This is the first of a series of articles addressing common arguments in the student loan bankruptcy debate.

“If private student debt can be discharged in bankruptcy, that creates risk, and the result will increase the cost of tuition.”
Scott Talbot, Financial Services Roundtable, quoted in a May 15 USA Today article

Mr. Talbott seems to be saying that treating student loans the same as other debts in bankruptcy would create greater risk for creditors.  This is far from obvious.  If most borrowers who file for bankruptcy don’t have the money to repay their debts, a more restrictive bankruptcy policy isn’t going to make the loans less risky.

It is certainly true that private student loans, made without government guarantees, can be risky for both creditors and borrowers.  Many students are young, with little or no credit history.  Their earning power is mostly speculative. Yet responsible underwriting of student loans is not impossible.  Recent trends in the industry show that creditors know how to sell less risky products.  Lenders such as  Sallie Mae are creating loans with “safer” features such as requiring students to pay interest during school and requiring co-signers.

Mr. Talbott also assumes that creditors will be less likely to lend if there is too much risk.  But this clearly wasn’t true during the subprime lending heyday.  Creditors generated huge profits making risky student loans mainly because they sold the loans after origination, passing the risk along the food chain.

There is no evidence that student loan creditors adjusted their lending in response to changes in bankruptcy law.  The private student loan market was growing rapidly long before Congress in 2005 made private student loans harder to discharge.  This shouldn’t be so surprising.  During the past decades of irresponsible lending, creditors threw credit around like candy in markets where the credit was dischargeable in bankruptcy (such as credit cards) and those where it was harder to write off debts in bankruptcy.

There is simply no good evidence that bankruptcy policy affects creditor behavior.  Interest rates, for example, were largely the same before and after the 2005 bankruptcy law which made private student loans more difficult to discharge in bankruptcy.  Until recently, the private student loan market was growing rapidly, but there is no proof that this was because of the stricter bankruptcy policy.  The market has shrunk dramatically in the last year even with a restrictive bankruptcy policy.

The second part of Mr. Talbott’s statement connects bankruptcy policy to the cost of tuition.  It’s not clear what he means by this.  Mr. Talbott could be saying that if bankruptcy policy becomes less stringent, fewer creditors will make student loans and tuition will increase as a result.   As we noted earlier, there is no evidence that bankruptcy policy affects the volume of loans.  But assuming for the moment that there is a connection,  Talbott’s conclusion is that a smaller private loan market will drive up the cost of tuition.   Is there a causal connection here?  If students have less money to pay for education,  couldn’t this drive down the cost of tuition?  The high cost of education is generally a big mystery, but at least some  studies have found that the widespread availability of financial aid creates incentives for schools to raise tuitions.

The truth is that lending always involves some risk.  No credit scoring model can accurately predict every contingency.  People get sick, lose their jobs, or fail in their careers. Should we keep constricting the safety net for borrowers because we think this will encourage creditors to keep lending?  Is this really better for creditors?  Do they make more money from loans without consumer protections?  This is not  entirely clear.  It is certainly not better for students who need a safety net.  Is it better for society?  Certainly not if the goal is to improve equal access to higher education because under the current policy of increased loans and lower grant aid, the gap in access  to education for lower income students keeps growing.  The path to equal access to education will never be paved with predatory student loans.

Ultimately, it is better for society if individuals have some flexibility to take chances.  If public policies only encouraged safe choices, few would borrow to go to college.  Few would start businesses either.  Megan McArdle notes in a recent article in the  Atlantic that one of the worst decisions anyone can make from a financial point of view is to start a business.  She says that “all of the business literature indicates that starting a business is a phenomenally stupid thing to do.”  Most businesses fail, even those started by those who have previously run successful businesses.  Yet we have decided as a society that we want people to start businesses even if this means writing off some bad debt.  Why isn’t the same principle applied for education?

Emma (not her real name) is typical of borrowers we assist at the SLBA. She is 60 years old, sufficiently disabled to qualify for Social Security Disability and Supplemental Security Income, but not considered permanently disabled by Department of Education standards. She has over $5,000 in federal loans from a community college she attended in the mid-1990’s. She paid for a while, but could not continue after she was no longer able to work. She gets by on about $760 from Social Security and lives on her own.

There is no perfect solution for Emma, but there is an imperfect one. It is a resolution we seek for many of our clients. Emma can get out of default by consolidating her loans with the Direct Loan program and selecting an income contingent repayment plan (or income based repayment as of July). Under the income contingent (ICR) or income based (IBR) formula, Emma’s payments will be 0. If her income improves for some reason, she can start paying more.

At this rate, she will never pay off the loan, but she will be free from collection. After 25 years, if Emma is still alive, the remaining balance should be written off, although under current law some of that amount could be taxable income.

It is not easy to get this imperfect resolution. The first problem is that until Emma sought legal assistance, no one told her about this option. Our experience is that guaranty agencies, collection agencies, the government, and just about everyone servicing student loans rarely takes an objective look at each borrower’s situation to review the pros and cons of different options. This is a lost opportunity because many borrowers would not end up in default if they were counseled properly.

The second hurdle occurs at the application phase. All too often guaranty agencies cause unreasonable delays by sitting on these applications. The applications that get out of guaranty agency offices often get stuck in Department of Education back logs.

The third hurdle is unique to borrowers seeking ICR. This problem has arisen with every borrower we have represented. While the Department is calculating the ICR amount (unclear why this takes so long), they send misleading billing statements that confirm that the borrower has an income contingent payment plan, but then list the interest-only amount as the required payment.

Our clients usually panic when they get these statements because they are expecting a 0 or very low payment and instead get what appears to be a bill with a higher amount. Nowhere on the statement does it explain that the borrower can request forbearance or deferment and postpone payments until the ICR amount is finalized.

The stakes are huge. If borrowers think this is another loan they cannot repay, they will default again. If they default on the new consolidation loan, they will not be able to reconsolidate. There are costs to taxpayers too. If the process is successful, the government will not waste resources trying to collect from borrowers who can’t repay.

There are a few simple steps the Department can take to help address this problem. They can change the billing statements to:

• explain to borrowers that the Department is still calculating the ICR payment;
• explain that borrowers can request forbearances or deferments instead of paying the interest-only amount; and
• that they will get a future billing statement with the ICR amount and that this is the amount they will be required to pay.

They should also figure out a way to calculate the ICR payments more quickly and efficiently.

We have been urging the Department to make these changes for over two years now. They keep telling us that it is very difficult to change a letter, even though they agree that it would be a positive change for borrowers. It is head-bangingly frustrating for us, but of course, much worse for our clients.

Changing a letter is not a catchy rallying cry. It is far from the radar screens of most policymakers and the media, but it is one of many important procedural issues that can make a huge difference for borrowers.

If you are a borrower seeking this option, this self-help packetwill help you find your way.

We have assisted many borrowers over the years and we continually encounter collection, guaranty agency and government staff that do not follow the rules governing the federal student loan programs. To make matters worse, many collection employees treat borrowers horribly even when those borrowers are trying to resolve their accounts.

When we call on their behalf, we are treated just as badly…at first. The difference is that we have the tools and knowledge to fight back on behalf of our clients.

Why does this occur? Is it because the workers are bored? Underpaid? Do they feel that so many borrowers are out to game the system that it doesn’t really matter if a few fall between the cracks?

After all of these years of representing borrowers, I can only say that I don’t know the reasons why borrowers are treated so poorly. It appears to be a combination of bad training, lack of oversight, incompetence, bad attitudes, and conflicts of interest. These problems are compounded by the fact that borrowers are getting information about rights from the parties that are trying to collect from them. Private collection agencies are delegated complex responsibilities such as determining the monthly payments for reasonable and affordable payment plans. These collection agencies also help determine if borrowers have defenses to collection procedures, even though the collection agencies’ financial incentive is not to offer reasonable and affordable plans or to acknowledge defenses.

Regardless of the reasons, the important point is that borrowers are not given accurate, objective information about their rights. It is unfair and counter-productive to treat borrowers this way if we want to help them get back on their feet. All student loan borrowers deserve a fair process. And fairness, as Supreme Court Justice Potter Stewart once said, is what justice really is.