Detroit News Op-Ed (1991)

The Detroit News

August 18, 1991




Jeffrey S. Lehman*

Bailouts are wonderful things.  At least, that's what I've always thought.  My earliest memories of bailouts are happy ones.  When I was a little boy growing up in Maryland, we often had wild summer rainstorms.  I remember how my father would get a funny little smile, say something under his breath, and go down the stairs.  "I'm off to bail out the basement," he would say.

When I grew older I learned about bailouts as public policy.  They were a kind of after-the-fact insurance that taxpayers gave to innocent disaster victims.  When Chrysler's insolvency threatened thousands of Michigan auto workers with unemployment, the government teamed up with the banks to keep the company afloat.  When the S&L fiasco put the savings of ordinary citizens at risk, another bailout was due.

So it should not be surprising that the Board of Trustees of the Michigan Education Trust has started to talk about bailouts.  MET is Michigan's prepaid college tuition program.  It sells contracts to parents of young children, promising to pay the tuition costs if the child ends up going to a Michigan public university.  The question is, what if MET can't keep its promise?

MET contracts certainly weren't cheap; last year it cost about $7,700 to buy four years of coverage for a newborn baby.  On the other hand, the contracts were substantially less expensive than what parents with kids in college are paying right now.  During the program's three years of operations, the "discount" has been as high as 25 percent.

I believe MET will be able to earn money fast enough to keep up with the rising cost of tuition.  But it probably won't be able to earn money fast enough to make up for the "discount."  If, over the long term, MET proves unable to make up that ground, state law calls for the program to be liquidated, with its assets distributed to the participating families.  MET families would end up with substantially more money than they paid in; they would effectively receive whatever their money had earned in MET's hands.  But they wouldnot have gotten the discount on tuition that they were promised.  That prospect led the MET Board at its most recent meeting to ask the state's taxpayers to accept a "moral obligation" to bail the program out if it ever has trouble making good on its promises.

I think MET should have some kind of a bailout plan -- but not the one the Board is proposing.  Why do I say that?  Because the Board wants the legislature to commit itself to a transfer of tax dollars to MET families, and such a transfer would be the worst form of wealth redistribution.  The trouble is that, on average, MET families are much better off than the average Michigan taxpayer.  In 1988, MET published the breakdown of contract owners by zip code; if one ranks zip codes by average income, it appears that at least half of MET contracts went to the most well-off fifth of Michigan families.  Meanwhile, only 4% of contracts were purchased by the 20% of Michigan families living in the poorest zip code areas.

[Pie Graph]

Of course, even a well-off MET family might have reason to feel wronged if the program went under.  Back in 1988, newspapers quoted official statements that beneficiary children's tuition would be paid unless "the state of Michigan were blown up or the government was somehow destroyed."  After puffing like that, one has to feel that the state owes investors something.

Luckily, there is a way to address the legitimate interests of taxpayers and contract holders alike.  The key words are indeed "bail out," but we need to concentrate on the other way those words are used.  Sometimes, instead of speaking about "bailing something out," we speak about "bailing out of something."  Like an airplane.  Or a sinking ship.  What MET contract holders need is the right to bail out of the program.

If MET were dissolved right now, it would have enough money to give everyone back their purchase price, with a little interest to boot.  Not the kind of return they may have been hoping for, but not bad for at most three years' investment.  Unfortunately, the contracts deny individual purchasers the right to change their minds and pull out.  Refunds are available only for parents of children who die or reach college age and decide not to attend a Michigan public university.  In the meantime, those parents who may have second thoughts about their investment are stuck.

So here's what the MET Board and the state legislature should do.  If they feel that contract purchasers were not adequately warned about the risks of investing when they first bought in, they should draw up a full explanation of the risks right now.  Then they should send that explanation to all current contract holders.  Finally, they should tell contract holders that they now have six months in which to change their mind and bail out.

If investors were given that kind of bailout option, then anyone who chose to leave their money in would be taking the same kind of gamble they take whenever they put money into a mutual fund.  They might get lucky and end up even richer than they started.  Or they might need to come up with another 25 percent of the tuition bill when Junior starts school.  But Michigan's taxpayers wouldn't have any obligation -- moral or legal -- to guarantee them a successful investment.

And what about the traditional kind of bailout, the kind for victims of disasters that are not of their own making?  If the legislature is listening, lots of causes need that kind of bailout more than the holders of MET contracts.  The public schools.  The Medicaid system.  The foster care system.  Maybe even a few flooded basements.

* Jeffrey S. Lehman is an Assistant Professor of Law at the University of Michigan .