Plan to Discharge College Student Loans through Bankruptcy Avoids Real Issues
Higher education debt suddenly has become one of the nation's hottest domestic issues. In response, a number of lawmakers believe they have a way to preserve both the integrity of the financial system and the opportunities to attend college. Several weeks ago the House and Senate introduced legislation to enable adults to discharge outstanding student loans in bankruptcy court that had been underwritten by private-sector lenders. The bills, the Fairness for Struggling Students Act (S.114) and the Private Student Loan Bankruptcy Fairness Act (H.R. 532), would repeal the portion of the 2005 bankruptcy law overhaul that removed this option. Sen. Dick Durbin, D-Ill. (in photo), declared in late January, "We can no longer sit by while this student debt bomb keeps ticking." Yet the details lead the conclusion that the legislation would enable irresponsible lending more than curb it.
It's a growing fact: People are struggling with student loans. And more than a few have developed a case of buyer's remorse. Jean Pierre Salendres, a junior attending Columbia University who anticipates owing $40,000 upon graduation, told Bloomberg Businessweek last September: "My question becomes, is studying in a liberal arts college a bad choice? Maybe something more practical lands you a job." Michael DiPietro, 25, a Brooklyn, N.Y. resident who graduated from the Parsons School of Design with a bachelor's degree in fashion, sculpture and performance, and who owes about $100,000 for his effort, likewise stated: "I've come to the conclusion that it's an obsolete idea that a college education is like your golden ticket. It's an idea that an older generation holds on to."
Data from a Federal Reserve Bank of New York report released in February (see pdf), "Household Debt and Credit: Student Debt," suggest that such cases, while still in a minority, are on the rise. While only about one in eight outstanding student loans as of the close of Fourth Quarter 2012 carried balances of $50,000 or higher, the grand total stood at $966 billion, a near-tripling from the total of eight years earlier. Adults in the age ranges of "Under 30," "30-39," and "40+" each accounted for a third. And the overall balance is likely to climb further. For one thing, the proportion of 25-year-old adults in the U.S. carrying student loans rose during 2004-12 from 27 percent to 42.5 percent. For another, the average balance grew to about $25,000, up from a little over $15,000 in 2004. Delinquencies also are on the rise. Some 6.7 million of all borrowers, or 17 percent, are at least 90 days delinquent, a percentage figure roughly double that of 2004. And this doesn't even include the 44 percent of accounts that haven't entered the repayment phase as a result of deferments and forbearances.
So why are so many Americans saddling themselves with so much student debt? Are we gluttons for punishment or simply naive? The most likely explanation is that we recognize that a college degree still opens career doors, especially for careers requiring a highly specialized set of skills. Data from the Census Bureau's American Community Survey (see pdf) underscore the close relationship between educational attainment and earnings. During the period 2006-08, median annual earnings for full-time, year-round workers aged 25-64 with no education beyond a high school diploma totaled $34,197. This figure rose to $44,086 for adults with a two-year associate's degree and $57,026 for those with a four-year degree. For persons whose highest level of educational attainment was a master's, professional or doctorate degrees, the respective figures were $69,958, $103,411 and $88,867. The ACS figures for "synthetic" (i.e., expected) lifetime work earnings also are revealing. Median synthetic earnings for non-Hispanic white high school graduates ages 25-64 during 2006-08 were $1.69 million. That figure rose to $2.85 million for non-Hispanic whites who had obtained a bachelor's degree. For those with master's, professional and doctorate degrees, the figures were $3.32 million, $4.75 million and $3.69 million. Similar upward tendencies can be found among females and nonwhites.
From a purely economic standpoint, students are right to expect higher education to be a sound investment. Yet they don't want to spend years and possibly decades paying off loans that made the education possible. The problem is that college costs are rising, and are doing so at rates faster than other costs. During 1978-2011, college tuition and fees grew annually on average by 7.45 percent. Annual medical care and new homes, by contrast, grew, respectively, by 5.8 percent and 4.3 percent, while the Consumer Price Index increase averaged only 3.8 percent. What's more, the fastest increases for higher education, unlike for the rest of the economy, occurred after 2000. In absolute numbers, the cost is hardly pocket change. For the current academic year, notes the College Board, average in-state tuition and fees at a public institution is $8,655; for private institutions, the figure is $29,056. Neither figure includes books or basic living expenses.
These indicators go a long way in explaining why many students who choose to borrow from a private lender have problems paying them off after they graduate. That's where Congress comes in. This past January 23, Sen. Durbin, joined by Sens. Al Franken, D-Minn., and Tom Harkin, D-Iowa, introduced the Fairness for Struggling Students Act of 2013 (S.114). Two weeks later, on February 6, the House, led by Rep. Steve Cohen, D-Tenn., followed suit with a similar measure, the Private Student Loan Bankruptcy Fairness Act of 2013 (H.R. 532). Each bill would allow private student loan debt to be discharged in bankruptcy court in a manner similar to that of other debt. This was, in fact, the way things were done from 1978 to 2005. In that latter year, Congress, after trying for close to a decade, enacted a landmark reform law known as the Bankruptcy Abuse Prevention and Consumer Protection Act, which included a provision eliminating student loans as a category of debt that could be discharged in a personal bankruptcy. The sponsors of the new proposals, needless to say, strongly object to this provision.
For sponsors and their supporters, allowing people to write off student loans as part of a bankruptcy filing is crucial to preventing a national credit collapse. Senator Durbin has been unveiling versions of this legislation since 2007. Those proposals went nowhere. But given that student loans suddenly are a "hot" issue, he stands a realistic chance of winning the day. In explaining his current version, he stated:
(S)ince 2005, private student loans have enjoyed a privileged status under the Bankruptcy Code. They cannot be discharged in bankruptcy except under the most extreme circumstances. Only a few other types of debt cannot be discharged in bankruptcy - criminal fines, child support, taxes and alimony. In contrast, nearly all types of private, unsecured debt - credit card debt, doctor bills - are dischargeable in bankruptcy, but not student loans.
His populist sensibilities aroused, Durbin emphasized that the statutory change was a political gift to the student loan industry:
There was no good reason for Congress to give preferred treatment to these financial institutions that are peddling these private student loans. It was a provision - a sweetheart provision - tucked into a massive bankruptcy reform bill with very little debate and even less justification. There is no evidence that private student loan borrowers were abusing the bankruptcy system before this law was changed. In fact, the private student loan market has been growing - even before this measure was enacted into law. But the private student loan industry got a sweetheart deal out of Congress, and now we are in a situation where many students have overwhelming private student loan debt, and they cannot repay, and they cannot escape. This is devastating for those students and a drag on our overall economy.
Such an assessment suggests a scenario of untold millions of adults facing lifelong servitude to banks and bill collectors. Yet the reality is more complicated. There is, in fact, every reason to believe that a borrower, once having found full-time gainful employment following graduation, can and will make timely payments. The legislation, at bottom, is a demand-side bailout. It gives borrowers, certainly those determined to attend a private college or university, an added incentive to take out loans they can't afford. Lenders might respond to escalating defaults by sharply curtailing their lending or imposing severe terms upon even qualified borrowers. Equally plausible, the Department of Education would supplant bank lending by ramping up its direct loan program.
There are several reasons why the Durbin-Cohen approach is premature and potentially counterproductive.
First, bankruptcy, properly understood, is a last resort. Making student loans eligible for discharge encourages debtors to take the easy way out and creates long-run difficulties as well. Federal law allows for two types of personal bankruptcy: Chapter 7 and Chapter 13. Under Chapter 7, unsecured debts are cancelled within 90 days of filing. But it's not quite the proverbial ‘fresh start.' The bankruptcy stays on one's credit report for 10 years and potentially longer. A bankruptcy petition can be awarded only after a minimum of eight years following the discharge of debts of a previous Chapter 7 filing. And the person usually winds up selling property anyway - most importantly, the home - with the proceeds distributed to various creditors. Under Chapter 13, the debtor sets up a three-year or five-year repayment schedule. While he gets to keep his home and other property, he must live under strict court-supervised financial guidelines during the entire period. That means, among other things, he can't take on any new debt. Bankruptcy, in short, can be "the kindness that kills." It offers respite, but it also forces him to put his life on hold.
Second, the 2005 bankruptcy reform law doesn't altogether preclude writing off student loan debt. It allows a borrower to discharge outstanding debt if he can prove that paying back the loan would create "undue hardship" for him and/or dependents. Such cases are especially likely to receive favorable action if the borrower is physically incapacitated or otherwise unable to obtain gainful employment. The process isn't easy. The borrower must file a separate petition in addition to the main one. A judge won't discharge a loan unless the borrower can make a strong case that the loan is impossible to pay back and he has exhausted all reasonable remedies. And the definition of a "hardship" varies from state to state. Still, the hardship exemption is a live option. And most importantly, it typically applies to the sorts of cases that the new Senate and the House bills seek to address. When Sen. Durbin speaks of "devastating" student loans, he's talking about those totaling more in the neighborhood of $80,000 than $18,000. Up to a certain point, then, the proposals replicate existing exemptions.
Third, college loans generally don't place impossible burdens upon borrowers or their families. They carry terms ranging from 10 to 25 years, which is considerably longer than for most other types of unsecured debt. And extensions are available through deferment and forbearance. Moreover, the use of the median, as opposed to the mean (i.e., average) reveals a less scary situation because the mean, not the median, can be skewed way upward by a relative handful of extreme cases. In a study released last August (see pdf), the Federal Reserve Bank of Kansas City concluded that the average total of student loan debt for First Quarter 2012 was $24,218. That's fairly substantial. Yet the median, the point at which half of all observations are greater and the other half are lower, was only $13,662. And the median per-borrower minimum monthly payment was only $190 in First Quarter 2012. The rapid rise in overall debt, argue the authors, is more due to the rising size of the student population than to the size of the debt. They observe: "Increasing levels of debt have been driven largely by growth in the number of borrowers, rather than growth in the average debt levels of individual borrowers, but average debt has also increased, and individual debt has become an increasing burden in light of recent performance of the national economy."
Fourth, high rates of default are nothing new. Indeed, they were at their highest, by far, more than 20 years ago. According to the Kansas City Fed study, the cohort default rate (the percentage of borrowers who enter repayment in a fiscal year and default by the end of the next fiscal year) rose during the Eighties, peaking in 1989 and 1990 at 21.4 percent and 22.4 percent, respectively. By 2005, the rate declined to 4.6 percent. But in 2009 it rose to 8.8 percent. One understandably could conclude from these numbers that the 2005 bankruptcy reforms, as they applied to student loans, weren't needed. Yet there is another reality here. It was the Default Prevention and Management Initiative, a U.S. Department of Education tracking and counseling program started in 1991, which drove defaults downward. The initiative mandated sanctions, including revocation of federal student loan eligibility, against institutions with unacceptably high rates of defaults. As for the uptick during 2005-09, the main story is where problem loans have been happening with the greatest frequency - for-profit and historically black institutions. As of the fall of 2010, the school with the highest student loan default rate in the country - 34.6 percent - was the southern Arizona campus of the for-profit University of Phoenix. Students at the more than 100 "Historically Black Colleges and Universities" (HBCUs) in the U.S. also are exhibiting financial liability. The GAO reported in 1993 that during fiscal years 1987-90 average annual cohort default rates on loans made to students attending such institutions ranged from 21 percent to 27 percent, well higher than the national average. The pattern hasn't changed much. By fall 2010, HBCUs, which constituted well under 10 percent of all four-year public and private colleges in the U.S., accounted for 42 percent of institutions with default rates of at least 10 percent. And of the 10 colleges and universities across the nation with the highest default rates, eight were "historically black." The Durbin and Cohen bills, knowingly or not, would prop up poorly-managed institutions.
Fifth, the bankruptcy bills fail to address the corruption that long has plagued federal student lending. Corruption raises program operating costs and, indirectly, raises interest rates and heightens the likelihood of default. In private-sector lending - the type of loans which the bills address - banks forward loans directly to educational institutions rather than to borrowers. This arrangement gives colleges, universities and trade schools vast opportunities to pocket some of that money or divert it toward money-losing activities. It's not a new problem. A 1991 Senate investigation found that student loans programs were "plagued with fraud and abuse at every level" and had racked up a combined $13 billion in losses during 1983-90. In 1994, the Education Department admitted it was losing at least $3 billion a year to waste, fraud and default. The pattern has continued even after the 2005 bankruptcy law. The Government Accountability Office in 2009 estimated that taxpayers lose more than $1 billion a year to fraud and abuse in student loan programs. To some extent, students were hustlers. Beginning in the Seventies, it became common for students to file for bankruptcy soon after they finished their education, a practice that went largely unaddressed until the imposition of the "undue hardship" rule in 1998. "Students" also have applied for loans under fake names and identification (it still happens even with the 2005 law in place). But administrators are in on the take, too. Many accept bribes from banks and then include them on the respective school's "preferred lender" list. Sometimes they get into trouble. An investigation conducted by then-New York State Attorney General Andrew Cuomo yielded a $13.7 million settlement in 2007 with a dozen financial institutions, including Sallie Mae, Bank of America, Citibank and JPMorgan Chase, following charges they had engaged in deceptive student loan marketing practices.
Sixth, the measures before Congress rest on the implicit assumption that loans are the best vehicle for a student to obtain aid, and that altering bankruptcy law is needed to keep the system afloat. Yet students have alternatives to loans. Scholarships and other grants remain a common way to defray expenses. Of the average $27,453 yearly total cost for first-time, full-time students living on campus during the 2009-10 academic year, those students who took out loans, factoring in grants, owed only $16,459. And there is room for more, especially at the most expensive elite schools. A study by the National Association of College and University Business Officers found that university endowment funds rose 21 percent in 2007 to a record-high $411.2 billion, while spending constituted 4.6 percent of those assets, which is even less than the 5 percent threshold required of private foundations. By 2011, Harvard, Yale, Princeton and Stanford had respective endowments of $31.7 billion, $19.3 billion, $17.1 billion and $16.5 billion. Online education, moreover, while not providing the prestige of an accredited degree, costs a fraction of enrollment at a traditional campus and can provide high-quality instruction. Independent online distance learning operations such as EdX, Coursera and Udacity, as well as those affiliated with established colleges and universities, now play a prominent role in preparing young adults for the modern workplace.
Defenders of the Durbin-Cohen legislation - and they include co-sponsors such as Sen. Sheldon Whitehouse, D-R.I., Sen. Barbara Boxer, D-Calif., Rep. Danny Davis, D-Ill., and Rep. George Miller, D-Calif. - argue that the significant decline in defaults from early-Nineties levels underscore that the exclusion of student loans from bankruptcy law coverage is both unneeded and unfair. They also emphasize that their proposals would affect only private loans; that is, the area of student lending most susceptible to exploitation. But this view doesn't address, beyond hardship exemptions, why literally tens of millions of adults of all ages in this country should have the option to write off their college loans should they file for bankruptcy. Nor do they address the fact that the cost of a college education has grown well in excess of the cost of living generally. The proposals simply assume that higher education should be: 1) accessible to one and all; and 2) too big to fail. In that, they are well in line with the prevailing philosophy of the Bush and Obama administrations. This approach has worked rather poorly in the area of mortgage lending. There is no reason to believe college lending is immune from the logic of the marketplace.
As an alternative to the easy lure of loans, higher education officials should much more focused on cost control. For lowering the costs of running a university leads to lowering a student's costs to attend that university, and ultimately, the student's costs of borrowing money for that purpose. Spending can be controlled, especially on administrative salaries and benefits. The number of campus bureaucrats at leading universities, proportionately, has grown at minimum at twice the rate of students and faculty. Growth has been especially explosive at offices that establish and enforce rules with respect to "diversity," "equity" or "inclusion," even at institutions that seem to be cutting back on everything else. Such agencies are worse than simply superfluous; they are destructive of free inquiry and discussion of "forbidden" subjects, and hence undermine the whole purpose behind higher learning. Among campus agencies ripe for culling, these are the first that should come to mind.
Leading campus administrators themselves admit the pressing need for cost reduction. David Skorton, president of Cornell University, in an interview with Bloomberg TV last September, stated that college tuition is "rising much too quickly and it's gotten much too high just in the period of time that I've been in higher education - in three and a half decades it's gotten astronomical. It's way out in the stratosphere." He emphasized the need to control administrative costs. Congress would do well to heed such words. In the long run, encouraging colleges and universities to get costs under control is a better way of serving their students than allowing them later on, as cynical graduates, to wipe away their loan obligations.