The U.S. Senate Committee on the Judiciary Subcommittee on Administrative Oversight and the Court held a hearing this week on “The Looming Student Debt Crisis: Providing Fairness for Struggling Students.” In our testimony, we focused on the importance of restoring bankruptcy rights for student loan borrowers. We have written about the reasons for this common sense approach in previous posts.
Among other arguments against restoring relief for student borrowers, Professor Marcus Cole stated in his testimony that student loans should be treated differently in bankruptcy because they are fundamentally different from either secured or unsecured credit. Student loans are different, he said, because they are based upon the debtor’s projected future ability to repay.
This argument doesn’t stand up for a number of reasons. First, it is inaccurate to say that private student lenders base lending decisions only or even primarily on speculation about future earnings. In fact, nearly all private student lenders require co-signers. These co-signers are usually parents or other adults who have earnings records and provide a safety valve for creditors if the student cannot repay. Further, the majority of students pursuing higher education are not financially dependent young people. The majority are “non-traditional” students, meaning that they are working adults over 25 or otherwise financially independent. Many have prior earnings records and credit histories.
This argument is also unconvincing because it would mean that consumer bankruptcy policy should favor creditors that make loans that supposedly have greater risk. As Senator Durbin pointed out at the hearing, any type of credit can be risky if the borrower ends up unable to repay because of health problems or other reasons. This is what underwriting is all about. Creditors must plan for contingencies if the student’s income is either temporarily or permanently different than projected.
Private student loans are not financial aid. They are private credit products that creditors make for profit. Creditors can price the products and create safeguards, such as requiring co-signers, that allow them to make money and absorb the minimal losses that arise when financially distressed borrowers are unable to repay. Creditors should also create non-bankruptcy alternatives that help financially strapped borrowers get back on their feet and avoid bankruptcy. This won’t work for everyone, but in many cases, loan modifications, flexible repayment and other options enable student borrowers to stay out of default until their financial prospects improve.
Given the tremendous damage caused by the mortgage crisis and subprime student lending, we should have learned that it is preferable to create incentives for responsible lending, including putting creditors on notice that borrowers who cannot repay their loans will have the opportunity to get bankruptcy relief. The bankruptcy system then has its own safeguards to weed out those who actually have resources to pay their debts. The current undue hardship system does not provide this relief, except to a small minority of borrowers. It is an arbitrary, random and inaccessible system.
Bankruptcy relief should not be doled out based on subjective determinations of who “deserves” relief. It is a pragmatic program aimed at giving a fresh start to borrowers who do not have the resources to repay their debts. Relief of personal liability, as Professor Melissa Jacoby notes, is the centerpiece of the bankruptcy system, which plays a critical role in a healthy economy.
Professor Jacoby pointed out in a 2010 post that for-profit consumer lenders in the 1970’s criticized treating student loans differently in bankruptcy. “If the social utility of what is exchanged for the debt is to be determinative of dischargeability then the question can be raised of whether it is proper to discharge medical bills, food bills etc..This proposed [legislation] simply suggests that if sufficient political pressure can be generated, a special interest group can obtain special treatment under the bankruptcy law.”
That is not right.