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January 10, 2012 3:08 PM Bankruptcy Bill Time

By Daniel Luzer

One of the more troublesome things about student loan debt in the United States is that, unlike normal consumer debt, it can’t be charged in bankruptcy.

If you’re broke and you can’t pay off your debts, you file for bankruptcy and the debts get restructured. If you’re broke and you can’t pay off your education debt, you just stay broke. The federal government can garner wages, Social Security, and even life insurance to service student loans.

Many progressive education reformers think this is unjust.

There are currently private student loan bankruptcy bills in the House and Senate. Members of Congress are likely to introduce similar bills soon. This is a good thing, says Peter Reilly at Forbes. Some people have “raised concerns,” however. As he writes:

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 today, and really never did for that matter.

Until 1990 Americans could discharge student loans in bankruptcy. That seemed to work out pretty well for both students and lenders. Reilly:

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”.

It is the other point—that allowing for bankruptcy protection will drive up the cost of student loans—that’s perhaps more salient. But it’s still wrong. What’s more, according to Reilly, it’s wrong in a way that obscures the really important changes that will likely come about as a result of changing the bankruptcy rule.

The other comments (that returning bankruptcy will cause lenders to pull out of the market, and cause the loans to become more expensive) are even less impressive, because the consequences they threaten are exactly what is desired! For private loans, it is a good thing if the lenders tighten their underwriting, and make loans more expensive. The schools, if faced with losing large numbers of students, or lowering their prices to levels where the banks will lend to their students (and thus keep the seats filled), will cut their prices. This free market pricing dynamic is long, long overdue in fact. I suspect that on average, colleges could charge students 30 percent less, and still function well. Certainly they have a lot of room to tighten the belt, and this is the way to make that happen. Students who still can’t get financing will have to choose a less expensive school. While this is an unfortunate outcome, it is far preferable to saddling the students with outrageous amounts of debt that they will forever regret, and perhaps never escape.

There is, after all, a real market in education. And if the country changes the rules of that market, the market will operate differently.

Markets need rules. Too many rules and the industry is stifled and can’t operate. Too few rules and the system becomes one of theft. Bankruptcy protection isn’t some special, sweetheart deal; it’s just the same thing that applies in commercial markets.

Daniel Luzer is the news editor at Governing Magazine and former web editor of the Washington Monthly. Find him on Twitter: @Daniel_Luzer

Comments

  • Owenz on January 11, 2012 7:45 AM:

    What drives me nuts about my loans is how I am forced to repay the federal government (supposedly my friend in education) at an interest rate 7% on a loan I cannot default on discharge in bankruptcy - in other words, a loan that is totally risk free for the lender. What this means is simple: the first $7000 I pay each year ($580/month) is interest on my $100,000 loan. Thus, to even put a dent in my loans, I need to pay at least $1000/month, which prevents from saving any money, and leaves me living paycheck to paycheck at all times.

    I have no problem paying back the money I borrowed, but with interest rates for mortgages around 3.5%, which is the federal governement scalping me at twice that rate on its risk free loan? The interest on the loans is the crippling part -- the part that makes you feel you will never crawl out of the hole, and that you will end up paying twice what you borrowed (you will!).

    If the Feds made their loans interest free (or low interest), it would be a way to put money back in the economy and invest in education without giving anyone anything for free. The Feds seem to have no problem loaning billions to banks interest free. Why not America's best and brightest students?

  • Owenz on January 11, 2012 8:07 AM:

    One other note for the author: I believe that private student loans were dischargable in bankruptcy until 2005, when the new bankruptcy law provided the same protection as federal loans. What people don't realize is that federal stafford loans max out at $18,000 per year, which no longer covers room, board and education at large state universities. To get more loan money, students must have their parents co-sign "parent plus" loans, thereby forcing low income parents into the terrible choice of taking on their kids' debt in full or not sending their child to college. If your parent cannot or will not co-sign a parent plus loan, you must borrow privately.

    If you look at tuition prices since 2005, I guarantee you will see that the huge jump in college costs is being paid for by private loans with their non-dischargable in bankruptcy protection. The private lenders are what allow students to borrow higher and higher, paying bigger and bigger tuitions. The schools love, it obviously.

    The problem is that students have no idea what $150,000 in loans will mean for the rest of their lives. Here is the truth: the moment you leave school, you must begin paying $1200/month in loans, or you immediately begin falling behind. Defer payment, and the loan grows at a clip of $10k a year with compound interest. How long will you pay? Probably 20 years.

    Unless you earn a salary well over $100,000 per year, your debt payments will cripple you financially. They will likely be your biggest monthly expense, bigger even then rent. And as you pay, you will see that *most* of what you pay is interest; that is, profit being earned at your expense by the Feds and private lenders at a rate of 7% per year -- a rate of return that any Wall Street investor would kill for. If you get sick? Lose your job? Sorry, no relief for you. They will let you "defer" payment, but the interest will compound and skyrocket, erasing all of your hard earned gains.

  • Hello on January 12, 2012 2:00 PM:

    The problem is that the loan consolidation places make it so hard to qualify for IBR(Income Based Repayment) and have it wrapped up in legal language. If they made it easier for people to understand, more people could qualify for that. But, the consolidation places want to make their profits, so they make it hard for us working stiffs to qualify.

  • Bankruptcy Attorney with huge student loan debt on February 04, 2012 9:40 PM:

    The current system that makes student loan debt a life long burden is unconscionable. Even if you make $100k+ a year, owing over $100k in student loans (as most who make 6 figures a year DO owe) makes even 6 figure earners live paycheck to paycheck. There is absolutely no reason to treat student loan debt any differently than other consumer debt and no reason to burden well-meaning individuals with crippling debt that they can never truly afford to pay back. It's onerous, debilitating and depressing to know that we punish people for trying to better themselves through education who come to discover that the crippling cost of their education only left them in a worse position than if they would have just skipped college and grad school all together. Truly a sad state of affairs.

  • Unemphysist on July 26, 2012 9:12 PM:

    I know two friends that have taken their lives due to the pressure of student loan debt and the feeling of never having anything. One, told me months before they passed that they couldn't believe that with their "prestigious" education that when their grandparents passed away they would officially become homeless even if they were still employed. The other only mentioned that they felt like a burden and a failure, and was embarrassed to go to family events being a "broke aerospace engineer". I too am an engineer and feeling that there is no way out. I recently was diagnosed with a life threatening disease and am burdened with over 100k in student loans. I was unemployed at the time of my diagnosis and had little time (after graduation) to prepare for such an event financially. I wonder if anything will ever be done? Even if I survive my up coming struggle I am sadly aware that my loans which, even though obnoxious, were still manageable while I lived with my grand-mom, will have doubled, if not tripled in principle (since maximum deferment is already exceeded). I ask what do I have to fight for? Even if I make it, my disability will be garnished, and I have only a single grandparent surviving who up until a month ago was depending on me for support. I have no-one! And no way out......