On September 23, the U.S. House of Representatives Judiciary Committee, Subcommittee on Commerical and Administrative Law held a hearing on discharging educational debt in bankruptcy.

Brett Weiss delivered testimony on behalf of the National Association of Consumer Bankruptcy Attorneys (NACBA) and NCLC’s Student Loan Borrower Assistance Project.  Chairman of the House Committee on Education and Labor George Miller issued a statement in support of the need to change bankruptcy laws to protect student borrowers.  Representative Danny Davis also testified at the hearing.  Other testimony is available on the hearing web site.

We cited a report from the 1970’s in our testimony because 1)  This is the report Congress commissioned during the initial debate on this issue, 2) This report did not support the conclusion that students were more likely to discharge debts in bankruptcy, and 3)  It is the only comprehensive report on this issue that we know of.   There simply isn’t any evidence to support the claim that student borrowers are more likely to declare bankrutpcy than other consumers.

The hearing focused on problems with the current undue hardship system.  The current system is broken in many ways, as we detail in our testimony.  Professor Rafael Pardo also testified about problems with the undue hardship test.

The undue hardship system is broken, but we urge Congress to do more than simply tweak the hardship test.  Low-income borrowers have few, if any, resources to pay for legal assistance to prove to judges that they suffer from undue hardship.  This would still be true even with a more defined standard.   Although it would be helpful to have a clear definition under the current system, the better solution is to restore dischargeability rights for students.

Policymakers should also beware of arguments that changes in bankruptcy policy would constrict the availability of private student loans or make them more expensive.  The reality is that before the bubble burst, lenders spent years making all kinds of loans regardless of risk.  They lent money like candy in cases where the debts were ultimately dischargeble in bankrutpcy (e.g. credit cards) and in cases where debts were harder to discharge in bankruptcy (e.g. mortgages and student loans).   The result was a largely unregulated predatory student lending market.  (Lauren Asher, President of the Institute for College Access and Success, testified at the hearing about key problems with private student loans).

A more restrictive bankruptcy policy probably made the student loan securitization packages more attractive to many investors, but investors were buying up just about anything during the bubble years.  A return to the days of risky lending is not good for borrowers, creditors, or the economy.

We will not rein in abusive credit practices by denying rights to financially distressed borrowers.  Rather, we need regulation to ensure that creditors lend more responsibly.

In April, we released a report about the lack of options for private student loan borrowers.  Unfortunately, our clients and other borrowers who have contacted us tell us that not much has changed since April.

We are hopeful that there will be a brighter future going forward, perhaps with a new consumer financial protection agency.  Even if this much-needed re-regulation occurs, there are countless borrowers stuck with loans that they have no hope of repaying.    Lenders and the government have decided that, unlike the lenders that made these loans, these borrowers are “too small” to help.  In reality, their numbers are large, but their political power is not.

Is there political will to do something about this and if so, what can be done?  We listed a number of possible solutions in our report, including:

1.  Mandating Loss Mitigation Relief

2.  Restoring Bankruptcy Rights for Private Loan Borrowers, and

3.  Creating Loan Cancellations for Fraud Victims

Senator Sherrod Brown of Ohio recently added another proposal to this list.  The basic concept is to allow some borrowers to swap private student loan debt for federal student loan debt.  These borrowers would then be eligible for the range of federal flexible repayment and other options.  Borrowers would choose whether they want to participate and at least in the current proposal, would be able to swap only up to what they could have borrowed (but didn’t) under the federal loan limits.

We have concerns about this proposal.   Among other issues, it does not go far enough to help the neediest borrowers, mainly those who are delinquent or in default.  Also, many borrowers will be left with balances on their private loans even after the swap.

Despite these concerns, we commend Senator Brown for focusing on these financially distressed borrowers and for recognizing the need to talk about possible solutions.   We hope this discussion will occur in Congress, in the Administration and across the country because the borrowers we wrote about in April are still stuck with high cost loans, economic conditions and unemployment rates are still dismal and the lenders who created this mess are not voluntarily providing relief.