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Bankruptcy and Student Loan Debt

posted by Adam Levitin

My thoughts on whether the Bankruptcy Code should be amended to allow easier discharge of student loan debt are upon The Examiners at the Wall St. Journal. Short of it is yes for private student loans, no for public student loans. I'm sure to catch hell for this from some of the more aggressive student loan forgiveness advocates, given that most of the market is public student loans, but there are other restructuring and foregiveness options available for public loans and serious fairness problems with allowing discharge of existing student loans.  New borrowers shouldn't have to subsidize older ones' dischargeability, and taxpayers shouldn't be picking up the tab for social insurance to the extent that bad educational/career choices are within individuals' control.      

Comments

Okay, here's some preliminary hell from a "more aggressive student loan forgiveness advocate."

"Taxpayers shouldn't be asked to fund mandatory insurance against poor educational and career decisions." I mean, MMT and USG spending isn't "taxpayers" spending etc, but that's a deeper objection. Accepting your formulation, I'm tempted to just say: yes they should. They should, in fact, be asked to fund affordable/free education for everybody: insurance for folks who find themselves broke because taxpayers failed to make education affordable for them is the least taxpayers can do. But even if you don't buy that, this notion that what is happening when students are declaring bankruptcy is asking taxpayers to pay for their personal irresponsibility is unexpectedly removed from reality coming from you. Life's vicissitudes don't only come in the form of illness and business cycle fluctuations. Shitty wages in a shitty job market (secularly shitty--not a fluctuation) and state defunding of education have a much bigger role to play in unsustainable education debt than "poor decisions". And what is a poor decision anyway? Majoring in something other than finance or pre-med? Do we think that the only people who should take a career risk or attempt to work in a less lucrative field are those wealthy enough to pay for an education or lucky enough to find a scholarship? And what about for-profit college students who, even if they manage to get lucky and go to a campus that isn't completely a scam and that even helps them get a job (scams make one eligible for full discharge and rescission but the DOE doesn't do actually do that), are still in way more debt than their medical assistant job can ever help them pay? What mandatory insurance should taxpayers have to pay them?

As for IBR and the like, these aren't the panaceas that you make them out to be. Many of them only apply prospectively, first of all. Second, most students have no fucking idea how to sort them all out and what is best for them and their servicers are at best not fully reliable in placing them in the right program. And if you don't do it right, you can really screw yourself. Third, IBR does not stop interest from accruing, and, unless, you've managed to find a career that qualifies for public service forgiveness, figure out how to get on that plan and submit the right paperwork, maintain that career, etc., you're eventually going to be on the hook for that money anyway. Or maybe your retired parents will, finding their SS checks garnished. Hopefully your kids won't. Of course there's more, but let's stop there.

Bankruptcy is far from the optimal policy tool here, I agree. College should be cheap to free--mostly publicly funded--and all student debt should be forgiven. But I take it that's not what you're recommending.

Student loans were made all too easy for individuals that had no experience, education or training in financial accountability, contract law or general life responsibility. Basically, teenagers could obtain their own financing easier than an abortion. It took 2 sides to create this debt - the financial institution and the individual and apparently, neither had a full sense of consequence.

Student loans induced the inexperienced and were marketed and designed much like NTMs to minorities.

Should they be able to bankrupt the debt? Certainly and the penalty is 10 years with bankruptcy on their credit report. Bankruptcy is never the best solution, but sometimes it is the only answer.

I don't see why it makes a difference that the federal government holds the student loan debt. If we follow that logic, then other types of federal debt should be excepted from discharge. Should taxpayers subsidize failed VA home loans? What about failed SBA loans? Maybe those ought to also be excepted from discharge, even though that would largely deprive people of a fresh start.

Income based repayment and forgiveness programs are still terrible alternatives to a genuine fresh start. Those programs take years to complete, and I seem to remember that there are pretty bad tax consequences too.

I agree that tax payers shouldn't subsidize bad career choices, which is why the federal government should stop subsidizing loans.

Compromise: we still allow bankruptcy for federal student loans, but only Boomers are on the hook for the bill.

I'm only half-joking. It seems equally obvious to me that:
1) Kids these days have it rough, with a horrendous job market, outrageous tuition, and an utterly callous legislature, which, amazingly, is made up almost exclusively of
2) Olds who were thrilled to benefit from 90% marginal tax rates on others to give themselves enormous subsidies, even though they would've been fine in their ass-backward fall into the greatest economic boom in the history of the world (other than current China).

This wouldn't even come close to leveling the playing field, but it's a start.Why feel solidarity with the future when you can sabotage it instead?

The nature of the debt is not the dispositive issue on determining the fairness of providing some American families a fresh start and others not. To the party injured, it is brutally "unfair" for a debtor to discharge liability from a simple auto accident. For a couple renting out their duplex, the burdens of a former tenant's nonpayment are hard to make up. But we provide the "poor but honest" debtor with an opportunity to start over.
Student loans are precisely the sort of obligation that cry out for an independent third party to determine the fairest way to provide the needed fresh start (which is a societal and economic benefit) balanced against the ability of a debtor to pay. But as a trustee I see way too many people - whether they are relatively young or approaching retirement - carrying huge burdens of student loan debt without the benefit of the good job, or even the degree.
Remember that bankruptcy does not have to be all or nothing. We might want to think back to a time when some debts would survive a chapter 7 bankruptcy but would be extinguished after a debtor completed the chapter 13 repayment plan. It is not hard to imagine that we could ask our bankruptcy system to permit debtors - those that undertake the significant sacrifice and effort to repay all of their available income - to restructure the student loan debt after they finish that would let them see a light at the end of the tunnel. I think that giving borrowers a way out would serve us all much better than simply applying the Brunner test to every student loan.

I semi-agree with you, provided that at the same time we eliminate the taxability of the amounts forgiven in the various forgiveness programs. Either it's forgiven or it isn't.

An alternative: Allow the loans to be dischargeable after 7 years, but tighten up lending standards, and also the loan is dischargeable only if the student graduates (or does not graduate due to a new medical disability arising after the loan was funded). Tightening up lending standards means (among other things) we would actually look at the educational programs being supported by federal dollars. We don't need to subsidize starving poets, and we also don't need to subsidize for-profits charging $40K to train people for "technician" jobs that pay $10 an hour max. Requiring graduation means you don't get to attend 3 years of frat parties on the taxpayers' dime and then drop out.

There are a lot of government debts that are dischargeable, including people who simply chose not to pay taxes more than a few years ago. If all debt was recoverable, fines or taxes might be lower, so it's also a taxpayer subsidized discharge. Why should student loans be treated worse? Or should all government debts be subject to the undue hardship test?

Further, some might argue that "illness, accidents and business cycle fluctuations" would be less likely to result in a bankruptcy if people made better "educational and career decisions." You make more, you save more, you weather hard times easier.

I also take issue with the "intergenerational equity problem." If something is bad policy, that policy should nonetheless remain ad infitum because it would be unfair for future citizens to not suffer like past/current citizens?

I agree with a reasonable waiting period (even if it addresses a non-existent "graduate and discharge" problem) and maybe some test between no test and "undue hardship." But overall, both private and public student loan debt should be easier to discharge.

This talk about how discharging student loan debt unfairly imposes losses on third parties sounds a lot like the "bankruptcy tax" idea Professor Zywicki testified about in support of BAPCPA. As others have noted, debt discharges always hurt someone else, and the government is frequently on the business end of a discharge order. And there are of course many compromises between making student loans general unsecured claims and entirely nondischargeable.

I think talk over reforming 523(a)(8) glosses over some real issues though, such as:

(1) how easy it is for trade schools to offer useless degrees financed by student loans;

(2) the glacial pace of shutting down schools with abysmal graduation and employment rates;

(3) schools' willingness to consistently increase tuition to engage in a zero-sum arms race over USNWR rankings, including the equity of financing full scholarships to credentialed students paid for by their fellow students;

(4) what in the world some people are thinking when they take out $200,000 in loans when equally good educations are readily available;

(5) what the hell colleges are doing with all this money; and

(6) why even good schools are so bad at transitioning some of their students, especially liberal arts majors, from education into any job other than serving coffee or the like.

In other words, like a fever, high student loan debt is merely a symptom of a bigger problem.

I could not agree more with the six issues listed by "D" but they are seldom discussed and giving anyone something free without any recourse, and without any consequence is wrong. Educational institutions keep getting free rides because why should they care if students do not repay their loans, leave the institution without any degree, and without any recourse to the educational institution. Lets just add the burden to taxpayers.

I agree with the previous comments. I'll simply add that I was disappointed in the complete lack of nuance in the article. That could have been written by a non-bankruptcy hack, let alone a respected bankruptcy professor. The points above are well stated, so I'll leave the arguments as they lie. I'll just add that I understand the age-old moral hazard argument, and especially where an education can benefit the recipient over a lifetime. Why not discharge the debt and reap the benefits for the next 50 years? I get it. I do. But the same reasoning applies to the failed business person. I often wondered, what about adding a "super chapter 13," where if the majority of your debt is student loan debt, the applicable commitment period is 8 years, or even 10 years? I disagree totally with the assertion in the comments that bankruptcy is not the optimal tool. I think the bankruptcy system is a shining example of a how government institutions can function well and efficiently, and produce the desired results. Well into the hangover from the 20th century, during which the U.S. created great public institutions, where the great challenge will be how to get those institutions to function well (I steal that observation from David Brooks of the NYT), I think the bankruptcy system is fantastic, and an under-appreciated influence on our County's unprecedented rise. Its processes and administrative systems are sound (but far from perfect, I know), and are exactly what needs to be utilized as the tool to help solve the student loan problem.

When a leading bankruptcy pro gets a platform like the WSJ to scream bankruptcy's praises to the masses, and to Congress, he should take the opportunity to educate. Oh I wish that you would have. It is the misunderstanding of bankruptcy that is the problem, which I fear was simply echoed and reinforced in the article.

One more thing, think of all the freed up capital for families (young families, who do most of the buying) to buy things and travel and spoil their kids! And yes, less dollars for Uncle Sam, but hey, maybe while bankruptcy is demonstrating its functioning prowess, the other federal institutions will be forced to show theirs by operating better? All the while getting rid of the systematic problem that began with a twist of the GI Bill, well after the societal expectation of a college degree was firmly adopted, by parents and employers alike, into a forced borrowing situation.

Taxes don't fund spending…

Spending must precede Income which must precede [income]Taxes.

As a point of logic then taxes cannot fund spending.

Taxes are a mechanism for the control of inflation.

Thus, one of the main premises of the author's argument is false.

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