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For-Profit Student Lenders Win Again

posted by Bob Lawless

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.

Bankruptcy experts will be familiar with the following history. Really serious bankruptcy experts also may recognize that I am gliding over a few nuances, but the general frame of the history is correct. In 1976, Congress first added an exception to the bankruptcy discharge dealing with student loan debt. That exception was continued in the 1978 Bankruptcy Code, and the exception was expressly limited to student loans from a governmental unit or nonprofit institution. Even then a student loan could be discharged if more than five years had passed since the loan first became due (typically after graduation) or if the debtor could show payment of the student loan would cause undue hardship, which is a difficult burden to show.  In 1990, five years was changed to seven years and in 1998 was dropped altogether, leaving undue hardship the only reason a court could discharge a student loan from a governmental unit or nonprofit institution. As part of the 2005 changes to the U.S. bankruptcy law, Congress again amended the student loan discharge exception to allow even loans from for-profit lenders to be excepted from the bankruptcy discharge.

Before H.R. 4317 left the House of Representatives, Rep. Danny Davis (D-IL) offered an amendment that would have subjected for-profit student loans again to the bankruptcy discharge if they had become due more than five years before the bankruptcy filing. Student loans that were less than five-years old would still only be dischargeable upon a showing of undue hardship. The House defeated Davis's amendment 179-236 with 52 Democrats and 184 Republicans voting against it.

On its merits, the amendment should have been adopted. The idea behind the student loan discharge exception is that student loans are essentially a loan against future human capital. The lender is looking to the debtor's increased earnings potential for repayment. The concern was that such a relationship is especially subject to abuse by a debtor who refuses to take advantage of the increased earnings potential the student loan might have afforded. We can't force the debtor to work at a higher paying job, but we can deny the debtor the benefit of discharge if he or she refuses to do so. As it was originally enacted, five years was viewed as enough time to avoid most concerns of abuse, and it would make sense to reenact the rule to all student loans. Student loans from for-profit lenders, however, have the biggest potential for abuse, and they should have to play by the same rules as all other for-profit loans.

In any event, those horses have left the station after the ship has sailed. H.R. 4317 passed the House with a veto-proof margin, and the bill is in the Senate without the Davis Amendment. Perhaps Credit Slips readers might have a sense of the prospects to add something like the Davis Amendment in the Senate?

The vote in the House, however, shows the continuing power of the consumer financial services lobby to work with sympathetic legislators to block legislative changes. Is the vote on the Davis Amendment perhaps an indication of what might happen to legislation that would help alleviate the mortgage crisis, especially bills to give bankruptcy judges power to amend home mortgages? One is tempted to think it might be, but I wonder whether that is correct. The mortgage crisis obviously has a lot more visibility than this student loan issue. Representatives or Senators who stand in the way of home mortgage relief legislation should pay a heavier political price and thereby might not be so able to resist legislative reforms.


Thanks for posting this. I agree that the student loan issue isn't getting nearly the amount of visibility that the mortgage crisis is. That makes sense, since a lot of people own homes and not nearly as many people have huge amounts of student loan debt. But, for those of us who do, I think it's a lot worse. At least if you're caught in a bad mortgage you CAN declare bankruptcy and get a clean slate. When I was young, I made the dumb mistake of taking out a huge sum in student loan debt--over $100,000--from SallieMae. Last year, I declared Chapter 7 bankruptcy and discharged about $30,000 in credit card debt (which I couldn't pay because I pay so much in student loans every month), but I still have the student loan debt millstone hanging around my neck. Just like a bad mortgage, my payments are adjusting to higher amounts this fall--from $750 a month to over $1000 a month--and my student loan debt now takes up about 35% of my monthly take home pay. I never thought that choosing to get a graduate degree, and to finance it with student loans, would come back to haunt me like this.

A friend e-mailed me with the following, which goes back even further on the history of student loans. It's from Professor Douglass Boshkoff's article "Fresh Start, False Start, or Head Start?" at volume 70 of the Indiana Law Journal, pp. 549, 552 (1995):

"The most significant educational assistance program for students at institutions of higher education originated during Lyndon Johnson's final term as President. The funds advanced were never loans as that term is conventionally understood. It is difficult to imagine any responsible lender advancing funds to a borrower who has no assets to serve as collateral and no steady income to support repayment. Calling these grants of public assistance "loans" was simply a way to make this program politically palatable. The term suggested no long-term claim on the fisc. Not surprisingly, default was soon common as some students did what many of us might do: following graduation, they filed for bankruptcy to protect future earning power. As the default rate shot up in the early 1970's, legislators anxious for political cover and looking for a scapegoat found it in the shiftless scholars who too quickly sought bankruptcy protection. The congressional reaction to this outrageous demonstration of moral laxity was the exception to discharge for educational debt."

I think Clinton allowed Congress to take out the seven year rule to placate his buddies who ran high-tuition high-failure rate trade schools. one silver lining however, even if the student loan is not dischargeable, the creditor still has to collect it. The student lender can intercept tax refunds, but again thats a function of earning power. Help reduce the federal debt by taking lower refunds

The student loan crisis--and that is exactly what it is--is not as politically visible as the housing crisis, because many student debtors are embarassed by their predicament. How can they be so smart and educated and yet so dumb at the same time as to take out loans they can never pay back? So many feel guilty, blame themselves and retreat into a private life of misery, there is no political lobby for student debtors.

The housing crisis on the other hand, goes to the core of the American dream: home ownership. OF course over the last decade and a half home ownership has not meant a modest home, but an environmentally destructive McMansion in the suburbs. Pretty sad that our society and political leaders are going to give people who got wrapped up in this type of materialism a break, before they will give any relief to people whose biggest crime was to get an education. Instead of helping student debtors, politicians of both parties continually push the pendulum the other way. The non-dischargeability of student loans in bankruptcy is totally medieviel and revanchist and needs to change, but unfortuantely it still seems like there is no political will to stand-up and do what is right. Bankruptcy is a form of relief for people who truly can't pay anymore; it is not a walk in the park, you have to hand over your non-exempt assets, etc. Student debtors deserve relief more than the materialistic sheep who bought McMansions.

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