Credit Slips

Student Loans and U.S. Bankruptcy Law: Hard to Understand

Student loan debt in the U.S. is a growing problem, with college students graduating with an average debt load of nearly $20,000 as of 2006.  In my last post, I pointed out a recent opinion suggesting a bankruptcy approach that might help students with these loans, even though the debts are nearly always nondischargeable.  Comments to this post suggested that there is an underlying problem in the way U.S. bankruptcy law treats student loan debt.  The comments are right: this treatment of student loans is very difficult to understand.

Bankruptcy Help for Students and Their Lenders?

Yesterday, the President signed into law H.R. 5715, the “Ensuring Continued Access to Student Loans Act of 2008.”  The law responds to a perceived liquidity crisis in student lending by allowing government purchases of privately-issued student loan portfolios, so that the lenders will have funds to re-lend. The law is characterized as a useful first step in the lead editorial of today's New York Times, but the Times urges a broader remedy: greater use of direct governmental student loans.

From the perspective of bankruptcy, though, the question is not how students can best get into educational loans, but how they can get out of them.  Under current U.S. bankruptcy law, all student loans are nondischargeable unless the debtor can establish “undue hardship” under a test that requires proof (among other things) that the debtor will not be able to repay the loan in the future—i.e., permanent disability—a very tough standard.  However, for at least some student debtors an easier way to get bankruptcy relief may be the suggested by In re Orawsky, a recent decision from a Philadelphia bankruptcy court.

Student Loans, and the Housing Crisis

I am honored to have been asked to be a guest blogger on Credit Slips.  Not only is this my first posting for the week, this is the first time I’ve ever posted anything to a blog anywhere.  With that warning, here goes.

Thanks to the metastasizing housing crisis, the Bush Administration is urging Congress to increase the government's participation in the private student loan market.  Rather than just guaranteeing loans, though, President Bush urged Congress in his weekly radio address this Saturday to approve quite broad legislation that is designed to encourage private lenders to continue to remain in the federal student loan program.

What the Foreclosure Mess Tells Us About Private Student Loan Dischargeability

The most recent attempt to roll back some of the BAPCPA's limitations on the scope of the bankruptcy discharge seems to have faltered in the House. The House passed an education bill, but without a proposed amendment that would have made private student loans dischargeable in bankruptcy, as they were before October 2005, was voted down. A Senate bill (S.1561) sponsored by Dick Durbin (D-Ill.) that proposes making the private loans dischargeable is still in committee. (For a discussion of the legislation see here.)

For-Profit Student Lenders Win Again

Yesterday, the U.S. House of Representatives passed H.R. 4137, College Opportunity and Affordability Act of 2007. Reading that, you might query whether the House has a calendar, but the main point of the bill is to make some reforms to the market for student loans. I'll leave those details to the N.Y. Times story reporting on the bill's passage. Readers of this blog are likely more interested in the fact that the bill left the House of Representatives without changes to how student loans are treated in bankruptcy.

Pricing Student Loans by College

The New York Times reported today that New York Attorney General Andrew Cuomo sent a letter to Senator Christopher Dodd and Representative George Miller complaining that private student lenders are setting interest rates based on the colleges students attend. The NYT story explained the practice this way:

Students at colleges with default rates of 3 percent or less, the letter said, were eligible for private loan interest rates of 8 percent to 9.25 percent. At schools with default rates of 3 percent to 5 percent, students could obtain loans at interest rates of 9 percent to 12 percent. And at colleges with default rates of 5 percent to 10 percent, students paid interest rates of 11 percent to 14 percent.

What's wrong with that? Consumer lenders are entitled to earn a profit and part of earning a profit includes considering the possible default rates of borrowers.

Because I could not find Attorney General Cuomo's letter on his web site or on the web sites of Senator Dodd or Representative Miller, I have to rely on the NYT's summary of it. Cuomo is quoted as comparing the private student lenders activities to redlining: "Just as lenders in the mortgage industry once made judgments about credit lending in entire neighborhoods as a whole, so too are lenders making generalized judgments about student and parent risk based on a student's school neighborhood." It may be effective political rhetoric to compare the two situations, but they are inapposite. The practice of redlining had the taint of racial prejudice, and there is no evidence that is occurring. Cuomo's letter mischaracterizes the facts. Lenders are not making judgments based on the "neighborhood of the school"--and a good thing that is for some schools!--but on repayment histories.

Later, the story cites statistics from Cuomo that a student at Duke University might pay 8% interest, but a student at the University of Phoenix pays 11%. These examples were chosen carefully because they raise the specter of a privileged Duke student getting a break the blue-collar student at the University of Phoenix does not (to draw on the stereotypes of the students at the two universities).

Rolling Back the 2005 Law on Student Loans

Generally speaking, a consumer cannot discharge a student loan in a U.S. bankruptcy case unless the consumer can show undue hardship. Before 2005, the restriction on discharge reached only student loans made by governmental entities and nonprofit institutions. The idea was that governmental entities and nonprofit institutions made student loans to persons who otherwise might not be able to afford to attend college. To protect these student loan programs, the Bankruptcy Code gave government and nonprofit lenders this special advantage not available to most other consumer lenders.

The 2005 bankruptcy law amended the Bankruptcy Code so that student loans even from private lenders could be nondischargeable in bankruptcy. With the disclosures of side payments to college loan officers and other abuses in the student loan industry, Congress has been taking a closer look at lenders of student loans. On June 6, the Senate Committee on Banking, Housing, and Urban Affairs held hearings on the state of student loans, with New York Attorney General Andrew Cuomo describing private loans as the "Wild West of the student loan industry."

Senator Dick Durbin made what appears to have been the first response to these hearings. He has introduced S. 1561. Under Senator Durbin's legislation, only student loans "made, insured, or guaranteed" by a governmental unit would be nondischargeable in bankruptcy (absent a finding of undue hardship). The legislation would allow loans from private or nonprofit lenders to be dischargeable in bankruptcy. The discharge of loans from nonprofit student loan lenders would be a change from the pre-2005 law and was prompted, as I understand it, from reports that for-profit private lenders were sometimes working through nonprofit organizations. Also, as I read the legislation, it would make loans from state, but not private, universities and colleges nondischargeable. Take that Harvard.

Student Loan Scandal Fallout

Among the many wonders of the 2005 bankruptcy amendments is the provision that for-profit student loan agencies would get the same protection of non-dischargeability as government lenders.  No one seems to know where the amendment came from and no one seems to recall any evidence of abuse that would cause these for-profit lenders to get treatment usually reserved for domestic support recipients and the taxing authorities. 

In the wake of the scandals over loan company payoffs to college officials, higher education experts are taking a closer look at BACPA.  In a document that was leaked last week, the lobbying strategy of for-profit lender Sallie Mae was exposed.  Educational policy expert Bob Shireman has started asking questions about those strategies, particularly as they relate to bankruptcy. 

Debt Relief for Prosecutors and Public Defenders

Earlier this week Senator Dick Durbin introduced legislation that would create a student-loan repayment program for new prosecutors and public defenders.  The program would cover up to $10,000 per year of loans, with a lifetime cap of $60,000.  To be eligible, attorneys would commit to at least three years of service.  It is heartening to see progress on student loans being made during the week that Credit Slips guest blogger David Moss has so effectively articulated the inadequacies of the current system.

More than 80 percent of law students finance their education with loans, and they graduate with extraordinary amounts of student debt – an average of $51,056 for state school graduates and $78,763 for those who graduate from private schools.  Many of these students still carry additional debt from their undergraduate educations.  Starting salaries for attorneys in the criminal justice system are in the mid-$40,000s, with a median of $46,000 for State prosecutors and $43,000 for public defenders.  (Federal prosecutors are already covered under a separate program.)  Persuading students to take jobs with starting salaries below their level of total debt is a tough sell.  A program like this would eliminate some of the hardest choices students face.

Transforming the Way We Finance Higher Education

In my various posts this week, I've focused on some of the problems that afflict our current system for financing higher education.  The new approach I've suggested would ensure that every American could pay for college on the basis of income-contingent federal loans. 

A comprehensive income-contingent-lending (ICL) program would transform the way we finance education and training in this country, much as social security transformed the way we finance retirement. In fact, such a program might be thought of, roughly, as social security in reverse. Instead of paying-in over one’s working life to finance retirement (i.e., once one’s human capital is depleted), an ICL program would allow a young person to build human capital up front and then spread the cost over his or her working life. Like social security, an ICL program would allow Americans to cover risks they couldn’t otherwise cover on their own, and it would take advantage of the withholding system to simplify and streamline administration.

The ultimate investment we can make as a society is an investment in the education of our young people. Sadly, our existing system for financing higher education is hopelessly inefficient and complex – and this, at a time when the benefits of higher education have never been more clear. We can do better. A comprehensive ICL program would be like a GI bill for everyone, but one that would also pay for itself over the long term. Social security transformed retirement by changing the way we finance it. It’s time we do the same for education.

 

Promoting Investment in Education through Income-Contingent Lending

In yesterday’s post, I identified a number of problems with our current system for financing higher education, and I promised that I would suggest a new approach.

The option I think we should strongly consider is to ensure that every American can finance college or graduate-school tuition (or the cost of job training) with a special income-contingent federal loan. The loan would have an extended term (up to 30 years, like a mortgage) and would defer or potentially forgive interest payments for any year in which the recipient’s household income fell below a pre-specified trigger.

Income-contingent lending for education is certainly not a new idea. In the past, its intellectual champions included both Milton Friedman and James Tobin, two Nobel laureates in economics from opposite ends of the political spectrum. Among politicians, key supporters have included Congressman Thomas Petri, Republican from Wisconsin, and former Senator Bill Bradley, Democrat from New Jersey. The idea has broad appeal because it addresses an important weakness in our market system.

Just as limited liability law encourages investment in financial capital, an income-contingent-loan program would encourage investment in human capital by limiting the investor’s downside risk. In my view, it would represent a vital – and ultimately self-financing – policy innovation for the information age.

In Need of a New Approach for Financing Higher Education

Over the course of this week, I want to discuss student loans, including the inadequacies of the existing system for financing higher education and a potential strategy for improving it.
 
As I see it, the current patchwork of programs for covering college tuition makes little sense. The system is maddeningly complex. What’s worse, it does a poor job of managing risk and assessing need, and it actually discourages household saving. Most student loans, moreover, require borrowers to bear the heaviest burden when their earning power is lowest. For such a major lifetime expense, it is imperative that we do better.

I’ll suggest an alternative approach in my next post. First, though, I want to focus on the nature of the problem we need to solve.

Bush Opposes Cut in Student Loan Interest Rates

The prospects for slashing the interest rates on student loans have dimmed considerably. The Chronicle of Higher Education reported this morning that the president has announced his opposition to the bill currently working its way through the House. A copy of the president's full statement is here. Although the president did not come out and say he would veto the bill, that appears to be a distinct possibility.

I am all in favor of cutting interest rates on student loans, but I also recognize there is no free lunch here. Someone has to pay. In a post earlier in the week, I raised the question of exactly who will pay for this. Today's N.Y. Times reports the following:

The rates would drop from 6.8 percent to 3.4 percent in stages over a five-year period under the House proposal. That would cost nearly $6 billion, according to the Congressional Budget Office.

To avoid increasing the deficit, the bill's cost would be offset by reducing the yield on college loans the government guarantees to lenders and cutting the guaranteed return banks get when students default. Banks also would have to pay more in fees.

Cutting through the rhetoric, it appears that the lenders would ultimately bear the costs. Proponents of the interest-rate cut say that the student-lending industry could easily afford it. Its loans are federally subsidized and carry little risk. For example, student loans are generally not dischargeable in bankruptcy. I see that point, but we're talking about a 50% rate cut. The target interest rate of 3.4% would be below the yield on a 10-year U.S. Treasury note, which stood at 4.7% this morning. Sure, student loans are profitable products for lending institutions, but are the returns so dramatic that the industry could absorb a 50% decrease on its interest rate?

UPDATE (1/19/07): This bill has passed the House on a 356-71 vote. It is now pending before the Senate Committee on Health, Education, Labor, and Pensions. The bill's status can be tracked through the Library of Congress' THOMAS service.

 

Looking for the Unfree Lunch on Student Loans

Much has been written about the Democrats' promises to enact new legislation in their first 100 hours of control over the Congress. (Aside--if my students think time passes slowly during my classes, they should see the way the congressional Dems keep time (NYT, reg. req'd).) One of the pieces of legislation is a promise to slash interest rates on student loans by half over the next five years. There have been a number of news stories on this plan, and the story in today's New York Times (reg. req'd) will get you up-to-date.

I don't know enough about the student loan program to understand exactly how this is going to work, and I'm too busy or lazy (take your pick) to educate myself on it. Maybe Credit Slips readers will help me out here in the comments. There is no free lunch, to coin a phrase, so who's paying for this? Debb Thorne posted on student loans a while back, and there is no question that reducing the crushing debt burden on graduating students would be a huge policy win for the middle class. The bankers claim the rate cut will fall on them. Is that right? Is the Democrats' plan just a big federal subsidy?

Student Loans: A Modern-day Form of Slavery?

This past week, students in my Social Inequality course were asked to read and think about causes and consequences of various types of debt. Given the audience, it's no surprise that student loans kept coming to the fore. Well over three-quarters of the students indicated that they would graduate with loans--many of them well over $20,000 owed on a Bachelor's degree in the social sciences, majors that are vital for our society but not notorious for their high salaries. They described an increasingly common pickle--there was no way that they could have attended college without the loans, and they are frightened that they will not be able to repay them, but they knew that without the college degree, their futures were beyond bleak. To say they feel between a rock and a hard place would be an understatement.