The Best Way to Solve the Student Loan Crisis: Change the Bankruptcy Laws
Americans are quickly reshaping the way they approach paying for university, the risk-reward of going into debt to get a degree and how to pay off student loans. There are roughly 44 million Americans with student loan debt, totally around 1.5 trillion. While some owe a manageable amount, it’s not uncommon for a borrower under the age of 40 in 2020 to have $80,000 to $200,000 in student loan debt. For most individuals with suffocating debt, much of the total amount they owe is actually accrued interest. Many of those same debtors haven given up hope on paying back the full amount. They are the generation that that was brought up in the 1990’s and during the first two decades of this century believing that success could only be achieved if one held a university degree. Of course, that ontology is quickly crumbling as many with substantial student loan debt are either underemployed, employed but not making nearly enough to make their monthly payments or working in a field that is completely unrelated to what they went to school for in the first place. Essentially, it is the segment of the population that was sold a false bill of goods and now these same individuals are scrambling for a way out.
The story is all too familiar. Jane takes out 30k to get a bachelor’s degree in English, graduates and finds herself working at Trader Joes. She goes back to get a master’s degree in education and takes on more debt. At this point, she is $75,000 in debt, but she does manage to land a teaching job with a starting salary of $60,000 per year. The time Jane pays rent, makes her car payment and other expenses, she can barely make her $700 monthly student loan payment. Tired of living paycheck to paycheck, she opts for two years of forbearance. Now she can save that extra $700 a month to invest, go on vacation or pay off other bills. There is only one problem. The interest on her loans continues to accrue during the forbearance period. If she owes $75,000 in student loan debt with a 5% interest rate, an additional $10.27 in interest is added to the principal each day of forbearance. That is $300 per month and $3,600 per year. However, that daily amount gradually increases as the total principal amount owed balloons. A few years go by and a couple of unexpected events like an illness or loss of unemployment and suddenly Jane is 33 years old and owes $110,000. Many in Jane’s situation opt for an ‘income driven repayment plan’, which essentially decreases the monthly payment, but extends the lifetime of the loan up to 25 years. Even under IDRP, monthly payments remain high if one is making a decent income. It is at this point that those in Jane’s situation capitulate, having resigned to the idea that they will never be able be able to pay the total amount.
I am not going to make Jane out to be a victim. Yes, she is saddled by student loan debt, but she did manage to get an education and she was born in the first world. Let’s be real about this. These are first world problems. But the student loan system is inherently dishonest, misleading and unethical. First, it should be pointed out that the federal government never had any business getting into student loans in the first place. Myopic government policy is entirely to blame for the current student loan crisis and for the rising cost of college. Nevertheless, there are millions of former students like Jane contemplating ways to discharge their student loans. Canceling student loan debt through debt forgiveness has been an enticing talking point by several prominent progressive Democrats. But it will likely remain a talking point and merely a way for clever congressional members to score points with their constituents and the media. Although possible, waiting for the federal government to forgive all student loan debt is a bit of “hopium” in my opinion. Hypothetically, a president could flex his executive power and cancel all student loans with the stroke of a pen, but I wouldn’t count on Biden being that person. The more surefire way would be for all debt to be cancelled through an act of Congress, but considering how polarized Washington DC is at the moment, that seems unlikely for the foreseeable future.
The real solution is changing the current bankruptcy laws
Anyone that has a mountain of student loan debt knows that the real obstacle is the way the current bankruptcy laws are written. We often hear of wealthy individuals and large companies filing for bankruptcy. Upon hearing such news, we might falsely assume that same individual or company is broke, but that usually is not the case. Bankruptcy court is tool for the rich. When the wealthy file bankruptcy, it often leads to them increasing their wealth. Everyone made a big deal about Trump filing bankruptcy on more than one occasion, but this is a common practice by many prominent and established business elites. It is also common and fairly easy for regular people to discharge housing, credit, medical and auto loans through bankruptcy. The only caveat is that one must wait seven years after filing bankruptcy in order to reestablish credit. However, the enticing part of filing bankruptcy is that you can discharge consumer and medical debt while keeping assets, such as real estate, stocks, cryptocurrencies and cash.
But student loan debt is categorized differently under the current laws. The federal government began guaranteeing student loans provided by banks and non-profit lenders in 1965. At the time, student loan debt was treated like consumer debt and could be discharged in bankruptcy court. Consequently, there have been a series of acts, starting in 1976, that have made it increasingly more difficult to discard student loans through bankruptcy. By 1998, new congressional policy made it nearly impossible for one to relinquish student through bankruptcy and this was augmented a few years later in 2005 through the polemic “bankruptcy reform” legislation. Interestingly enough, the bankruptcy reform act in 2005 extended these measures to also include privately issued student loans, which really makes no sense considering that privately issued student loans are not guaranteed by the federal government.
As it stands in 2020, student loans can only be discharged in bankruptcy court if one can show “undue hardship”. So it is technically possible, but it is very difficult to meet this standard and to convince a judge to rule in your favor. However, there has been legislation proposed in congress with bi-partisan support during the past two years that would essentially treat student loan debt like ordinary consumer debt. While nothing has passed yet, it is conceivable that bi-partisan support could push through a new act to reverse the current bankruptcy laws. This would be a win-win situation for both sides of the political aisle. Progressives should support such legislation because it would provide a loophole for debt cancellation and some conservatives would support it simply because the federal government should not have their hands in the student loan business in the first place. The avalanche of bankruptcy filings that would ensue a reversal of the current law would conceivably force the federal government to detangle itself from student loans. I would also argue that the federal government should not be involved in any capacity in regards to student loans. Furthermore, real student loan reform should be more about divorcing the government from the business of student loans and treating all loans, including student loans, as consumer debt.
How will the Biden Administration impact the student loan debt crisis?
It should also be pointed out that newly elected President Biden ardently supported both the 1998 and 2005 bankruptcy reform act as then Senator Biden. He also originally supported the crime bill in the 1990’s, but has since reneged his support for such policy. Will he also reverse his position on the current bankruptcy laws? It remains to be seen and certainly possible considering that he has to occasionally bend the knee to the Progressive wing of his party. Biden has already publicly said that he supports a $10,000 loan forgiveness for all borrowers across the board. Then there are high ranking Senators, such as Elizabeth Warren and Chuck Schumer advocating to raise the stakes to a $50,000 loan forgiveness for all federally backed student loans. Assuming the GOP maintains control of the Senate and continues to pick up seats in the House in 2022, it is going to be nearly impossible to pass a bill for a $50,000 loan forgiveness through both the House and the Senate. However, it is hypothetically feasible that a Democratic senator could introduce a resolution in the Senate for a $50,000 loan forgiveness as an executive order for Biden to implement. While that could happen, there would also be a fair amount of political backlash to such a drastic action. After all, it is entirely unfair to those that have already paid back their loans and to the parents that saved for years so that their kids wouldn’t graduate college hampered with debt.
What seems more doable is reversing the provision in the current bankruptcy laws that denies a borrower from discharging student loan debt as normal consumer debt. Rather than pushing for the federal government to forgive all loans with a magic wand, advocates for debt forgiveness should be focusing on the current bankruptcy laws. This is an idea that could garner bi-partisan support. Debt forgiveness is a catchy phrase for Progressive Democrats and a clever talking point to galvanize their constituents come election time, but may never materialize to anything in our lifetime. The practical alternative is to quietly rewrite the Bankruptcy laws in a way that at least makes it easier to discharge student loan debt in bankruptcy court. Coalesce that with growing public support for some sort of resolution for the issue and sympathetic, activist-type judges, and a realistic loophole could exist for borrowers to discharge thousands of dollars in student debt. If wealthy business elites routinely discharge debt through bankruptcy, why shouldn’t the Jane Does with $100,000 in student debt be able to do the same?