Student loan relief expected to come to bankruptcy court
The Biden administration is reportedly considering expanding its targeted student debt forgiveness efforts to a broader policy that “at least” $10,000 (some have advocated up to $50,000) in student loans per borrower, eventually subject to an annual income cap, would be eligible for cancellation.
There is a rough consensus that rising levels of student debt are a problem, and proponents of debt relief note that the total amount outstanding has increased by about two-thirds over the over the past 10 years to reach a total of approximately $1.7 trillion. The changes made to the United States Bankruptcy Code in 2005 are largely overlooked in the debate, which greatly increased the difficulty of repaying student loans in bankruptcy.
The “undue hardship” standards that apply to student loan forgiveness create a significant barrier to discharge, as borrowers must meet various criteria adopted by the courts. The difficulty of meeting these requirements, as well as the costs associated with filing for bankruptcy, means that little student debt is relieved in this way.
As a financial professional, I am familiar with the legal regime governing the resolution of financial obligations that cannot be honored. I believe that to the extent the borrower and lender fail to reach a mutually agreeable agreement, such disputes should be adjudicated in the federal bankruptcy courts created for that purpose.
Unfortunately, the 2005 changes to the Bankruptcy Code, combined with the federalization of the student loan market in 2010, have placed what is fundamentally a business issue – the repayment of financial obligations – within the scope of public policy. Originally as a guarantor and now as a lender to student borrowers, the federal government has a direct seat at the table. Having broadly outlawed the resolution of student loans in bankruptcy subjects its ultimate disposition to political whims. Politically, the President and Congress would do well to consider several considerations:
• The implications of loan forgiveness for current borrowers. Universal debt relief without specific borrower qualifications would represent a massive transfer of wealth at a time of record federal deficits and scarce public resources. What is the rationale for general relief when the vast majority of this debt is paid off as required by the contract? Traditionally, when the government targets federal resources at individuals, it is to advance a political imperative or create incentives for desired behavior. No one can credibly claim that canceling student debt encourages financial responsibility or other normative behaviors in the same way, for example, that the mortgage interest deduction promotes home ownership.
Another justification is that students were encouraged to borrow money under false pretenses. But targeted relief for loans taken out through for-profit “degree mills” already exists and is largely unchallenged. In the case of the proposed comprehensive student debt extinguishment, which perpetrated the alleged fraud – the federal government, private lenders active in the former federally guaranteed student loan market, colleges and universities, another villain or a combination of these? The collectivization of the cost of the “student loan crisis” suggests systemic market or policy failure, not discrete examples of individuals failing to meet their financial obligations. If it really happened, the public deserves a clear account.
Even if you support such a policy and are comfortable making student debt cancellation a priority over other federal spending, it should be applied fairly. What about those who have already repaid their loans? There is also the prospect of rewarding failure and subsidizing moral hazard. Every borrower prioritizes student loan repayment over other expenses and makes other trade-offs in pursuit of an education and career. General forgiveness ignores these decisions.
• The message to higher education institutions. Colleges and universities have increased their costs to match the abundant federal resources available to students, including student loans. A late 2021 report based on College Board data suggests the cost of a college education has risen about 4.6 times the rate of inflation over the past 50 years.
As state support for higher education has declined, the role of the federal government has increased. Institutions became more dependent on student tuition, and federal aid in the form of grants and loans stimulated student demand, leading to considerable cost inflation. The indiscriminate cancellation of loans, by making higher education “free”, exacerbates these factors and removes any incentive for institutions to manage their costs.
• The impact on future students. Will all future federal aid be in the form of grants and not loans? Or will new loans be expected to be canceled in a future “jubilee” year? Leaving aside the budgetary and inflationary impacts of a policy of rolling off loans or replacing loans with grants, any generationally consistent or “equitable” treatment of prospective students would suggest that higher education will indeed become free.
The notion of free college for all is not new in progressive circles, and the cancellation of student loans is perhaps a step in that direction. But is it the one we want to take when the value of a college degree is increasingly questioned?
Complete cancellation of student debt is bad public policy. A legal regime — the federal bankruptcy system — already exists for those who really need debt relief, with well-established rules and consequences. Rather than pushing yet another inflationary, anti-budget policy initiative, the Biden administration had better propose that the student loan provisions of the Bankruptcy Code be changed and reform student loans to circumscribe the outsized role of government. federal government in funding higher expenditures. education.
Mr. Shinder is founder and managing partner of Theatine Partners, a financial advisory firm.
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