If borrowers don’t have the money, they’re not paying anyway. But because they can’t get loans discharged, they can’t participate in the credit economy. They’re off the economic grid. They’re the indentured generation. – Daniel Austin, a bankruptcy law professor at Northeastern University
This week, President Barack Obama introduced a proposal that would give colleges federal money based on performance and affordability for students. Such measures, Obama said, would require accountability at institutes of higher education across the country in an effort to curb the escalating costs of student loans.
Experts say there may be an additional way to solve the student debt crisis: bankruptcy law.
Under the current system, it is all but impossible to get student loans wiped out through bankruptcy, unlike most other forms of unsecured debt such as credit card and medical bills. And legal experts say this is creating a generation of Americans who are unable to get out from under the crushing weight of college debt.
“If borrowers don’t have the money, they’re not paying anyway,” said Daniel Austin, a bankruptcy law professor at Northeastern University. “But because they can’t get loans discharged, they can’t participate in the credit economy. They’re off the economic grid. They’re the indentured generation."
The student loan burden
A substantial chunk of student loan debt has been a growing fact of life for many Americans. The Consumer Financial Protection Bureau found that total student loan debt is approaching $1.2 trillion, which would exceed credit card debt by more than 28 percent, using Federal Reserve data. Forty-five percent of all American families now have student loans, according to a report released this week by David Bergeron and Joe Valenti from the Center for American Progress, a progressive think tank. And the average student loan balance for a 25-year-old has jumped 91 percent from 2003 to 2012, from $10,649 to $20,326, a recent study from the Federal Reserve Bank of New York showed.
With unemployment high, particularly among young Americans — 12.6 percent for 20- to 24-year-olds compared with the overall rate of 7.4 percent, according to July's jobs report — default rates on student loans are on the rise as well. According to a New York Federal Reserve study, in 2011, 14.4 percent, or 5.4 million of the 37 million borrowers who had outstanding student loans, had at least one past due payment. That number is more than 7 million borrowers this year, according to the CFPB. And the 2013 New York Federal Reserve study showed the proliferation of student loans means that students are delaying other major life purchases like homes and cars and even delaying life milestones like marriage and having children.
“There’s this [idea] that if you go to college, then you’re able to get a job, and you’re on your way in life,” Austin said. “But education has become so expensive … and people are coming out of college with $50,000 to $100,000 in debt. Then they meet hard times and now they become this permanent underclass. It’s horrible. We ought not be doing that in this country.”
“… They’re in a different economy than we are," he said. "If we at least allow them to discharge that debt in bankruptcy, they can return to be participants in the economy.”
The muddled mess of bankruptcy law
Although bankruptcy reform legislation passed in 2005 placed a number of hurdles on the ability of people to file for bankruptcy, the number of filings jumped when the recession hit, according to the Wall Street Journal. While the number has decreased from the 2011 high of 1.53 million, slightly more than 1 million Americans filed for protection last year, according to Bergeron and Valenti. In bankruptcy, a borrower can wipe out most of his unsecured debt entirely, or repay a portion of it over three to five years. This gives what bankruptcy practitioners and courts have called a “fresh start.”
But the ability to discharge student loans in bankruptcy has been eroded over the years to the point where now the borrower has to prove that any student loan, even a privately issued one, would cause an “undue hardship” to them in order to get it discharged. Whether a debtor can prove this or not may depend completely on which state the debtor lives in, as the Supreme Court has not provided guidance on what the standard means, and courts interpret it in different ways, according to Austin.
Another wrinkle is that in order to discharge a student loan debt, a debtor needs to file a separate action and argue in front of the bankrupty court, a process that usually requires an attorney and money. And according to an April report from the National Consumer Law Center, a legal services nonprofit agency for low-income consumers, most individual debtors, especially those most in need of a hardship discharge, are not able to afford the costs needed to go to court.
“The reason we have bankruptcy laws is that going back to founding of this country, we believe people get a second chance,” said Bergeron, one of the authors of the Center for American Progress report. “Even for federal loans, if you as a student go into programs that don’t adequately prepare you for the work force, that is, if you’re prepared in college but can’t find a job in your field, through no fault of your own, you shouldn’t have the obligation of repaying that loan. That creates some fundamental unfairness that is inconsistent with reasons for the bankruptcy system.”
Reforming the code
Experts have proposed a number of fixes that would help out borrows stuck under unmanageable debt burdens.
Austin has proposed allowing all private loans to be dischargeable, as he believes lenders should not get the “best of both worlds": lending to whomever they want at whatever terms they want while not having to participate in the loan forgiveness programs — in which a borrower repays an affordable amount over 20-25 years before getting the rest discharged — required of government-backed loans. He also proposed allowing bankruptcy courts to value a debtor’s student loan at its fair market value, which is what another investor would be willing to pay to buy the loan off the original lender, and discharge anything above that value. A similar process is currently available to some debtors on their mortgages in bankruptcy.
Bergeron and Valenti propose creating a set of “qualified loans” that meet certain lending standards: reasonable interest rates and fees, deferment and forbearance provisions similar to today’s federal student loans, and access to income-based repayment. Loans that shared these characteristics would be unlikely to substantially harm debtors, and so would remain nondischargeable in bankruptcy. But loans that did not meet these standards, whether public or private, would be dischargeable.
But given the enormity of the student loan problem, even experts who propose bankruptcy reform think other issues must be addressed to control costs and make student loans a good bargain for young borrowers.
“Bankruptcy doesn’t solve the whole problem,” Austin said. “Thirty million households owe student debt. There are different figures on default, but the overall average may be 30 percent [of student loan borrowers] depending on what set of numbers you look at. That’s a lot of people, and we might be better if we have them back in the economic grid.”
Bergeron thinks that it’s going to take a lot more than even the president’s proposal and bankruptcy to fix the system. He proposes looking at institutions, both for profit and nonprofit, who are doing innovative things to get students to graduation and employment. “It’s gonna take more than those two pieces — it takes more than the president’s plan and bankruptcy reform. It really needs to be everyone thinking about driving down costs and improving quality. Because if we don’t do it, somebody else will. And by somebody else I mean some other country will. And they’re going to kill us.”