The stupidity of privatising HECS debt

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By Leith van Onselen

Following on from my article yesterday questioning the merits of the Government’s proposal to sell-off Australia’s $23 billion of outstanding HECS debt to the private sector, Matt Cowgill has published a neat post fleshing-out some of the concerns in greater detail:

…The proposal is kind of bananas.

Think about it from the perspective of a potential investor who might consider buying a security that entitled them to a stream of future HECS repayments from former students. As they’re currently structured, HECS debts have a 0% real interest rate (they’re just indexed by the CPI), there is no fixed timetable for repayments, and unpaid debts can’t be recouped from a debtor’s estate when he or she passes away.

It wouldn’t make sense to buy such an asset at its full value, when there are other safe assets with guaranteed repayment that pay real interest. To induce people to buy his HECS securities, then, Mr Hockey would have to either:

  1. Sell them at way below their face value; or
  2. Change the terms of the debt by charging real interest and/or allowing the debt to be recovered from the estates of deceased debtors.

In option 1, Mr Hockey would be exchanging an asset from the Government’s balance sheet (outstanding HECS debts are an asset from the Government’s perspective) for a sum of money upfront that would be worth way less than that asset. This is the opposite of responsible financial management… This is the fiscal equivalent of hocking your possessions at Cash Converters…

In option 2, the Government could make HECS more attractive to potential investors by changing the terms of HECS debts. It could lower the repayment thresholds, collect HECS from Australians working overseas, and/or recoup HECS liabilities from the estates of deceased debtors. These options would all reduce the proportion of HECS debt that is never repaid. It could also start charging real interest on HECS debts. Each of these measures would increase the flow of income from HECS debtors to the owner of the asset.

There are a few problems with this. First, any change like this that would make the ownership of HECS debt more attractive to private investors would also make it more attractive to retain on the government’s books…

The second big problem with changing the terms of the HECS debt is that it could discourage people from going to uni, particularly prospective students from relatively poor backgrounds. At the moment, HECS is a pretty good deal. Your debt doesn’t rise in real terms, you don’t start paying it back until you earn somewhere around the median full-time wage, and the repayment levels are not too onerous. If you change that deal, you risk putting people off from going to uni…

It is difficult to imagine conditions under which this policy makes sense.

Matt Cowgill provides other reasons why privatising HECS would likely be poor policy, which you can read in-full here.

Interestingly, Stephen Koukoulas posted a tweet yesterday suggesting investors would pay between $6 billion to $8 billion for the HECS pool, which is roughly one-quarter to one-third the face value of the outstanding debt:

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Let’s hope the Abbott Government doesn’t proceed with this fiscal vandalism.

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Leith van Onselen

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

Latest posts by Leith van Onselen (see all)


  1. It might result in some “innovative” ways to recover debt from graduates who have left the country long-term.

    • Of course there is nothing to stop the government from doing that now, and trousering the money for us, the taxpayer.

      So while an interesting suggestion, it does not affect the argument that much.

  2. A disgraceful proposal. The intergenerational warfare continues.

    In Canada and the US the private student loan market is so out of control that experts are now proposing HECS-style models as a way out of the mess.

    And Hockster is going the other way. I’ll say it again, what a discrace that this is his “week three” fiscal policy priorty. Unbelievable.

    What Hockster forgets is that, in other jurisdictions, it isn’t long before the government has to step in and begin guaranteeing student loans and covering a portion of exhorbitant interest payments anyway.

    • disco stuMEMBER

      Actually as a long term guerilla campaigner against the boomers intergenerational war, I am not too adverse to this proposal.

      Basically the HECS bonds would be the equivalent of CPI issued bonds, the credit discount that the Kouk and Cowgill are concerned about could be overcome with a Fed Govt guarrantee (I would be less against a Fed Govt guarrantee applied to this debt, than the free ride were currently giving our banks).

      It would also provide additional high quality liquid assets for our financial institutions, which could theoretically weaken the arguement about the necessity of the RBA to provide them a liquidity facility, as well as provide additional income securities for a fledging retail bond market, should it ever get off the ground. Assuming there didn’t tinker with other aspects of education funding, then it I wouldn’t be too much against it.

      The worst aspect that I can see about this proposal is that it could act as an intellectual neo-conservative beachhead against the current structure of education funding, and eventually result in higher market rates being applied to new debt and/or, the Govt being encouraged to increase reliance on HECS for education funding… ie all the worst aspects of the US system.

      If the proposal to sell to securitise the HECS debt simply resulted in the funds flowing back into general funding, this too would be bad, however if it was ploughed back into improving education infrastructure, imho it would be a good outcome.

      • Actually, would this not be a guerilla campaign against the XY generation and those coming after, and therefore be exactly what you are accusing the boomers of?

        Do you think the boomers are going to take to the streets against something that isn’t going to affect them? Not many boomers have HECS debts, and if you think that increasing interest rates on HECS and much more stringent measures to ensure those debts are paid are going to do anything other than make life harder for XY, I have a bridge to sell you DS.

        Still, mindless hate and all that.

      • Ah emess, I have missed the confused logic emanating from your withered frontal lobes, but it is pleasing to see that a mild post by myself can still draw you away from your latest Boomer Overlord meeting.

        I suggest you go adjust your adult diapers and perhaps make yourself a cup of tea (provided it doesn’t led you to becoming over stimulated) then re-read my post again.

        You will find that the caveat to the suggestion regarding the securitisation of HECS debt, rests with them not doing anything further to it, in terms of applying a market rate of interest or increasing users liability towards it. Indeed my main concern, which I expressed at the time, was that it would be used by arch neo-cons as a beach head to further alter our education funding model.

        It may surprise you, that as a member of GenX I have actually managed to slip out of that particular debt yoke which your lot placed around my necks. It may even surprise you further that I wouldn’t really have a problem with them abolishing HECS all together and going back to a fully funded model, even if it resulted in me [shock] paying more taxes.

        But as you yourself said, there are still plenty of Boomers around who couldn’t give two hoots about anyone other than themselves, so for the moment I imagine HECS isn’t going anywhere.

      • LOL.

        Well, of course the Boomers could have kept the old model which was many many fewer places but which were free, instead of that shocking yoke you refer to which enabled a rapid expansion of uni places.

        Of course, had the boomers done that, either you would have been one of those missing out on places and therefore whining about your parents for that, or you would have been one of the relatively few lucky ones who got a uni place, and then you would have been all right, eh Jack?

        Still, I am not sure why I am bothering, because unlike the Boomers generation who were prepared to get out and demonstrate against Apartheid, the Vietnam War, Women’s Rights, Gay Rights etc etc at the drop of a hat, it is not as if XYers are actually going to do anything. Some of the Boomer parents I know are mildly taken aback that their kids don’t seem to have any interest in getting out and changing anything. Perhaps their kids might inherit that trait from their grandparents. We can but hope.

        Yes, I read your caveat. It is such a loophole that it renders your post meaningless. I can paraphrase your post thus: “Privatising HECS is a good idea, unless it is bad.”

        Keep it up DS.

    • So let me see if I can paraphrase your original post DS:

      Privatising HECS might be a good idea, if it is not a bad idea.

      That’s it?

      Pure genius, I tips me lid to the awesomeness of your logic.

      • disco stuMEMBER

        Obviously (but unsurprisingly) you are befuddled if that is the best critique you can come up with.

        Securitising HECS debt is something that is not without merit, but there are caveats that I applied to that original statement… gosh, I sound like I am repeating myself, but then I suppose I am trying to explain something to a boomer.

        Now, why don’t you suck up your injured pride and go and do a crossword puzzle and maybe take a nap? Surely you don’t want to be late for your boomer overlord meeting at 6pm tonight and risk falling asleep during it.

      • Disco,

        As discussed not only on this thread, but others here and on Matt Cowgill’s site. Securitisation of HECS debt is entirely without merit.

        None, nil, zip, nada, nix.

        Unless you are an investment banker wanting to suck on the public teat.

      • disco stuMEMBER

        Ahhh…. I see what the problem is – you’ve been told something so you believe it.

        Well once you reach ‘a certain age’ those lobes at the frontal cortex start withering and it does become harder to reason things out for yourself, so you’ve simply latched on to something you’ve read.

        Still it could be worse, at least you are reading/listening to intelligent commentators who I generally (but not always) agree with…. you could be someone who tunes into Alan Jones to form your view points.

        BTW – despite the views expressed by your favourite commentators, and even the views put forward MB my favorite blog site, I will repeat myself, securitising HECS debt is not entirely without merit, with some notable caveats applied.

        Without those caveats and assurances, I am just as opposed to the proposal as you are.

  3. Ronin8317MEMBER

    HECS debt is structured so that the normal risk/reward ratio is inverted. Payment does not start until the student earns over 51K, at 4%, gradually increasing to 8% at 100K+, so a higher chance of repayment result in a higher payment, while ‘risky’ loans pays nothing!! Furthermore, repayment is dependent on income rather than the loaned amount. A 100k debt from a student earning 51k pays ~2%, while a 50k loan from a student earning 100K pays 16% per year!! It doesn’t make any sense commercially.

    Barring changes to HECS like making it non-recourse, the debt needs insurance or a government guarantee to be sold. . If only the revenue stream is sold without regard to underlying debt, then it is just government bond which pays variable but higher than normal interest!! When Abbott say ‘open for business’, is this what it means? Looting the Australian government and giving it away to investment bankers?

    That being said, there are problems with the way HECS works right now. Student who leaves the country should be forced to pay, and the available funding must be capped. When the ALP got elected in 07 they vastly expanded the number of university positions. In response, the universities lowered their standards to fill those places up, leading to UNSW announcing they will no longer accept students with ATAR (Australian Tertiary Admission Rank) less than 80 next year. Increasing the number of places doesn’t increase the aptitude of the student.

    To fix HECS, it should change from a loan to a fixed income levy similar to Medicare, payable by those who benefited from HECS. That makes it sustainable. Furthermore, those who pay will choose the courses their HECS will pay for. The feedback will limits the number of student studying courses with poor outcomes, and vastly reduce the number of Master/PhD students working as waiters. (It’s not just art, I personally know a PhD in material engineering who ended up serving sandwiches for 2 years.) Compared to the ‘market’ oriented approach in the US, HECS is a much better system, but it is unsustainable unless some limit is applied.

    • “Student who leaves the country should be forced to pay, and the available funding must be capped. ”

      How would you do this, other than trying to sign agreements with every single country that students might go to live in?

      Normally these type of agreements have incentives for both sides but why would any country want to sign a one-sided agreement with benefits only for Australia?

      If I was a foreign government, I’d be trying to encourage tertiary-educated Australians to live in my country by not signing an agreement with Australia.

      “When Abbott say ‘open for business’, is this what it means? Looting the Australian government and giving it away to investment bankers? ”

      That’s a rhetorical question, right?

    • Student who leaves the country should be forced to pay

      I think you’ll find that this is too difficult to manage and enforce for the relatively little gain it will get you. If the government focused on maintaining a diverse local economy, those graduates wouldn’t need to travel overseas for a job.

  4. So the fiscal balance sheet (or net worth?) would actually be $15-$17 bn worse off if the Government goes ahead with this securitization?

  5. I spent last night trying to estimate the “illiquidity loss” which would arise from privatisation.

    Naive dilettantes often go on about “private sector efficiency” without ever explaining what that actually means.

    What they overlook is that government – especially the major or central government – also has certain efficiencies. The most important of these is financing efficiency. Irrespective of underlying credit risk the largest borrower will be the most efficient raiser of finance because of the liquidity of its securities.

    When arriving at an interest rate lenders are concerned not just with the risk of default, but also with the risk of being able to on-sell their asset if their circumstances change. A more readily saleable asset (i.e. a more liquid one) will attract a lower interest rate. That is why the interest rate swaps market could come into existence.

    [If memory serves me correctly – and I’ll need to check this – Eugene Fama’s 1991 paper showed that in the equity market this effect actually exceeded the effect of beta factors in determining stock returns!! But I’ll need to check that.]

    Anyway, we can arrive at an estimate of the absolute minimum illiquidity loss by comparing the yield on Queensland state bonds and Commonwealth bonds in the year 1993. If memory serves me correctly, in that year that state had almost zero net debt. It was AAA rated. And the ratings agencies routinely noted that they assumed an implicit Commonwealth guarantee of all state debts.

    In other words, there was almost no difference in default risk between it and the sovereign debt of the Commonwealth. It provided a great case study of illiquidity premium.

    And (if memory serves me correctly – again!) its debt attracted a 20-25 basis point premium over Commonwealth bonds. That is an estimate of the absolute minimum illiquidity premium between two levels of government.

    The illiquidity premium on a private securitisation will be higher.

    Let’s assume – still conservatively – that it is 50 basis points. And let’s assume a 20 year annuity for $23 billion of debt at a Commonwealth bond rate of 4.75%. The present value of that income stream at 5.25% would be only $22.15 billion. In other words, $850 million is lost in pure financing inefficiency.

    That has nothing to do with the default risk of the debt. It has nothing to do with the low interest rate on HECS debt. It is simply the price the Treasury must pay to allow Mr Abbott and Mr Hockey to pretend that the government’s net debt has been reduced: the gross debt would be paid off and recognised, but the offsetting income stream would also be lost and not recognised.

    It is the same as the Howard government’s claim to have reduced government debt by privatising assets such as Telstra, the airports, and the electromagnetic spectrum.

    Now, admittedly, there is an argument that illiquidity premium is somehow “absorbed” into credit risk when one moves away from risk-free and nearly risk-free securities. Certainly it becomes harder to separate out the two. But it is desperate to suggest that it does not exist at all.

    Moreover, the current method of collecting HECS debt means that it is one of the lowest risk unsecured debts in Australia. It is collected through the taxation system and (correct me if I am wrong) has priority over all other unsecured debt except for the funeral expenses of a deceased estate.

    To move away from that system would make matters worse. It would actually create credit risk where it previously did not exist. It would require a duplication of the collection system. Yet more inefficiency!

    Solely for the purpose of allowing Mr Abbott and Mr Hockey to pretend that the government’s net debt has been reduced.

    And one doesn’t need be too cynical to guess at what would happen next. Having cosmetically reduced the size of the net debt, they would immediately raise it again in a desperate spending spree (by the “infrastructure Prime Minister”) on projects aimed at winning votes before the next election. Leaving aside financing inefficiency, this proposal is likely to increase net debt.

    There are good reasons for privatisation. There are good reasons for accepting illiquidity premium and other financing inefficiencies if other forms of efficiency can be captured from the private sector. But they do not apply here.

    This proposal serves one purpose and one purpose only: allowing Mr Abbott and Mr Hockey to pretend that the government’s net debt has been reduced.

    • Give this man a blog spot?

      Well said Stephen, and great post Leith and Matt.

      One of the worst outcomes for Australia would be to follow the road of “innovation” in education reform, ala US privatisation of the tertiary education sector.

      This is the first step, IMO.

    • Since writing the above I have learned that the present value of the HECS debt is about one quarter of the face value. The calculations above should be applied to the present value. The final amount of the loss is therefore a quarter also.

  6. Perhaps it is time to rethink the whole idea of individuals paying for tertiary education. The idea that a degree is a valuable item that provides certainty of lucrative employment may not be as true as it used to be.

    I suspect that for a lot of young Australians, if they didn’t spent a few years at uni after high school they would just end up at the CES office. Even after they graduate they still may not have reasonable job prospects. Are we padding the unis to hide an underemployment problem?

    There is a conflict here – you borrow money from the government to buy a tertiary education, while at the same time that same government is busy destroying the industries that would employ you. Isn’t that a case for consumer affairs – a full refund due to faulty goods?

    The other unresolved problem with student debt is this. Universities were traditionally places where a wide spectrum of disciplines were taught. For example, you might specialize in the mating habits of the lesser spotted tree fog. A noble academic pursuit, but hardly likely to set you up like the guy who studies corporate law. Do we want doctors, scientists, philosphers – or do we just want lawyers and bankers?

    Setting Mr Market to work restructuring our tertiary education system in his own image may deliver the coup de grace to centuries of academic tradition. It just seems like another case where we continue to cede more power to the financial sector with a foolish hope that if it makes money it will all be for the best in the long run.

  7. A recent article I read (24/7 wall street from memory) had Australia as 10th in terms of proportion of adults with tertiary qualifications.

    Increases in costs to the student through changes to HECS would likely reduce that.

    In the US the sectors that depend on credit availability in mature years (eg cars and housing) are getting a little crowded out by the level of student debt.)

  8. Why should a graduate, who couldn’t find work in Australia due to its inherent lack of economic diversity, be forced to pay their HECS debt? If this country cannot provide work then why should it receive the labour of the student? P.S. Most expatriate graduates already had the expertise and skill sets to perform the job they studied for in the first place & they obtained the degree for the sole purpose of expatriation (see E-Class VISA).