there any possibility that the designation of a preferred lender for Drexel students could actually be in the interest of the students? I think it could be, if there are economies of scale on the transactions between Drexel students and the loan company. "Economies of scale" means that when the economic activity gets bigger, the costs associated with it increase less than in proportion. Volume discounts and "affinity group" credit cards are other arrangements that are consistent with economies of scale.
Economies of scale are tricky as a concept, but a numerical example should help. Suppose that the (fictitious) Thoughtmoney Loan Company lends to 1,000 (fictitious) Pixel University students with an overhead cost of $250,000. This overhead cost represents the cost of maintaining an office to deal with Pixel students, communication, organization, and administrative coordination with Pixel University and its students - administrative costs, in short. The overhead cost is $250 per student, which must be covered by fees or higher interest rates if Thoughtmoney is not to lose money. Now, in a change of Pixel policy, Thoughtmoney becomes the sole recommended lender to Pixel students, paying Pixel $100,000 for the privilege. Due to the designation, Thoughtmoney now loans to 5,000 Pixel students instead of 1,000. This increases their administrative costs, but only by $100,000. (This increase is less than in proportion to the increase in loans and so is an example of increasing returns to scale). Thoughtmoney now has an overhead cost of $450,000 for its dealings with Pixel -- $250,000 as before plus $100,000 of new administrative costs plus the $100,000 payment to Pixel. But this sum, $450,000, is only $90 per student, $160 less than before! From this $160 decrease, Thoughtmoney can reduce student fees by $100 and increase their own profits by $60 per student - or allocate the reduction in infinitely many other ways, depending on their agreement with Pixel University.Labels: student loans |
posted by ^%&^
@ 11:00 PM
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