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Human Capital Contracts Could Revolutionize the Way We Borrow Money

According to their adherents, these contracts represent an end run around the entrenched and often predatory lending structures that had flimflammed so many young people into bankruptcy.

Illustrations by Amanda S. Lanzone

A long time ago in an economic, educational, and employment climate far, far away, I declared a college major. This was the early 1990s, and although nerds such as myself had already begun heeding the dark call of easy money in Silicon Valley, I chose creative writing. My father, a computer-security expert and corporate lifer, accepted this decision with grace. Confronted with a Jewish son determined to renounce his genetic birthright in private medical practice, he beat his breast but didn't rend his garments, and he offered a bit of advice: "Would it kill you to take a computer class or two?" For reasons obscure to me now—getting stoned, getting laid—I studied the sestina and villanelle and ignored Java. My bank balance has regretted it ever since.


This past winter I found myself in need of a job, at a moment when some facility with technology (data journalism: boom!) might have helped. After being turned away by one high-profile employer, I mulled the idea of enrolling in a data-science class at a local tech incubator, in hopes of number-crunching myself into the second coming of Nate Silver. The only problem was the cost: $4,000 for an 11-week course. I was reluctant to join my millennial brethren in the student-loan market, which had reached a crisis point. US student debt amounts to more than $1 trillion, according to the Federal Reserve, a usurious fiasco seemingly designed to chain my fellow overeducated and underemployed Americans to our desks and credit scores. Crowdfunding my education didn't seem quite right, either. Maybe I've grown delicate in my dotage, but a Kickstarter campaign to bankroll a 41-year-old's attempt to learn to use his computer struck me as gauche.

I was almost ready to give up when I stumbled across a tech-world approach to personal finance. Pave and Upstart, two much-ballyhooed online start-ups, had figured out a way to "hack" the traditional loan formula, be it fixed, variable, jumbo, or liar. The "human capital contracts," as they're called, offered by these new companies didn't require the return of the principal plus interest. Instead, borrowers, euphemistically referred to as "talent" and "upstarts," pledged a portion of their future income—typically between 3 and 10 percent, for as many as ten years—to the backers who came onto the Pave or Upstart platforms to finance them. Basically, it was a Rumpelstiltskin arrangement: You promise a portion of your earnings (almost) forever, and an investor gives you the gold to get started.


Human capital contracts, according to their adherents, represent an end run around the entrenched and often predatory lending structures that had flimflammed so many young people into bankruptcy, one that could only be conceived of by tech companies unimpeded by the baggage and burdens of the past. "The old way of borrowing was predicated on a world in which the job market was stable and everyone had a steady income," James Surowiecki wrote in the New Yorker. "That world of work is changing."

Critics of human capital contracts, meanwhile, focus on the ethical dilemma of bartering one's innate talents for cash. These aren't loans, goes the logic, but a form of tech-enabled "indentured servitude," a "suspect" or "dystopian" sleight of hand posing as financial innovation, yet another way for capitalism to dehumanize us all. "We will look at the upsides, the inspirational success stories," predicted communist journalist Malcolm Harris on Al Jazeera America, "and we will rationalize [it] the same ways people have always rationalized buying and selling each other."

Human capital contracts began as a footnote buried in economist Milton Friedman's co-written 1945 book Income from Independent Professional Practice. Friedman, the patron saint of the free market, imagined a world in which individuals could transform themselves into living and breathing equities to be bought and sold like any other financial instrument. "If individuals sold 'stock' in themselves," he wrote, "investors could 'diversify' their holdings and balance capital appreciation against capital losses."


The first full-scale effort to implement human capital contracts, however, didn't take place until 2001, when, an unfortunately named, and now defunct, company began offering them out of an early tech-world belief that any problem could be solved simply by bringing it online. "We thought we were incredibly original for six weeks," co-founder Raza Khan told me. "Then we found Friedman's paper and realized everything old is new again."

MyRichUncle's attempt at this form of finance lasted only a couple of years. They were, according to Khan, too far ahead of their time. "No one had built a loan platform for this product," Khan told me. "We were making logical arguments about how it would perform, but that isn't as compelling as actual data."

Pave and Upstart launched their sites in the US within a few months of each other in 2012, viewing themselves as a finance-world response to the crowdfunding and sharing economies. Americans were by then more familiar with online lending, and the scale of the student-loan problem was such that people were receptive to new solutions, even those that ran counter to centuries-old notions of debt. "We thought [human capital contracts] were a better option for a lot of people," said Pave co-founder Oren Bass, a British banker and lawyer who started out at Goldman Sachs in London. "And it was an opportunity to have a profound socioeconomic effect by giving people access to funding that they've never had before."


Investors and borrowers populated the sites of both companies, which resembled a hybrid of Facebook and your friendly neighborhood loan-origination shop. Prospective borrowers were matched with investors who could peruse their profiles, which featured well-lit photos and share-worthy videos and an outline of what they'd like to do with the money. The projects skewed heavily toward technology-dependent education notions like mine, but not exclusively. Pave, in particular, gravitated toward arts and culture. One Pave borrower I spoke to, an Ivy League–educated filmmaker named Clara Aranovich, raised $50,000 (in exchange for 5 percent of her income) to start a production company. Joshua Brueckner pulled in $7,000 for a novelty-necktie company called Skinnyfatties. ("People send me their ties, and I tailor them.")

In some ways, the specific use for the money, and the demand for a market-moving return, didn't really matter: Pave and Upstart had an app for all that. Each site boasted proprietary models for estimating the expected income of various careers, from doctor to lawyer to cinematic auteur (the tie guy may be sui generis). The percentage payment and the expected returns were based on the models, which were underpinned by data from the Census and other demographic sources.

The government also took an interest in human capital contracts. Democrats in Congress introduced "pay-it-forward" legislation, a modified version of human capital contracts that would replace college tuition with a share of each student's future income, and that money would then be used to finance the next generation of students. Republicans favored the private route with the "Investing in Student Success Act." Largely modeled on a paper by the right-wing American Enterprise Institute, it aimed to create regulatory exemptions from the tax code for human capital contracts.


Whatever dangers these loans entailed—people "buying and selling each other"—Pave and Upstart did have one inarguably revolutionary quality: They inverted the standard power dynamic of loan finance. Traditional loans are awarded based on the financial track record of the borrower and the returns on similar investments. Credit history becomes less relevant, however, when a loan depends on what you will do. Human capital contracts gamble on the latent potential of the individual—the future of a borrower rather than his or her past—and the majority of the risk is therefore borne by the lender and not the borrower.

One thing human capital contracts don't change is the potential for lenders to turn a big profit on a little investment. Say, for example, my data-science course blossomed into a six-figure job as an online chart-bloviating soothsayer. If I reached the dizzying heights of the Ezra Klein–osphere, I might end up paying the lender significantly more than the initial $4,000 investment (although both companies cap repayment at about five times the loan). This scenario, in which the return outstrips the input without additional labor, is what the 19th-century writer and political economist Henry George liked to call economic "rent." Human capital contracts won't force this country's usurers to get a job or anything. Nothing could be that radical.

Likewise, what if nothing came of it and I remained a miserable and forlorn writer? With a human capital contract, if I didn't earn anything, then I would pay nothing back. The lender would lose money, but there would be no ritualized Chapter 13 seppuku, no nuclear detonation of my credit rating. For me, the only risk in failure would be just that: failure. My only debt would be to my father, whom I owe an apology either way.


Then, on May 7, as I was preparing to start using the Pave site, I came across a post on the Upstart company blog that announced it would be "sunsetting" human capital contracts. Within days, Pave followed suit, abandoning the loans in favor of conventional student financing. Cumulus Funding, a small outfit based in Chicago, continues to broker these deals, but only in four states, and largely for older borrowers who need to pay down debt on their credit cards or medical bills. Effectively, and abruptly, human capital contracts were once again no more.

So what happened? Early this summer, I met Pave's Oren Bass, a slender man in his 30s, dressed casually in tan shorts and a white button-down, at a natural-foods restaurant not far from the company's offices in lower Manhattan. Over a cranberry juice, he told me that Pave would attempt to continue a small human capital program, directed at low-income students, using a pay-it-forward model. But, he said, chagrin cutting through both his banker's reserve and the upbeat energy of the tech entrepreneur, "you can't sustain a business that has had as little growth rate as we've had."

The biggest problem, Bass explained, was the lack of federal regulation over human capital contracts. Congress may be interested in these loans, but as is so often the case, it hadn't taken any action. Students still pay tuition as they always have, and the Republican and Democratic bills have descended into committee, a legislative morass from which they may never emerge.

"Everyone knows how a loan is treated, how it's taxed, how it's enforced," Bass said. "Everyone knows what happens when you invest in a start-up, or a company. If you invest in the future earnings of an individual, you don't have the clarity around that." Pave spent $1.7 million in search of that clarity, consulting with the IRS and the accounting firm Ernst & Young to make sure they worked within the law. But it didn't matter. "People want to know that what you're doing is blessed by the consumer regulators," Bass said.

Another issue had to do with who was allowed to make the investments. By law, only so-called accredited investors could buy into people like me on Pave or Upstart. Accredited investors include large banks or investment firms, pension funds and charities, and individuals with a net worth of $1 million or $200,000 in annual income. That's a rather high bar, and one that limited the "viral coefficient," as Bass put it, needed to build online word of mouth. "Look at Kickstarter. It has a huge viral transition because people can tell their friends, 'Invest in my project. Spend $70 or $80.' But how many people raising money actually know accredited investors? How many know institutions? It's very limited."

Speaking to Bass, I detected none of the "fail fast, fail often" bravado of the tech visionary primed for the next seed round. "It's always hard when you're emotionally involved," he said. "If I could have done this again, I may have done a very simple project first. Get traction, get credibility, and then bring in an innovative product."

That might have helped. Or maybe not. I tend to be a fatalist when it comes to good things happening with money. Ultimately, dollars flow in directions that can't always be controlled, even by computer programmers armed with Milton Friedman's theories and ample venture capital. Pave and Upstart could have provided an intelligent, timely, and humane service, one that placed confidence in the abilities of individuals, which seems to me a safe harbor. But the belief that technology and a smart idea are all that's needed to solve a problem is a simplistic one, and for now, the trillion-dollar tide of student loans will continue to swell. As for me, I'm still interested in data science, and I should have taken those classes like my father said. Perhaps I will one day. Once I figure out where to get the money.