Bankruptcy Bill Time

One of the more troublesome things about student loan debt in the United States is that, unlike normal consumer debt, it can’t be charged in bankruptcy.

If you’re broke and you can’t pay off your debts, you file for bankruptcy and the debts get restructured. If you’re broke and you can’t pay off your education debt, you just stay broke. The federal government can garner wages, Social Security, and even life insurance to service student loans.

Many progressive education reformers think this is unjust.

There are currently private student loan bankruptcy bills in the House and Senate. Members of Congress are likely to introduce similar bills soon. This is a good thing, says Peter Reilly at Forbes. Some people have “raised concerns,” however. As he writes:

First were concerns that returning bankruptcy protections would allow widespread abuse of the system. The second concern was that bringing bankruptcy back would cause private lenders to tighten up their lending, and also cause the loans to be more expensive for the students. These two concerns have been used for years to stop this debate, and keep the lending system on its current, unsustainable trajectory. To be blunt, those dogs don’t hunt today, and really never did for that matter.

Until 1990 Americans could discharge student loans in bankruptcy. That seemed to work out pretty well for both students and lenders. Reilly:

When bankruptcy was allowable for all federal student loans, far less than 1% were ultimately discharged this way. One legislator who participated in the legislative process which first began restricting bankruptcy protections for student loans characterized it as a response to “a crisis only in the imagination”.

It is the other point—that allowing for bankruptcy protection will drive up the cost of student loans—that’s perhaps more salient. But it’s still wrong. What’s more, according to Reilly, it’s wrong in a way that obscures the really important changes that will likely come about as a result of changing the bankruptcy rule.

The other comments (that returning bankruptcy will cause lenders to pull out of the market, and cause the loans to become more expensive) are even less impressive, because the consequences they threaten are exactly what is desired! For private loans, it is a good thing if the lenders tighten their underwriting, and make loans more expensive. The schools, if faced with losing large numbers of students, or lowering their prices to levels where the banks will lend to their students (and thus keep the seats filled), will cut their prices. This free market pricing dynamic is long, long overdue in fact. I suspect that on average, colleges could charge students 30 percent less, and still function well. Certainly they have a lot of room to tighten the belt, and this is the way to make that happen. Students who still can’t get financing will have to choose a less expensive school. While this is an unfortunate outcome, it is far preferable to saddling the students with outrageous amounts of debt that they will forever regret, and perhaps never escape.

There is, after all, a real market in education. And if the country changes the rules of that market, the market will operate differently.

Markets need rules. Too many rules and the industry is stifled and can’t operate. Too few rules and the system becomes one of theft. Bankruptcy protection isn’t some special, sweetheart deal; it’s just the same thing that applies in commercial markets.

Daniel Luzer

Daniel Luzer is the news editor at Governing Magazine and former web editor of the Washington Monthly. Find him on Twitter: @Daniel_Luzer