Student Loans and Bankruptcy - The Debate Continues

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Alan Collinge recently contributed a piece on the idea of allowing student loans to be discharged in bankruptcy.? It sparked quite a few comments and he has returned to address them systematically

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Returning Bankruptcy Protections to Student Loans, in Practice

I recently wrote a piece in this column showing why bankruptcy protections are essential for the healthy functioning of the nation’s federal and private student loan systems, and the public interest that they serve. Of the 50 or so comments received, very few challenged the validity of the argument or the soundness of its premises. Surprisingly, a significant proportion of the readers not only agreed with the piece, but actually called for more ambitious remedies, such as forgiving all student loan debt, adopting a free higher education model, and so forth. While these solutions merit serious attention, in this and other forums, I remain focused on the question before us, since private loan bankruptcy bills are in the House and Senate as we speak, and similar legislation for federal loans is expected in the near term. In this context, there were legitimate questions raised about the practical effects of returning bankruptcy protections to both private and federal loans, and so these are what compel this continued discussion.

There were essentially two concerns raised on this front. First were concerns that returning bankruptcy protections would?allow widespread abuse of the system. The second concern was that bringing bankruptcy back would cause private lenders to tighten up their lending, and also cause the loans to be more expensive for the students. These two concerns have been used for years to stop this debate, and keep the lending system on its current, unsustainable trajectory. To be blunt, those dogs don’t hunt t! oday, an d really never did for that matter.

Here’s why: Alarmist predictions of widespread bankruptcy filings fly in the face of all available historical data. It is well established by John Pottow (U Mich) and others that when bankruptcy was allowable for all federal student loans, far less than 1% were ultimately discharged this way. One legislator who participated in the legislative process which first began restricting bankruptcy protections for student loans characterized it as a response to “a crisis only in the imagination”.

Like today’s “Pell Runners” (people who enroll in school only to abscond with Pell Grant proceeds), a vanishingly small number of citizens who acted in bad faith were pointed to by the lending industry, and a crisis was manufactured with the aid of the national media. This crisis served as political cover for removing bankruptcy protections from everyone, not just the handful of bad actors who actually deserved such a response. In hindsight, this was essentially a cheap trick (and I suspect the same gimmickry is being employed in the current Pell debate). The point, here, is that people never rushed out to file for expediency or convenience. It just didn’t happen.??????

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Many will claim that the filing statistics I point to were during a different time, when the relative cost of college was far lower, and this is a valid point given current debt loads, a more cynical younger generation, etc.. But what they fail to acknowledge is that the increased pressure that today’s student debt loads might put on borrowers to file is more than balanced by today’s far more stringent bankruptcy laws compared to 40 years ago. Simply put, bankruptcy isn’t nearly the “walk away” option that it used to be. Bankruptcy filers who are gainfully employed (or even employed), usually are compelled to repay a significant portion of their debts by ! the cour t. So the widely perpetuated stereotype of people washing their hands of the debt, scott-free is a myth, and has been for years.

Also, the claim that young people today are less concerned about the negative implications of filing for bankruptcy than in previous generations is dubious at best. No one wants to file for bankruptcy, and in my experience I would say this holds particularly true for young adults fresh out of college, and full of optimism. This is another myth perpetuated by the lending industry- one which that plays upon the paternalism that naturally wells up in adults when discussing college related issues (I suspect, frankly, that this cynical characterization is more a reflection of the ethical shortcomings of those painting the picture than those who are being painted). Whatever the case, suffice it to say that bankruptcy is still as stigmatizing, embarrassing, and unpleasant today as it ever has been- the last, worst possible course of action to be forced into. No one would choose this if other options existed (options not involving public humiliation or usury, ideally).

And indeed, there are payment options for recent graduates that are clearly preferable to bankruptcy. The first option (obviously) is to get a good job/income stream and repay the debt quickly. Absent that course, there are two repayment programs in place which allow the student to repay a fairly low portion of his/her income over 20 years, or what is more attractive, 10 years if the student is employed at a non-profit or works in the public sector.

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