Bankruptcy

The Perverse Consequences of a Bankrupt Policy

Ed Policy — Wed, 23 Sep 2009 17:45:00 -0400

(Editors Note: Today we are running an abridged version of testimony that three major higher education associations have submitted to the U.S. House Judiciary Committee's Subcommittee on Commercial and Administrative Law, which is holding a hearing this afternoon on the treatment of private student loans in bankruptcy. The three groups -- the American Association of Collegiate Registrars and Admissions Officers (AACRAO), the American Association of State Colleges and Universities (AASCU), and the National Association for College Admission Counseling (NACAC) -- argue for a reversal of a federal law that makes it exceedingly difficult for financially distressed borrowers to discharge private student loans in bankruptcy. At Higher Ed Watch, we have long argued that Congress should end this cruel policy, which treats private student loans (those without any government backing) much more harshly than nearly any other form of consumer debt, including credit cards.)

By AACRAO, AASCU, and NACAC

Bankruptcy law has restricted the ability of borrowers to discharge their federal student loans since the mid-1970s. For more than a decade, federal student loans have been non-dischargeable altogether, except for cases of undue hardship. While this exceptional treatment of federal student loans under bankruptcy law is harsh, federal student loans do provide basic consumer protections, their own specific discharge provisions, and flexible repayment options that serve as meaningful alternatives to bankruptcy discharge for borrowers. We therefore do not seek any change to the treatment of federal student loans in bankruptcy.

Our concerns focus on the treatment of private educational loans in bankruptcy. Beginning in the early 1990s, for reasons that were never articulated or debated, Congress began to extend the bankruptcy code's exceptionally harsh treatment of federal loans to private educational loans. Until the 2005 bankruptcy reform act, this identical treatment was limited to private loans that were funded or guaranteed by states or nonprofits. This ill-advised expansion rendered a large number of non-federal loans non-dischargeable in bankruptcy, even if they had none of the important attributes that justified that treatment for federal loans.

In making this change, Congress appears to have assumed that states and non-profits would voluntarily configure their educational loan offerings in a manner that would eliminate the need for bankruptcy discharge for their borrowers. It should come as no surprise to any observer of the student lending industry that the exact opposite occurred. Nondischargeability of educational loans provided eligible lenders with a carte blanche to impose ever harsher conditions on borrowers. Many of these borrowers were unaware that unlike with federal loans, the promissory notes they were signing would obligate them to repay the loans even in cases of school fraud, school closure, or total and permanent disability.

The primary benefit to eligible issuers of these loans was that the bankruptcy code's unorthodox treatment of their loans insulated them from the economic consequences of otherwise untenable lending practices. Predictably, these lenders were at the forefront of predatory educational lending practices, and began to provide high-dollar private-label loans to borrowers without much concern about their ability to repay the loans. Low-income students, particularly those attending expensive for-profit career schools, were targeted through collaborative marketing and origination relationships between schools and lenders, who in some cases jointly forecasted future default rates of more than 50 percent on the subprime loans that they aggressively promoted.

The comparative advantage that the "non-profit" issuers of such private-label loans enjoyed was quickly seized upon by other predatory providers, who sought a similar advantage for their products. In 2005, again without hearings or debate, Congress extended the exceptional bankruptcy treatment initially afforded only to federal loans to all educational loans. That unfortunate change, in turn, led to an explosion in subprime educational lending practices, which this ill-thought-through federal incentive unwittingly facilitated. Predatory lending targeting low-income and minority communities expanded, while an entire new line of "direct-to-consumer" programs targeted middle- and upper-middle-income families with easy, but punitively harsh educational credit offerings. The most salient feature of these programs is that their issuers were substantially shielded from the consequences of their high-risk products by the fact that borrowers could not discharge these predictably unaffordable loans even in bankruptcy, and that the promissory notes were really a modern indenture instrument.

In addition to its fundamentally negative consequences of promoting irresponsible lending practices, the vagueness and imprecision of the actual language of the 2005 amendment has created loopholes for additional fraudulent and abusive practices. For example, the statutory language fails to define the "educational loans" that it excludes from eligibility for ordinary bankruptcy discharge. This lack of precision allows virtually any credit transaction with families with students in school to be arguably nondischargeable. This same imprecision makes it impossible to track and analyze the scale and scope of the private-label educational loan market, since colleges may well be entirely unaware of credit that might be marketed to their students and their families. This same lack of institutional awareness makes it quite likely that families and students may be induced to borrow more than their actual unmet need.

Mr. Chairman, the subcommittee's hearings today are a very important first step in documenting and addressing the problems associated with the highly unorthodox special treatment that Congress opted to extend to private educational loans. As stated above, the unconditional extension of non-dischargeability to private loans has created a perverse incentive for risky lending practices that victimize borrowers and reward the most irresponsible lenders at the expense of other creditors. This fundamental distortion of the bankruptcy code also rewards shoddy schools by enabling them to arrange for inappropriately large private-label loans for their students through collusion with subprime lenders. We find it particularly offensive that entities profiting from these predatory practices justify their special treatment in the bankruptcy code by claiming that non-dischargeability lowers the cost of all private educational loans. There is no evidence that the enactment of the 2005 changes lowered the cost of loans, and therefore, no reason to believe that its repeal would increase the cost.

Legitimate private educational loan programs are subject to underwriting criteria to ensure reasonable prospect of repayment. Bankruptcy, let alone dischargeability in bankruptcy, is not even remotely probable factors for such programs. As previously stated, we believe that non-dischargeability of loans has facilitated the marketing of subprime loans to more vulnerable populations, and that their unorthodox treatment has served as a powerful incentive to promote over-borrowing. We urge the subcommittee to examine a complete exclusion of private educational loans from the special bankruptcy treatment previously reserved only for federal loans.

Mr. Chairman, we thank you for your leadership on this important issue, and stand ready to work with you and your colleagues as you act on the findings of today's hearing.

The American Association of Collegiate Registrars and Admissions Officers is a nonprofit, professional association of more than 10,000 higher education admissions and registration professionals who represent approximately 2,500 institutions in more than 30 countries. The American Association of State Colleges and Universities represents more than 400 state colleges, universities, and systems of higher education throughout the United States. The National Association for College Admission Counseling represents more than 11,000 college admissions officers, high-school guidance counselors, and financial-aid administrators. The groups' views are there's alone and do not necessarily reflect those of the New America Foundation.

Reader Mail

Joe Mathews — Fri, 22 May 2009 18:21:00 -0400

One of the polite email responses I received to my op-ed this morning in the New York Times (readers of that elite broadsheet are more foul-mouthed than one might think) came from a New Yorker familiar with the federal assistance to his city in the 1970s. Here is an interesting bit, which I checked out:

"When NYC asked not for $$ but simply for loan guarantees in the
1970s, the [MY NOTE, THEN FORMER] Governor of California (Ronald Reagan) said that he got
down on his knees every night and prayed that NYC would not be given
those guarantees.

"Another point: NYC was treated like a beggar, but in fact NYC gives
the federal government far more in taxes than it gets back. I would
guess that California might too. At first, this simply seems like it
would have to be true, as we give $$ to the Federal government for
defense, but, for example, when Newt Gingrich represented an ex-burb
in Georgia, his district got far more in federal $$ than it
contributed to the federal government in taxes (even as they were
complaining about great urban center such as NYC begging for $$ to
support education still 2 decades after Reagan)."

Guest Post: The Real Problem With Student Loans in Bankruptcy

Ed Policy — Tue, 19 May 2009 18:45:00 -0400

By Rafael I. Pardo

As the national economy continues to deteriorate to levels not seen since the Great Depression, the plight of the individual debtor becomes increasingly dire. While many of us are familiar with the manner in which mortgage and credit-card debt threaten the stability of American households, we hear significantly less about financially distressed student-loan debtors even though theirs is a struggle that warrants close attention.

The confluence of increasing student-loan defaults and rising bankruptcy filings portends a perfect storm where many student-loan borrowers will likely find themselves within the bankruptcy system seeking forgiveness of their debt. Unfortunately, many of them, including some who are among the most desperate for relief, are unlikely to get "the fresh start" that the bankruptcy system promises other types of individual debtors.

The problem is not that debtors are forbidden from discharging their student loans in bankruptcy, as is commonly believed. Debtors, in fact, are eligible for bankruptcy relief from their student loans as long as they are able to establish that repayment of the loans would impose an "undue hardship." As Tulane University's Michelle Lacey and I found in an empirical study we published on this subject in 2005, the real problem is that the undue hardship standard is left undefined by the Bankruptcy Code, which ultimately leads to the differential treatment of similarly situated debtors.

This discharge of student loans in bankruptcy is also potentially problematic because the Federal Rules of Bankruptcy Procedure require borrowers to initiate an adversary proceeding against their lenders, which is essentially bankruptcy's version of a full-blown lawsuit. Because bringing such proceedings necessarily requires monetary resources, it stands to reason that debtors who find themselves in bankruptcy as a result of financial distress will face significant hurdles in obtaining relief from their student loans. Lacey and I recently conducted another empirical study to determine just how big a problem the need to litigate these cases presents to borrowers seeking relief from their student loans. We found that this requirement presents serious access-to-justice concerns for student-loan debtors.

Shedding Light on a Flawed Policy

To explore trial-level outcomes of proceedings where debtors litigated their claims for relief from their student loans, we compiled an original dataset of 115 student-loan discharge proceedings in the U.S. Bankruptcy Court for the Western District of Washington that were commenced during the five-year period spanning 2002 through 2006. Because the data are confined to the experience of litigants in a single federal judicial district during a half-decade period, we cannot say that they are representative of undue hardship discharge litigation nationally. In particular, the legal standards applicable in the Western District of Washington allow for the partial discharge of student loans, which is not the case for all districts nationwide. Nonetheless, our data can still shed light on the manner in which some student-loan borrowers within the bankruptcy system have had to cope with the undue hardship discharge provision and thus help lead to a more informed assessment of whether the law has been a success or failure.

To start, we found that the student loan debtors in our study were in terrible financial shape and in severe need of relief. The annual income generated by the average debtor's household was $21,876. (All dollar amounts from our study have been converted to 2009 dollars for this post.) Once taking into account annual household expenses, exclusive of the debtor's student loans, the annual disposable income of the average debtor household was an annual deficit of $4,751 (i.e., -$4,751). In other words, the average debtor household had no excess income to repay the debtor's student loans, which averaged $79,954. To give a better perspective of the crushing student-loan burden faced by the debtors in our study, if the debtor's household could have lived expense free and the student-loan debt did not increase by virtue of accrued interest, fees, and the like, the average debtor would have had to devote more than four-and-a-half years of household income to completely repay his or her student loans!

Given this bleak financial portrait, how did the debtors in our study fare? More than half of the proceedings resulted in some amount of debt discharged. Moreover, for those borrowers who did obtain a discharge, the average debtor succeeded in getting approximately 72% of his or her student loans discharged. Despite these results, statistical analyses revealed a disturbing picture of the manner in which litigating a claim for forgiveness of debt has encroached upon the ability of struggling student-loan borrowers to get the fresh start that bankruptcy promises.

The legal standards for determining whether borrowers are entitled to a discharge of their student loans require consideration of debtors' income and expenses, as well as their age, employment status, and health status. While we found that such considerations mattered, we discovered that legally irrelevant considerations mattered even more. In fact, the most significant factors determining whether a case was successful or not were the level of experience of the debtor's attorney and the identity of the judge assigned to his or her case. We found that the adversary proceedings assigned to two of the five judges in the district were consistently associated with a significantly lower amount of discharged student loans, and that debtors who were represented by highly experienced attorneys routinely had a higher amount of discharged student loans than those represented by less experienced ones.

Reexamining Assumptions

These finding should raise serious concerns about the impediments we have put in the way of student-loan borrowers who are desperate for relief. They should also encourage policymakers to reexamine their long-standing assumptions about the manner in which our bankruptcy system works for student-loan borrowers.

Since 1976, federal lawmakers have made it increasingly difficult for struggling borrowers to obtain relief from their student loans in bankruptcy, even as the costs of higher education have skyrocketed. While reasonable minds may differ on whether it is normatively desirable for student loans to be conditionally dischargeable in bankruptcy, it is absolutely unreasonable to allow for the disparate treatment of similarly situated debtors who seek an undue hardship discharge of their student loans. The time has come for Congress to reevaluate this flawed policy.

Rafael Pardo is an associate professor at Seattle University School of Law, which he joined in 2006 after having been an associate professor of law at Tulane University from 2003 to 2006. Professor Pardo teaches in the fields of bankruptcy, commercial law, and contracts. Much of his research explores the relationship between educational debt and financial distress, particularly within the bankruptcy system. His views are his own and do not necessarily reflect those of the New America Foundation.

Guest Post: A Bankrupt Policy

Ed Policy — Wed, 03 Dec 2008 16:45:00 -0500

By Deanne Loonin

As most readers of Higher Ed Watch know, current bankruptcy law treats students who face financial distress the same severe way as people who are trying to discharge child support debts, alimony, overdue taxes and criminal fines. It's difficult to separate fact from fiction when trying to understand the logic behind this policy, but one thing is clear -- the restrictions came about without any empirical evidence that students were more likely to "abuse" the bankruptcy system.

Unfortunately, the legislative history of the student loan bankruptcy provision sheds little light.

The bare facts are that in 1976, Congress made student loans generally non-dischargeable except five years after default or if the borrower could prove "undue hardship." Since then, there have been three significant legislative changes. First, in 1990, the five year period was extended to seven years. In 1998, Congress eliminated the seven-year floor primarily as a budget savings gimmick to pay for student loan changes it made when it reauthorized the Higher Education Act that year. Finally, in 2005, lawmakers included private loans in the non-dischargeability category as part of comprehensive bankruptcy amendments (the change primarily affected for-profit lenders because private loans made by nonprofit providers were already exempt). If there were reasons to consider restricting bankruptcy for federal loans, there was absolutely no such basis for extending the policy to high-cost private loans.

The "Soft Fraud" Theory

In an excellent article, John Pottow, a law professor at the University of Michigan, lays out a number of plausible theories for why student loans should be nondischargeable. The most commonly cited reason is what Professor Pottow calls "soft fraud" or "opportunism." According to this theory, most students go to school with good intentions and only think about discharging their student loans later. Once they get out of school (or if they drop out), they find that jobs are hard to get, salaries are lower than expected, and many good jobs require even more education and more debt (hardly a far-fetched scenario in this economy). They see a long debt-burdened road and start looking for the bankruptcy exit.

Before addressing whether the current system is designed to address this issue, it is important to note that there is no evidence that student loan debtors are more likely than other borrowers to file for bankruptcy. In fact, a 1977 study by the General Accounting Office - which Congress appears to have ignored -- found that only a fraction of 1 percent of all matured student loans had been discharged in bankruptcy. "This compares favorably with the consumer finance industry," the study stated.

The "soft fraud" theory also assumes that the decision to file bankruptcy is cost-free when in fact there are many negative consequences, such as damage to credit rating. Further, in 2005, Congress added a number of new elements to the personal bankruptcy system, such as a means test and counseling requirements, that make it more difficult for all consumers to file bankruptcy, especially those who have assets to pay their debts. In any case, the bankruptcy code has always included safeguards to prevent discharge in cases where debt is obtained through false pretenses or fraud.

An Arbitrary System

Even accepting "soft fraud" as a concern, the problem is that the current system does not target only those who are supposedly abusing the bankruptcy system. While it may catch some student borrowers who can afford to pay their loans, it also snares those who are truly financially distressed and desperately need relief.

Under current law, most federal and private student loans can only be discharged if the debtor can show that payment will impose an undue hardship on the debtor and the debtor's dependents. The student must seek the hardship determination in court through a separate proceeding.

The system is strikingly arbitrary. Anyone who has handled one of these cases can tell you how random it is. A legal aid lawyer I know in the South tells me that the judge in her area almost always grants discharges. Other attorneys I work with practice in districts where the judges almost never grant discharges, regardless of the circumstances.

Judges are granted extraordinary discretion to make these decisions, especially since the code provides no definition of "undue hardship." An academic study of 261 reported decisions affirmed the randomness in the application of the undue hardship test. The study found few statistically significant differences between the debtors granted discharges and those that were not. The study also found that students seeking bankruptcy relief were in fact suffering financial distress. The authors conclude that judicial discretion has come to undermine the integrity of the undue hardship system.

Another problem with the current system is that it is pretty much stacked up against the most financially distressed borrowers. These borrowers have few, if any, resources to pay for legal assistance to prove to judges that they suffer from undue hardship. The sad fact is that there are very few lawyers that are willing to handle these cases through free legal services or on a pro bono basis.

Without legal assistance, these borrowers must litigate undue hardship while going up against aggressive creditor lawyers. Proving hardship requires independent evidence of medical conditions if the borrower is disabled. Borrowers also must show that their financial distress will last indefinitely. Some courts have adopted a nearly impossible to prove "certainty of hopelessness" standard.

A Middle Ground?

Many courts, recognizing the inequity of this system, have begun to create an ad hoc middle ground. Some allow partial relief by discharging a portion of the debt or by discharging some, but not all, of the loans. Some courts have allowed a restructuring of the loan, for example by discharging collection fees and accrued interest and even by delaying the student's obligation to start making payments, during which time no further interest accrues.

Whether a borrower gets the benefit of a middle ground approach depends entirely on where she happens to live and the judge she happens to draw. This is unfair, but the judges have a point. They are flying by the seat of their pants without any foundation in the bankruptcy code because they understand that the current all or nothing approach doesn't work for everyone.

There might be room for a middle ground approach for some borrowers, as long as that policy was administered across the board. The new income-based repayment system in the federal loan programs is especially promising as it gives borrowers the opportunity to manage their debts outside of bankruptcy. Once it is available in July 2009, this program will allow most federal student loan borrowers with economic hardships to repay their loans based on a formula that takes income and total indebtedness into account (though, as currently designed, it may not be as helpful to borrowers who are already in default as it should be.)

Regardless, the program, however, is available to only federal loan borrowers. The lack of this type of option in private loans is a good reason why restoring bankruptcy rights for private loan borrowers is such a critical step.

There might also be ways to incorporate some of the ad hoc policies into the bankruptcy system through partial discharges or by separately classifying student loans in Chapter 13 plans so that borrowers can make a bigger dent in these nondischargeable debts during the course of the plan.

These middle ground approaches should be considered, but not as a substitute for full bankruptcy rights for the neediest borrowers. If, however, the undue hardship system is retained for these borrowers, the standard should be refined to target those in the most distress and to ease the burden of proof. But this is not enough. Congress should also restore the waiting period as an alternative ground for discharge. A five year waiting period has the benefit of allowing a more straightforward process so that borrowers who cannot access the system are not unfairly penalized and of weeding out those borrowers who can work, but are choosing not to. If they truly have assets and income, their loan holders can try to collect during the waiting period. At a bare minimum, full bankruptcy rights must be restored for financially distressed private loan borrowers.

These solutions are not perfect, but can help correct a skewed system that unfairly penalizes students who discover that their education has not paid off as expected.

Deanne Loonin is a staff attorney with the National Consumer Law Center and the director of the center's Student Loan Borrower Assistance Project. She focuses on consumer credit issues generally and more specifically on student loans, credit counseling, and credit discrimination. She is the principal author of numerous publications, including "Paying the Price: the High Cost of Private Student Loans and the Dangers for Student Borrowers." Her views are her own and do not necessarily reflect those of the New America Foundation.

Election 2008: Our Wish List for the President-Elect

Ed Policy — Wed, 05 Nov 2008 18:15:00 -0500

Barack Obama's historic victory last night ensures that a change in direction is coming to the U.S. Department of Education and hopefully to federal higher education policy.

Starting tomorrow, we will take a closer look at Obama's signature higher education proposals. (Got to give him at least a one day honeymoon, right?) Today, we will present our wish list for the incoming administration. Here are some changes we would like to see:

Emphasize Oversight and Enforcement at the Department of Education: Over the last eight years, the Bush administration officials in charge of the Department looked the other way as widespread abuses occurred in the Federal Family Education Loan (FFEL) program. To this day, the Department has not disciplined a single lender for violating a federal law that prohibits loan providers from offering inducements to secure student loan business. At the same time, the education secretary allowed lenders to keep more than $1 billion they illegally obtained in improper subsidy payments. Federal leadership is sorely needed to protect the integrity of the federal student loan programs, for the sake of both the students who depend on them and the taxpayers who finance them. For starters, the new administration should take a close look at the conflict-ridden relationship between Sallie Mae and USA Funds, the guarantee agency it effectively controls. As we have noted, there is compelling evidence that the loan giant has exploited this arrangement to take advantage of borrowers who are having difficulty repaying their federal loans. A thorough investigation is needed.

Lead the Way on Federal Student Loan Reform: The time has come for the government to reassess the way we provide low-cost federal loans to students. Do we still need two competing federal student loan programs to fulfill this function? If so, we need to focus on finding the most efficient ways to run these programs. Currently, the way the government sets subsidy rates in FFEL is arbitrary, wasteful, and subject to political manipulation. In addition, the program's complexity makes it ripe for abuse and makes good oversight by both the Department and Congress more difficult. Hopefully, Obama and his Democratic colleagues in Congress won't let the lenders' scare tactics frighten them away from pursuing reform. If anything, the credit crunch provides even further evidence that policymakers need to fundamentally change the way the government compensates student loan providers.

Provide Relief to Student Loan Borrowers in Desperate Straits: In 2005, Congress tucked a provision into bankruptcy reform making it extremely difficult for financially distressed borrowers to discharge private student loans. As we have said before, we don't see any good reason for private loans to be accorded the harshest bankruptcy status. Individuals who borrow private loans are trying to better their lives. They certainly shouldn't be treated more harshly than those with excessive credit card debt. This summer, Obama unveiled a plan to rewrite federal bankruptcy law to make it easier for financially strapped senior citizens, military families, and individuals suffering from medical emergencies to get relief from debilitating debt. We would like to see Obama extend this relief to struggling private student loan borrowers as well.

Strengthen Consumer Protections for Students Against Unscrupulous Trade Schools: Over the last decade, some of the largest publicly traded for-profit higher education companies have come under intense scrutiny from federal and state regulators and have faced numerous lawsuits by former employees, shareholders, and students over allegations that they have engaged in deceptive recruiting and admissions tactics to inflate their enrollment numbers. Yet at the same time, the Bush administration and Congress, under both Republican and Democratic control, have weakened provisions in the Higher Education Act that aim to protect students from questionable schools. If Obama and the Democratic-led Congress are serious about changing Washington, they need to put the interests of students before those of deep-pocketed trade school lobbyists. The new administration can get off to a fast start on this front -- by using the Department of Education's upcoming negotiated rulemaking sessions to overturn regulatory changes the Bush administration made in 2002 that made it easier for unscrupulous trade schools to take advantage of low-income and working-class students.

Concentrate on Redesigning and Simplifying Federal Student Aid, Rather than Adding New Programs: The federal student financial aid system is not working as well as it should. Financially needy students are taking on too much debt and working an excessive amount of hours at jobs outside of school to pay for college. The last two Congresses have seen new additions to the federal student aid programs, including the introduction of new grant and loan forgiveness programs aimed at increasing the academic preparation of low-income students and encouraging students to go into low-paying, public-service careers such as teaching. While well-intentioned, lawmakers have created a mish mash of programs that are redundant and don't always interact well together. We would suggest that the new administration step back and consolidate, coordinate and simplify financial aid in ways that make it clear where students can get the best deal as it relates to paying for college and paying student loans back. The federal government doesn't need new programs, it needs a coherent system. It's also time for a president who is willing to take institutions of higher education head on in the debate over rising college prices.

That's our wish list. How about yours? Please send us any higher education recommendations you may have for the next president. We look forward to reading them.

An Opportunity to Aid Borrowers

Ben Miller — Tue, 16 Sep 2008 17:33:00 -0400

Yesterday, the U.S. House of Representatives pushed through a bill that would extend a previous effort to bail out student loan providers. Before the Senate acts on this legislation, Higher Ed Watch urges lawmakers to view this as an opportunity to come to the aid of financially distressed borrowers struggling with private loan debt.

The House legislation, H.R. 6889, would extend the expiration date of two parts of the Ensuring Continued Access to Student Loans Act (ECASLA) to July 1, 2010, a year longer than they were originally written to last. First, the measure would continue a program that allows the Secretary of Education to either buy outright or purchase participation interests in newly disbursed student loans. These programs have resulted in between $3 billion and $4 billion of loan agreements with student loan giants Sallie Mae and Nelnet, as well as several other lenders, according to various sources.

Second, the bill would also continue allowing entire schools to be eligible for assistance through the "lender of last resort" program if 80 percent or more of their students cannot find loans. While this would ensure that all students at a given institution would receive loans either through a guaranty agency or other designated lender of last resort, there are no reports that this extremely complex program has been used.

Given that this extension will affect loans for the 2009-10 school year, we find the timing of this extension curious. Many months remain before students apply for next fall's financial aid and, as we predicted long ago, students aren't having any problems finding loans now. To date, the Direct Loan program has accommodated institutions that wish to exit the Federal Family Education Loan (FFEL) program, lender of last resort systems have been updated, and there continue to be thousands of FFEL providers. Why act now before we know whether the assistance will really be needed?

Regardless of its timing, the extended bailout presents an opportunity for Congress to continue its efforts to ensure that students are getting the best possible deal on federal student loans and not plunging deeper into private student loan debt. There are at least three steps we believe Congress could take in these areas:

Make PLUS Loans More Attractive

First, Congress could lower the interest rate parents and graduate students pay on PLUS loans so that the terms are more favorable than those offered by private lenders. Some borrowers may be able to get better initial rates on private loans, but whether this "initial" rate holds depends on financial conditions. [Remember, most private loans carry variable interest rates that are not capped.]

We believe that PLUS loans are almost always a better option for parents and graduate students than private loans. For one, PLUS loans provide more certainty for borrowers because they carry fixed interest rates. They also have less strict credit requirements; allow a tax write-off for some borrowers; and offer more protections. For example, lenders making PLUS loans are required to offer financially struggling borrowers the option to enter deferment or forbearance, and to discharge the loans of borrowers who die or are permanently disabled -- features that are optional for private lenders.

End Bankruptcy Protection

The 2005 bankruptcy bill gave private student loans the same protections in bankruptcy proceedings that are reserved for child support, taxes, and other obligations to the government (including federal student loans) by making them extremely difficult to discharge in bankruptcy. As we have said previously, we don't see any good reason for private loans to be accorded the harshest bankruptcy status. Individuals who borrow private loans are trying to better their lives. They certainly shouldn't be treated more harshly than those who rack up credit card debt at the mall.

Concerned that this provision is stranding borrowers with unmanageable levels of debt, some legislators have attempted to reverse the 2005 legislation and make private loans dischargeable in bankruptcy. Rep. Danny Davis (D-IL) was the latest to try, but he was unable to slip a change into the House version of legislation to reauthorize the Higher Education Act. With the current bill headed to the Senate, Congress has an opportunity to make another attempt to help heavily indebted borrowers by repealing the bankruptcy protection. This is an especially important action as households are buffeted by worsening economic conditions.

Require Private Loan Certification

As we have also noted previously, a disappointing number of borrowers turn to private loans without first exhausting their eligibility for lower-cost federal loans. This may occur because borrowers do not fully understand their options or have been confused by lender pitches that promise a "better deal" with private loans. Some institutions, such as Barnard College and Colorado State University, have found a way to close this information gap by requiring all borrowers taking out private loans to first speak with aid counselors to ensure they have exhausted their federal loan eligibility. The schools aren't keeping students from taking on private debt; they are simply ensuring that students have all the facts before certifying a non-federal loan. The result of these efforts have been dramatic -- Barnard's private loan volume decreased by 73 percent the year after instituting the counseling requirement.

Congress could help schools enact similar programs by requiring that all private loans be certified by financial aid offices before distribution. This would give schools the opportunity to work with borrowers who are taking on unnecessary levels of debt or failing to exhaust their federal eligibility. From a research and public policy standpoint, such a change would also provide sought after statistics on the exact number of private loans disbursed and the demographic information of the borrowers taking them out -- data that is impossible to get now because lenders do not have to report direct-to-consumer loans.

Whether Congress decides to implement one or all of these proposals, we hope that it recognizes that the exhaustion of enacting several higher education bills in the past year and the 800-pound gorilla of No Child Left Behind reauthorization looming on the horizon may mean that the ECASLA extension may be one of its few chances to provide meaningful assistance to student loan borrowers in the near future. Because of this, we suggest that if Congress wants to extend its bailout to lenders, the least it could do is throw a few buckets in the direction of borrowers.

UPDATE: The Senate passed the ECASLA extension bill on Wednesday without including any additional help for borrowers. The bill is now awaiting President Bush's signature. To read more about the bill, check out our Weekly Roundup.

Obama's Disappointing Omission

Stephen Burd — Wed, 09 Jul 2008 21:59:00 -0400

Yesterday, Sen. Barack Obama (D-Ill.) unveiled plans to rewrite federal bankruptcy laws to make it easier for financially-strapped senior citizens, military families, and individuals suffering medical emergencies to get relief from debilitating debts. While we are pleased that the presumptive Democratic presidential nominee is proposing to overhaul the 2005 bankruptcy bill, which was a glaring example of politicians putting corporate interests over regular people, we urge him not to forget another group who desperately needs help -- borrowers who have taken on unmanageable levels of private student debt and now find themselves in severe financial distress.

As we have noted previously, Congress tucked a provision into that bankruptcy bill making it extremely difficult for borrowers to discharge private student loans. That special provision was added in a secret conference committee, without any public debate or notice.

For most unsecured debt, a borrower who runs into difficulty can file for Chapter 7 liquidation or Chapter 13 reorganization, so a judge can sort out the appropriate treatment of various loans. But there is a short list of debts that the law subjects to a different status, allowing discharge in only the most extreme circumstances. The government, for example, makes it nearly impossible for people to escape child support responsibilities, overdue taxes, and criminal fines.

Federal student loans also can't be discharged. There's at least some justification for providing federal loans that status since they are backed by taxpayer dollars and come with borrower protections in cases of economic hardship, unemployment, death, and disability. But there is no good reason for private loans to be accorded the harshest bankruptcy status.

To be clear, we're not advocating allowing borrowers to claim bankruptcy willy nilly in order to avoid student loan repayment. Our view is that private student loans should not be treated any differently than other forms of consumer debt when it comes to bankruptcy. Individuals who borrow private loans are trying to better their lives. They certainly shouldn't be treated more harshly than those who rack up credit card debt at the mall.

Shielding private loans from bankruptcy in most circumstances means that repayment demands extend essentially forever, leaving even the most destitute borrowers with no way out. Bankruptcy exemption also makes private student loan providers less cautious about peddling high cost loans to low-income and working-class students who may never be able to repay them. In other words, it promotes the kind of predatory lending that Sallie Mae and some other loan companies have been engaged in at scandal-ridden, for-profit trade schools. Treating private loans like other forms of unsecured debt would at least cause lenders to think twice before providing high-interest loans to people who can ill-afford to take on this debt.

Speaking on Tuesday at a high school in Powder Springs, Ga., Obama attacked his presumptive Republican opponent Sen. John McCain (R-Ariz.) for supporting the 2005 bankruptcy bill. "Sen. McCain does not believe the government has a real role to play in protecting Americans from unscrupulous lending practices," Obama said. "He would continue to allow the banks and credit card companies to tilt the playing field in their favor, at the expense of hardworking Americans."

If Obama is serious about protecting people from "unscrupulous lending practices," he should come to the aid of financially-distressed private student loan borrowers. For that matter, if McCain wants to prove Obama wrong and show that he is not beholden to the lending industry, he should offer a helping hand to these borrowers as well.

So far, neither Democrats nor Republicans in Congress have shown that they have the guts to stand up to the student loan industry and do what is right. Such change may only be possible with presidential leadership. Obama and McCain, are you up for it?

Buttressing Economic Policy with Assets

Alejandra Lopez-Fernandini — Fri, 06 Jun 2008 15:55:00 -0400

“I work to live.”

So goes the beginning of a quote by a mid-20s woman who was interviewed for a recent Washington Post piece on bankruptcy.

The front-page, above-the-fold-article described the growing number of working Americans seeking relief from unmanageable debt by filing for bankruptcy. As my eyes traveled across the page, my head nodded in agreement with the author’s points. Elizabeth Warren describes the economic tightrope that middle class households walk not as a recent, post-credit crisis phenomena, but as a reflection of the economic risk and instability of this generation (see her 2006 Harvard Magazine piece). Personal bankruptcies filings are on the rise, despite the recent change requiring debtors to meet more stringent criteria in order to file. And then, the ever-important point that bankruptcy wreaks havoc on one’s credit (in case any cynical readers viewed chapters 7 or 13 as an easy “out” for those struggling financially).

With all this in mind, the following day I attended an Economic Policy Institute event, “Rising Economic Insecurity.” The panelists were eye-opening, eloquent, and easy-to-understand (especially for the non-economists in the room). Moderator Louis Uchitelle opened the discussion observing that instability in family income and job security are norms, not exceptions today, and affecting a wider swath of the population. Even households earning well over $100,000 have “no reliable refuge from these downdrafts.” This happens not only to the detriment of family economic well-being, but to the detriment of workers’ self-esteem and mental health. Our country’s most valuable resource, human capital, is being massively undermined by income volatility.

Next, Jacob Hacker and Elizabeth Jacobs introduced findings from their paper and Peter Gosselin shared insights from his new book and recent research. Some highlights: The US is a distinctly riskier place for workers, from the low-wage to the well-paid. Over the last three decades, income volatility has increased for almost all education groups. The cost of broad economic growth was “greater risk for steep financial falls”. And workers are assuming a greater share of financial risk that was previously borne by government and employers (think moving from defined benefit to defined contribution retirement plans, and changes to the homeowners insurance coverage). The evidence abounded. Then, discussant Brink Lindsey critiqued the panelists research methodologies, suggested the panelists exaggerated the true economic picture, and proceeded to engage in a “seemly” back-and forth with the panelists.

Though the discussant and panelists finally converged on the premise that we are in a “new, insecure world,” I left sobered by the dismal prospect of achieving the same convergence on a public policy agenda to address the changing economic conditions.

Why, with qualitative and quantitative evidence to show that American workers of all income and education levels are working harder than ever but are no better off, does policy development stagnate?

I believe asset-building policies are a partial antidote to rising income insecurity and inequality.

For lower and moderate income workers in particular, acquiring assets and the financial skills to effectively manage those assets is a viable strategy to mitigate economic risk. Asset-building policy promotes the accumulation, equitable distribution, protection and inter-generational transfer of personal wealth. And the paradigm-field-outlook-what have you, has broad political appeal. An ownership society, in which individuals are rewarded for their hard work and protected from greater macro-economic trends, requires thoughtful, inclusive asset development policy.

Mailbag: Private Loan Borrowers in Distress

Ed Policy — Thu, 05 Jun 2008 15:45:00 -0400

At Higher Ed Watch, we hear regularly from financially-distressed borrowers with private student loans who believe they have been victimized by lenders' predatory practices. Much of that feedback comes in the way comments we continue to receive on blog posts that ran more than a year ago.

At a time when the federal government is providing a major bailout of the student loan industry, we think it is important to highlight the experiences of borrowers who are struggling with unmanageable levels of high-cost, private student loan debt. Surely borrowers such as these could use a helping hand too.

Many of our readers have shared stories with us about the seemingly inescapable burden these loans have had on their lives. Here are a few examples:

"I have borrowed about $50,000 in private loans. My estimated monthly payment for both loans is right around $800 and I earn around $1200 monthly. You guys do the math. I know I have a responsibility, but all I wanted was an education, not a $375,000 debt that i'm gonna carry all the way to my grave...At 18, I had no idea what I was doing to myself!!" (I have borrowed, May 7, 2008)

"My husband and I have over $200,000 in private student loans and over $150,000 in federal student loans. I am currently not working and my husband is a teacher. When our loans enter repayment, the monthly payment will be about $3,000! My husband doesn't even make that much per month and my degree (HISTORY-Lib. Arts) will not land me a high-paying job...We are currently driving one car that is 13 years old and we have two children in elementary school. HELP!" (Massive Debt, April 10, 2008)

"I'm a single mother that is not receiving child support. I have $39,000 of private loans and $17,000 in federal loans. I'm in default with my private student loans based on them not working out a payment plan with me. I have to pay $717 a month on my private loans -- mind you this does not include my federal loans. After taxes, I make about $1,700. This makes me hate the fact I even went to school and received an education." (Private Student Loans, May 8, 2008)

"I took out my loans two or more years ago. Part of that time I was working on my master's degree, but then put it on hold when I had my son in March of 2007. Since then I have been harassed, threatened, and basically called a liar and scam artist by Sallie Mae, when I was unable to start payment of the private loans. They want over $1000 a month and have now bullied me into putting my loans in forbearance twice, which they were kind enough to waive the $100 forbearance fee, but tacked on nearly $5000 each time for the forbearance itself. I am drowning in all this debt, I am disabled and my disability got worse after I gave birth and has been on a downward spiral ever since. I live on $600 a month from disability, so obviously I can not pay over $1000 a month to Sallie." (Disabled and Desperate, May 7, 2008)

Some of our readers say they fell victim to aggressive direct-to-consumer loan companies that never made them aware of their lower-cost federal loan options. Many of them acknowledge that they made bad decisions, but also believe that the loan companies took advantage of them:

"I am a victim of these financial institutions that are targeting college students with good credit. I was able to get $52,000 worth of loans over the internet never speaking to anyone. The terms were very unclear. I had no one to explain to me the devastating impact this would have on my life. By the time that these loans went into repayment status, I owed about $73,000. WOW!!! That is $20,000 worth of interest that they have racked up! My payment which I thought would be around $350 per month is over $700. There was no one to guide me and to explain what a libor rate is. I thought that my interest rate would be 4% and calculated like a regular federal student loan. I was so wrong and now my family is suffering because of this poor stupid choice that I made...I was only 22 years old and had no idea what a life changing event this would be." (Private Student Loans, April 12, 2008)

Others blame the colleges they attended for encouraging them to take on heavy loads of private loan debt with their favored lenders:

"I used Sallie Mae because the school I went to spoke of them like a god company. I borrowed $66,000 from them unfortunately, and now the payback amount is $266,000. (And they get away with it, April 23, 2008)

"I came to America to chase a dream and become a better person in this competitive world. I enrolled in the California School of Culinary Arts and being naive they recommended Sallie Mae to me. I wish I knew better. I was excited since I had no co- signer or good credit and I had the opportunity to get money for school. I jumped onto the train. I was told my payments would be about $200 dollars. Well, I am now looking at $500 dollar bills from Sallie Mae. I earn $2000 dollars a month. I can't even afford to send my people back in Africa some form of help because I basically have nothing left after I pay my bills. " (Sallie Mae worse than Enron, May 9, 2008)

And most cannot understand why the federal government treats private student loans differently than other forms of consumer debt by making it so difficult for financially-distressed borrowers to be able to discharge these loans in bankruptcy.

"Students should be able to discharge their student loans in bankruptcy as they can other non secured debt. Everyone knows there is risk involved with student loans and everyone should play by the rules that any other entity is forced to when it comes to loans. Sallie Mae is a company. A non government entity that is in the business of making money. The sooner people start realizing what is happening to the people of this country, the sooner things may turn around." (Will It Ever End?, December 11, 2007)

We appreciate all of the comments we have received on private loans and other items. Please keep them coming.

Where's the Bail Out for Borrowers?

Ed Policy — Thu, 17 Apr 2008 22:39:00 -0400

After Tuesday's surprisingly one-sided hearing before the Senate Banking Committee on the credit crunch, it's clear that Congress is prepared to take steps to add liquidity to the student loan marketplace. But as lawmakers move forward with plans to bailout student loan giants like Sallie Mae, they shouldn't forget about the financially-distressed borrowers who have been victimized by the lenders' predatory private loan practices. Surely, they deserve a helping hand too.

Over the last two years, we at Higher Ed Watch have written extensively about how loan companies' aggressive marketing practices and cozy relationships with colleges have pushed students to take on unnecessarily high levels of expensive private student-loan debt, often before they have exhausted their lower-cost federal loan eligibility. In fact, at least one in five private student loan borrowers take out a private loan before they exhaust safer, cheaper federal Stafford loan options.

Lenders will deny responsibility until they're blue in the face, but they're the ones who have been feverishly marketing $30,000, $40,000, or $50,000 a year direct-to-consumer private loans to undergraduates. In pop-up Internet advertisements, youtube videos, and television and radio commercials, the companies tout the convenience of applying for private loans but seem to brush by the fact private loans are more expensive than federal loans and lack important safeguards.

Lobbyists for colleges and financial aid administrators place the blame squarely on direct-to-consumer marketers. But many private colleges and high-priced public universities are also putting students in harm's way by including private loans in the financial aid packages they offer students. Packaging private loans gives students the misleading impression that they have no choice but to take out these loans. It also leaves them with the impression that these loans have the colleges' imprimatur and therefore must have pretty reasonable terms, which they seldom do. Worse, some lenders have encouraged colleges to brand the loans with their institutions' names -- which only adds to the confusion.

Perhaps the students who have been hurt the worst have been the low-income and working-class students who were pushed to take out subprime private loans, with rates and fees totaling more than 20 percent, to attend poor-performing trade schools owned by giant for-profit higher education chains like Career Education Corporation and Corinthian Colleges. By all accounts, defaults on these loans are growing alarmingly. And serious questions have been raised about whether these companies have duped disadvantaged students into taking on private loan debt without making them aware of their cheaper loan options first.

Now don't get us wrong. Congress is preparing to take steps that will make private loan borrowing somewhat safer for future students. Lawmakers are finalizing legislation to renew the Higher Education Act that would, for example, ban lenders from co-branding private loan products with a college’s name or logo. The legislation also includes provisions that aim to discourage lenders from making subprime private loans and that would make it easier for colleges to counsel students against taking on private loans prior to exhausting their federal student loan eligibility.

These provisions are all good, but they won't provide any relief to borrowers who have already fallen victim to lenders' predatory private student loan practices. The House had a chance to start to make things right for these students in February but punted. Under pressure from the loan industry, the House defeated a measure that would have allowed borrowers in severe financial distress to discharge their private loans in bankruptcy.

But now that Congress is considering bailing out lenders for past risky financing decisions, we believe that lawmakers have an even stronger obligation to revisit the bankruptcy issue. Private student loans should not be treated any differently from other forms of consumer debt when it comes to bankruptcy. Folks who borrow private students loans are trying to better their lives. They certainly shouldn't be treated more harshly than those who rack up credit card debt at the mall.

We also believe that policy makers need to consider efforts to help borrowers who took on private loan debt before exhausting their federal student loan eligibility. They can do this by authorizing the Department of Education to offer a debt swap to these borrowers. Under this proposal, which we floated last month, the federal government could make new unsubsidized federal Stafford loans available for all borrowers (out-of-school or in-school) with private loan debt and untapped federal loan eligibility. These newly borrowed funds would have to be used to pay off existing private student loan debt. Presumably, a debt swap policy would ease the financial burden of private loan borrowers and infuse liquidity into the private student loan market.

These proposals -- for revising the bankruptcy law and authorizing a debt swap -- are reasonable steps that Congress can take to help out private loan borrowers in dire straits. Borrowers with unmanageable debt loads may not be able to hire high-priced lobbyists or lavish lawmakers with generous PAC contributions, but that doesn't mean that they should be left out of the discussions. Because really, if we're talking about a bailout, who's more deserving?

This post was prepared by Stephen Burd and Michael Dannenberg.