September 21, 2013

For All Our Good, Let Student Debtors Go Bankrupt

BOSTON (TheStreet) -- We've all heard the figures: Student loan debt in the United States now exceeds $1 trillion dollars, surpassing our nation's collective credit card debt.

Yet, unlike our credit card debt -- or any other debt, for that matter -- student loans for the most part cannot be discharged in bankruptcy. A report released in August by the Center for American Progress, though, calls for that to change.

Specifically, the report calls for guidelines to define and differentiate "Qualified Student Loans" from other loans. A Qualified Student Loan is one that offers reasonable repayment conditions including low interest rates and "access to favorable forbearance, deferment and income-based repayment options," as well as requiring successful track records for career success and salary prospects among graduates from participating institutions. The center argues that loans that do not meet this criteria should be eligible for discharge in bankruptcy just as credit cards are.

Student loan debt hasn't always been exempted from bankruptcy. Restrictions began in the 1970s out of concern that recent graduates in fields with lucrative career paths would simply accrue as much debt as needed and then discharge it via bankruptcy immediately after getting their degrees.

Congress implemented a reform in 1976 for five years' wait after completion of a degree before debtors could declare bankruptcy. In 1990, this was increased to seven years. The intent was to allow students to advance up a career ladder and develop good credit they would be reluctant to mar with a bankruptcy filing.

The law was reformed again in 1998 to exempt federal student loans from bankruptcy. In 2005, this exemption was extended to private loans with the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act. Since then, student loans can now be discharged only in very rare cases of "undue hardship" -- usually the most dire of circumstances, such as the development of a debilitating medical condition.

Times have changed. The economic collapse of 2008 ushered in the Great Recession and along with it, historic rates of unemployment. The economic recovery has been slow, with recent college graduates ages 20 to 24 suffering levels of unemployment 40% to 50% higher than those in their age group nearly 35 years ago.

At the same time, the cost of college continues to balloon. Specifically, average college tuition and fees have increased by 440% in the past 25 years -- four times the rate of inflation. And yet a federal Pell Grant, which does not have to be repaid, now covers less than 34% of tuition for students from low- and modest-income families, as compared with nearly 70% in 1980.

College students now graduate with an average of $26,000 of debt, and about 45% of American families owe some student loan debt.

"We need to reform the nearly four-decades-old policy of blocking borrowers from discharging student loans in bankruptcy, a policy that only makes sense for good loans for good programs," said David A. Bergeron, co-author of the CAP report and vice president for postsecondary education there, in a press release. "Today's student-debt levels were unheard of when Congress last took up this issue, and our nation's bankruptcy laws should reflect that change."

The report is not the only sign of changing perceptions about the issue. This past January, U.S. Sen. Dick Durbin introduced the "Fairness for Struggling Students Act," which would make private student loans dischargeable like other forms of private debt. The bill floundered in the Senate but did call more political and public attention to the issue.

CAP cites the Durbin bill as a step in the right the direction. Unlike the Durbin bill, though, the CAP report supports inclusion of federal loans for bankruptcy, since private loans account for only 15% of all student loan debt.

There are also concerns that without the option of bankruptcy for all student loans, the continued rise of college costs will require students to take on ever-higher amounts of debt and discourage them from pursuing more diverse career paths.

In particular, a working paper by Princeton professor Jesse Rothstein argues that to pay off student debt, students will be more likely to forgo jobs in social service and nonprofit sectors in favor of higher-paying positions that do not necessarily play to their strengths or passions. There might be also be a lack of entrepreneurship, as those saddled with large amounts of debt will avoid the risk-taking necessary to get business ventures off the ground.

Such claims are not without merit. Statistics reveal that young adults are putting off or altogether abandoning what was once seen as cornerstones of adulthood, such as buying cars or homes, starting families or even just living independently. Pew Research reported last year that three in 10, or 29%, of people ages 25 to 34 lived with their parents.

According to demographer Cheryl Russell of New Strategist Publications, "debt, coupled with double-digit unemployment, has hobbled millions of young adults who would have bought homes, married, had children and feathered their nests with all the middle-class goodies that keep our economy humming."

"Rising student debt has been eating into the housing and auto markets," wrote Brad Plumer in The Washington Post in April, while many argue that letting students overburdened by student loans go bankrupt would actually invigorate the overall economy.

"This entire system must be overhauled," wrote Salon contributor David Dayen. "Otherwise, it will continue to damage our economy by indenturing talented students, our greatest renewable resource."

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