Friday, August 1, 2014

Student Loans and Bankruptcy - The Debate Continues

Originally Published on on January 10th,2012
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


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 andprivate 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 causeprivate 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.
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 allfederal 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.      
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 court. 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.

While these forgiveness programs may not perform quite as well as advertised, and valid concerns exist about their applicability and administration, the programs sound good, and to heavily indebted students looking for a workable payoff plan, these will serve to fulfill this need. They will see two reasonable programs, each far more attractive than bankruptcy. Certainly these folks will almost never consider bankruptcy seriously given these choices.
Of course, there will be an initial spike in filings, primarily among older borrowers. It is reasonable to expect $10-$20 billion in federal loans to be discharged within the first year. But this is a very moderate amount when considering the trillion dollars owed by the nation as a whole. And let’s be honest: much if not most of this would probably never have been collected anyhow. People in this group have been largely decimated by the predatory lending system for years. Many have already repaid far more than they originally borrowed, some are even well into their retirement years. So on balance, this is not any more of a loss than would have otherwise been incurred. And don’t forget that far, far, far more than $10 billion in damage has been done to these people over the years.
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% less, and still  function well. Probably far more, but that is another debate. 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.
It would similarly be a good thing if the Department of Education began underwriting their loans in some way. Again, I say this is long overdue. I would guess broadly that something like 40% of the for-profit colleges need to be cut off from federal loans altogether, and probably a good number of non-profit colleges as well. Federal lending limits should be reduced by something like 25% across the board, Good, trustworthy people who have good feels for the quality of various schools could adjust these on a school by school basis, and this would save tremendous amounts of public money and preclude financial hardship or even ruin for millions of citizens. Of course I am speaking in broad brushes, here, but the point remains, and such a good government model simply must be adopted if the Department of Education wishes to retain the confidence and trust of the public.
Remember that as we speak, the true default rate likely reaches or exceeds 40%, and that the general public is quickly learning about the systemic corruption that has been festering across the schools, lenders, and federal government for years. I would say that if the higher education decision makers (including Congress and the Executive branch) continue to ignore this problem for any significant length of time, they can expect the full-scale evaporation of public confidence in the lending system, and a morphing of public fear and compliance into deep resentment and focused anger. In this environment, few will pay their student loans, and the bureaucrats and electeds who, today, dishonor themselves through gross neglect of the public interest can look forward to explaining why they failed to act at this critical time, when all that will follow could have been efficiently averted.

You can follow me on twitter @peterreillycpa.

1 comment:

  1. It is really interesting post. I never read such kind of post. It impressed me. Thanks for sharing…