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The early 2000s are most often looked upon as the beginning of the subprime mortgage bubble which led to the devastating mortgage meltdown in 2008. However, while the growth of the subprime mortgage market was garnering all of the attention, the student loan market was quietly bubbling up at an unprecedented rate.
Private student loans more than quadrupled from $5 billion in 2001 to $20 billion in 2008. While federal student loans have always dominated the college financing realm, accounting for more than 90% of student loans, private financing was surging due to the rising cost of college. This attracted several new entrants into the private student loan market, including an innovative startup called MyRichUncle.
How MyRichUncle Started
MyRichUncle.com was launched in 2001 as an offspring of lempower, Inc., a company founded by two NYU grads, Raza Khan and Vishal Garg. They saw the opportunity to help more college students obtain private financing through the use of a proprietary algorithmic credit scoring model they developed.
Their concept was inspired by Milton Friedman’s writings and sought to quantify the earning potential of a college student based on their academic achievements and career prospects. Investors could then purchase an economic share of a student’s future income stream. Students who couldn’t otherwise get access to financing due to poor credit could use their future earnings as collateral. The concept was launched under the banner of “Banking on Someone Else’s Education.” The idea raised $3 million in investments during its first year.
Meteoric Rise to Major Player
The demand for MyRichUncle’s education financing product grew quickly, outpacing its investment capacity. Khan and Garg then set their sights on the burgeoning private student loan money by applying their “human capital” approach to underwriting private student loans. To compete with the more established players in the market, primarily Sallie Mae and the big banks, lempower set out to raise capital.
Through a reverse public merger with Pacific Technologies, lempower was able to raise $4 million in equity capital and then changed its name to MRU Holdings, Inc. With its unique underwriting platform, it was poised to compete for a share of the growing private student loan market, and the company launched its proprietary loan product known as PrePrime.
After obtaining more than $600 million in credit facilities from such notable investors as Nomura Holdings, Merrill Lynch, and a host of private equity firms and European investors, MyRichUncle went on to originate more than $550 million in loans from 2005 to 2008. This made it one of the largest providers of private student loans in the U.S. MyRichUncle also used its future value formula for underwriting to enter the federal student loan market, offering a 1% unconditional discount on loan repayments.
How It All Ended
Having gone public in 2007 with a market capitalization of $200 million, MyRichUncle became very active in the capital finance market, raising even more funds in the open market by issuing securitized bonds or asset-backed securities. The securitized transactions were the first to be issued with an A-rating in the private student loan market which was a testament to the high quality student loan assets in its portfolio.
But, MyRichUncle’s troubles began. Even with its high quality loan portfolio, MyRichUncle could not fend off the shockwaves created by the biggest financial crisis in history. Liquidity problems in the market caused the supply of capital to evaporate, forcing MyRichUncle to shut down loan originations in 2008. That led to its filing for bankruptcy protection under Chapter 7 in 2009. At the time of its filing, MyRichUncle had four times as many liabilities as it had assets. Its market evaluation had nosedived to less than $10 million.
How MyRichUncle Shamed an Industry
MyRichUncle may have folded due to circumstances beyond its control, but before it went down, the company left an undeniable mark on the student loan industry. MyRichUncle will be forever remembered as the impetus behind a wide-spread investigation by New York State Attorney General, Andrew Cuomo, of a conspiracy between college financial aid officials and private student loan providers to influence student borrowers. Allegations that private student loan providers were financially incentivizing financial aid officials to point student borrowers in their direction had barely begun to surface.
The notion that college financial student aid officials who were supposed to provide unbiased guidance to students were taking kickbacks in the form of cash, stock options, and more was appalling, yet the practice went largely unnoticed. That was until Khan and Garg took out a full page ad in the New York Times alluding to the practice and calling on students to question the integrity of their financial aid officials.
Of course, private student loan providers and financial aid officials reacted in horror and denied any wrong doing. It took a full-fledged investigation by the attorney general’s office and a separate Senate investigation to uncover the far-reaching scheme that extended to many of the top loan providers and colleges. As a result of the investigation, new state and federal laws were passed to put an end to the practice.
As the investigation unfolded, MyRichUncle used the opportunity to position itself as the “pure” private lender with no conflicts of interest which may have worked extremely well had the company not succumbed to its eventual bankruptcy.
>> Read More: List of student loan companies
Author: Andrew Rombach