Bankruptcy

(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.

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)."

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.

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.

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.

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.

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.

“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).

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.

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.