Political Animal


August 26, 2012 5:20 PM The nondischargeability of student debt and the urban legend of the student deadbeat

By Kathleen Geier

I didn’t want to end my weekend blogging stint without linking to Maureen Tkacik’s excellent recent piece about the history of the student debt crisis (H/T: Scott Lemieux). Tkacik is a fine journalist who has does some outstanding work on business and finance topics. Her article focuses on one feature of the student loan debacle that has always struck me as most curious: the fact that student loans are completely nondischargeable in bankruptcy. This is totally bizarre, because few (possibly no?) other forms of debt are treated in the same way. I mean, theoretically I could charge up $50,000 worth of Manolo Blahniks on my credit card, and eventually get that discharged if I go into bankruptcy, but my student loans? Never! Or at least, only under the rarest of circumstances. When and why did this come to pass?

Well, Tkacik explains that like so many cruddy things in contemporary American life, it began in the late 1970s. Back then stagflation and the craptastic economy meant that more and more people were having trouble paying back various types of loans. And she doesn’t spell this out, but high inflation meant we had an economy that was bad for the rentier class but good for folks who were paying off their debts — in other words, you and me — because it basically lowered the cost of those debts.

The banks started freaking out and racking their brains for ways to squeeze some more money out their customers. Making student loans nondischargeable was one of the ideas they came up with that proved to be wildly popular. And the reason why it was so popular is that the bankers cleverly sold the idea in culture war terms: on the one side were good, solid Silent Majority types who worked hard and paid their bills on time; on the other side were lazy, rotten, spoiled hippies who expected to go to college and grad school on the taxpayers’ dime, and then dodge the bills for it, just like they dodged the draft. Newspaper reporters wrote entire stories about the alleged epidemic of student deadbeats on the basis of flimsy, highly suspicious anecdotes such as this one:

A typical syndicated dispatch on the surge in student deadbeats was the August 27, 1972 exposé by Los Angeles Times reporter Linda Mathews, which began with the personal anecdote of an anonymous “Washington banker” who purported to have once “handed a $1,500 check” for the year’s tuition to a nameless “18-year-old college freshman” only to be insouciantly told, “Oh, I never intend to repay this loan.” The anonymous banker -who had since joined “the staff of the American Banking sic Association” - helpfully explained to Mathews that the kid was, “acting on advice in underground newspapers urging students to use bankruptcy to avoid paying loans.”

And you know something, this rings a bell. I remember hearing, during the 80s, stories about rich doctors and lawyers who took out student loans to finance their expensive educations, then opportunistically declared bankruptcy to avoid having paid back the loans. These people were never specifically identified to me, but nevertheless I was assured that many of these people existed, and that unscrupulous types like them were why all student loans had to be made nondischargeable — they were the rotten apples who spoiled everything for the honest ones. All of which goes to show that making policy on the basis of urban legend is a terrible idea.

Especially because, in reality, there wasn’t actually an epidemic of deadbeat student loans. As Tkacik reports,

only about 4 percent of people who filed for bankruptcy protection in 1975 had student loans on their balance sheets, and of those, fewer than one-fifth did not have substantial other debts motivating them to file.

Nevertheless, the law making student loans nondischargeable was passed in 1978. At first, it applied only to the first five years of the loan, and then, only to the first seven years of the loan, but now, it’s forever. Also, originally, it was only for federally guaranteed student loans, but since bankruptcy reform in 2005, it has covered any and every type of student loan, a little detail I find especially outrageous. What could the justification for that possibly be?

Tkacik notes that in the intervening years, the cost of college, especially relative to income, has skyrocketed:

In the years since the Bankruptcy Reform Act passed in 1978, the nominal price of college tuition has risen more than 900 percent. Over the same period the median male income - again, nominally - has risen 165 percent. And since the percentage of the workforce boasting a bachelor’s degree has expanded from less than 20 percent to nearly a third, I don’t have to convince you that the median de facto return on investment on those diplomas has diminished greatly over the same years.

So all too predictably, you get horror stories like these:

A military veteran sharing his story with Occupy Student Debt has paid $18,000 on a $2,500 loan, and Sallie Mae claims he still owes $5,000; the husband of a social worker bankrupt and bedridden after a botched surgery tells Student Loan Justice of a $13,000 college loan balance from the 1980s that ballooned to $70,000. A grandmother subsisting on Social Security has her payments garnished to pay off a $20,000 loan balance resulting from a $3,500 loan she took out 10 years ago, before she underwent brain surgery.

That brings us up to the present, sad state of affairs. One of Occupy’s successes is that, at long last, it shone a spotlight on these shocking abuses. Given the stranglehold that the financial sector has on our political system, I’m not optimistic about the possibility for the kinds of changes we need. But at the same time, given the alarming rate at which student loan debt has ballooned, and the potential it has to crush dreams and destroy lives, I think it’s incumbent upon us to fight for what change we can wrench from the system. There’s too much at stake to do nothing. Student debt has become the modern-day cross of gold.

Kathleen Geier is a writer and public policy researcher who lives in Chicago. She blogs at Inequality Matters. Find her on Twitter: @Kathy_Gee


  • Ron Byers on August 26, 2012 7:24 PM:

    I work with consumer bankruptcy on a daily basis. Anybody who tells you that it is impossible to discharge student debt is not very well informed. In the right case it is possible, but it is extremely difficult. I have been able to make that case on several occasions, but it is very, very difficult and discharge of student debt isn't available for the average bankruptcy client.

    The 2005 law is punitive and was really poorly written. It is counterproductive in a time of economic trouble. I would have thought we would see some serious adjustments to it after 2008, but it is still the law of the land.

    Apparently the Congress is too busy outlawing abortion and trying to deny Obama any success to trouble itself with tending to it's Consitutional duties.

  • Davis X. Machina on August 26, 2012 7:25 PM:

    Legends die when the last person who as a child heard them told dies.

    The last GOP president who presided over a budget in current-account surplus was who, Eisenhower? But the GOP is the party of fiscal probity.

    This one's going to last as long as the tales of the Trojan War, is my guess.

  • Ron Byers on August 26, 2012 7:28 PM:

    By the way, you want to get rid of student debt, make college affordable for all. How about free tuition for everyone taking a full load and making a C average or better.

    In today's job market, if you don't have a college education, you are probably unemployable. Anyway we need to keep people in their late teens and early 20s occupied with something other than war.

  • dp on August 26, 2012 7:32 PM:

    Geez, public policy made based on anecdotal evidence supplied by AN EMPLOYEE OF A LOBBYING ORGANIZATION! What could possibly go wrong there?

  • cwolf on August 26, 2012 7:34 PM:

    This got my attention:
    "...a $1,500 check” for the year’s tuition..."

    Ah, the good old days, before tuition cost $35K & up for a year's tuition.

  • RepublicanPointOfView on August 26, 2012 7:37 PM:

    It is pure satisfaction to have debtriden college graduates working for me. Fear is good! They are so damn afraid of losing their jobs that they will work whatever hours I want, under any conditions that I want, and cut any corners I want cut. I like having fearful workers who would never press for better wages or working conditions.

    The only thing I like better than having fearful employees is when I fire them.

  • msnthrop on August 26, 2012 8:16 PM:

    Is it not possible to use credit cards to pay your student debt...so you pay just off the loans with your credit cards and then declare bankruptcy on the credit card debt...hell people use one credit card to pay another all them time.

  • Doh on August 26, 2012 9:25 PM:

    I have a vague recollection that some of the onerous constraints on student loan borrowers were adopted back in the days of PAYGO-- when if you wanted to do anything you had to come up with an offset, so if CBO said that the feds would recoup $20 million from borrowers (or avoid losses on guaranteed loans) if the statute of limitations was removed, that was $20 million you could "spend" on some other program.

  • Bill VanDyke on August 26, 2012 10:50 PM:

    In 1988 I attended one of those 2 year trade schools. Remember we did not have internet back then, only Local TV.

    I borrowed 15k for 2 years. Worked full time to pay for my living expenses, went to school 5 hours a night 5 days a week for 2 years.

    For what? A chance at bettering my self, a chance at the American dream? Nope. It was for a piece of paper that wasn't worth the ink which was on it.

    I have defaulted twice, and rehabilitated twice since then. I have paid over 50 thousand and still owe 35 thousand. I don't have a penny saved for retirement and last week the company announced it was closing.

    I busted my tail working 2 and 3 jobs at times to make payments. Now I am doomed to default, and going on welfare as there is nothing left.

    My chances at getting these paid off are ZERO.

    WHERE IS MY BAIL OUT? How much more do I have to suffer?

  • CRA on August 26, 2012 11:39 PM:

    "Is it not possible to use credit cards to pay your student debt...so you pay just off the loans with your credit cards and then declare bankruptcy on the credit card debt...hell people use one credit card to pay another all them time."

    Paying for college costs a great deal more than the credit card limits a typical student could be granted. In addition, the interest rates are greater than those for student loans. Assuming you were able to perform the stunt you describe, in the time it took you'd end up paying much more (college takes years, bankruptcy awhile). That, at least, is my assessment; I'll assume it's roughly accurate, since it benefits or at least protects the creditors.

  • Robert Waldmann on August 27, 2012 5:00 AM:

    Huh ? "since the percentage of the workforce boasting a bachelor’s degree has expanded from less than 20 percent to nearly a third, I don’t have to convince you that the median de facto return on investment on those diplomas has diminished greatly over the same years" ????

    I think I could maybe be convinced indeed I think that there are some serious calculations of the return on investment in which it has diminished. But that claim isn't demonstrated by the numbers given in the article, because two key numbers are missing. One is the effect of a college degree on salaries which has vastly vastly increased since 1978. The other is the opportunity cost of lost labor income and labor market experience. The increase in this cost is roughly along the lines of the increase in median wages (but is lower). The issue is that if A increases proportionally less than B then A+B increases proportionally less than B. The nominal cost of getting a college degree has *not* increased 9 fold -- in 1978 y far the larger part of the cost was the opportunity cost. I think this is still more than half. I think the total cost of tuition fees plus lost earnings plus lost labor market experience has roughly roughly doubled.

    The implication of the reference to the fraction with diplomas is clearly that the college/just high school wage differential has declined due to increased supply of college graduates. But that differential has vastly increased. It was very low in 1978 (which happens to be the year I went to college). I wasn't there (didn't take the course) but I know freshmen in introductory economics were told that they would have gotten a better return on the total cost (tuition fees plus lost wages) investing in treasuries and labor market experience.

    This ceased to be true in the 80s with a huge huge increase in the college wage premium. Salary with a diploma minus salary with just a high school diploma divided by salary with just a high school diploma much much more than doubled. It remains very high.

    Note also that inflation wasn't helping students in 1978. The high expected inflation lead to high nominal interest rates. The people who made out like bandits at the banks' expense were people who had borrowed before inflation was high -- basically home owners who signed fixed interest rate 30 year mortgages in 1973 and before.

  • square1 on August 27, 2012 8:28 AM:

    If we had a properly functioning political system, with political parties that actually competed for votes by trying to deliver good policies for their constituents, then common-sense reforms of the bankruptcy code (or education-funding generally) wouldn't be off the table.

    If the current system were not so corrupt, the President would make the following political calculation: The economic prospects of an entire generation are being buried under mountains of debt. If I can relieve the youth of America of this burden, they will be eternally grateful voters....and the entire economy will be stronger. After all, most people in their 20s with $100-200k+ in student loan debt won't be buying a house any time soon, so the housing market will continue to suffer."

    The problem with our political system isn't that our politicians aren't altruists. It is that our politicians no longer function as traditionally self-interested politicians should act.

  • Mossup on August 27, 2012 9:07 AM:

    Hardly anything after this sentence in the Maureen Tkacik article is actually correct: "Until 2005 it only applied to federally guaranteed loans; now, thanks to the Bankruptcy Abuse Prevention and Consumer Protection Act, it applies to all." Collinge's book also is a mixture of interesting gossip, misinterpretations of the law and regs, half-truths, and plain non-truths. Truly below the standards of Washington Monthly.

    Loans don't routinely quadruple or quintuple. Do the math. If you didn't pay a dollar on your mortgage or car loan for 20 years (and the lender didn't take your car and house to close out the debt), then, yes, simple interest would results in mushrooming of the debt. If you have a typical 30-year mortgage, you are paying three times what you borrowed, at least in current dollars. (It is much less in real dollars.)

    Why do people magically think that student loans should be different, just because education is involved? When people like Collinge say they would be happy if the law was changed so that borrowers could pay back no more than they borrowed, what does this mean? If it is a 10-year repayment plan, then this might mean repaying 50% more than what you originally borrowed -- assuming you never used a forbearance and never became delinquent during that time. If you signed up for a 30-year plan, then, yes, you are paying more interest nominally, but you are reducing your monthly payment, reducing your chances of a credit-ruining default and improving your chances to actually have a life outside of ramen and tuna fish.

    "Between a quarter and a third of about $850 billion worth of federally guaranteed loans are already in default, so this is real money we are talking about."

    Wrong. Between 6% and 7% of the $900 billion worth of federally guaranteed loans are in default, and this percentage has declined steadily since 1990. "Already" is also a loaded (and incorrect) word, because, as the article notes, almost everyone who defaults pays something after defaulting, and many borrowers pay their way out of default and into regular repayment. Default isn't necessarily an end point. It is often a new beginning, a new phase of the life of the loan where the borrower realizes the seriousness of the commitment. Most are not "deadbeats" many could have been paying before default but simply did not understand the commitment until touchy-feely loan servicing turned into hard-core loan collections mode.

    "Given the $23 trillion worth of other securities the federal government has pledged to guarantee over the past few years, we can only expect the default rate to surge higher."

    Why would that necessarily be the case? What would deficit spending from the General Fund have to do with the $100 billion per year of solid, money-making (even according to Collinge), education loan assets the gov't plans to issue each year.

  • Benjamin Legal Services on August 31, 2012 5:19 PM:

    We agree that it was a fine piece by Tkacik that called attention to the growing problem of student loan debt. Unfortunately, the horror stories you highlighted are becoming increasingly common, and we fear Tkacik may be right in concluding that the student loan shark bubble will “prove far worse for business than the subprime mortgage bubble.” While a bill proposed by US Senator Dick Durbin would help many future students avoid taking out the costly, predatory loans from private lenders, there needs to be some type of legislative action to help those who have already graduated and are seeing their balances balloon to astronomical proportions.