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Wednesday, December 21, 2011

OWS: Let’s Amend the Bankruptcy Laws

I recognize that the Occupy movement so far has eschewed participatory politics in favor of blanket protest and raising awareness in the public mind of severe societal problems like income and wealth inequality, the corporate control over our political system, and the crippling student debt so many have been saddled with over the past decade or so.

But if there is one specific piece of affirmative legislation it seems to me the movement could and should get behind, it would be amending the law to make student loans dischargeable in bankruptcy once more.  Indeed, this should be a no-brainer.  The elimination of this substantial debt overhang would benefit the individuals themselves, it would benefit the country by helping free up income to be spent in the actual economy, and it would be the moral thing to do.  I also think it would do a great deal to rein in the skyrocketing cost of higher education, but I’ll admit to a bit of speculation on that last point.

The History of Student Loan Nondischargeability
To understand how we got to where we are now, it’s helpful to know a little bit of history regarding the evolution of the student loan industry and the bankruptcy process.  That history is set forth in this CRS Report for Congress:  Student Loans in Bankruptcy

Prior to 1976, all student loan debt was dischargeable in bankruptcy – just as if it were any other type of unsecured debt.  But in 1976 Congress amended the bankruptcy laws to prohibit discharge of education loans made by the government or by a non-profit college or university, unless those loans already had been in repayment for 5 years.  All other student loans remained fully dischargeable and even these particular loans could be discharged in bankruptcy after 5 years of repayment.  These amendments to the bankruptcy code took effect in 1978.

In 1979 the code was amended to make clear that loans not subject to discharge until after 5 years of repayment included all loans insured or guaranteed by the government.  In 1984 the 5 year nondischargeability provision was expanded to include any private loans made, insured or guaranteed by a non-profit institution, regardless of whether that institution was a college or university.

In 1990 the repayment period during which these loans could not be discharged was increased from 5 to 7 years.

In 1998 – note the year – the repayment period restriction during which these loans could not be discharged was eliminated altogether.  In other words, after 1998 student loans issued by any lender – whether public or private – that were insured or guaranteed by the federal government or were funded in whole or in part by a government unit or a nonprofit institution were now completely nondischargeable in bankruptcy

It is worth noting that most private student loans included a nonprofit organization as their guarantor, and the courts interpreted such loans also to be exempt from discharge.  In other words, a private loan made by a for-profit company – but guaranteed by a non-profit guarantor – could not be discharged in bankruptcy.  This included most private student loans. 

Finally, in 2005 the bankruptcy code was amended again, this time to eliminate any restrictions on the nondischargeability of student loans whatsoever.  Any loan now taken out to pay for higher education is completely and totally nondischargeable in bankruptcy.  Failure to repay these loans means that creditors can garnish one’s wages, i.e., money will be taken out of one’s paycheck and sent directly to the creditor by court order.  It is debt peonage, plain and simple.

(The only exception to the nondischargeability of student loan debt is if the debtor can persuade the bankruptcy court that repayment of the loan would result in “undue hardship.”  This is a court defined term, usually satisfied only if the debtor can meet the three pronged test set forth in Brunner v. New York State Higher Edu. Serv. Corp., 831 F.2d 395, 396 (2d Cir. 1987).  That is, the debtor must show that (i) she cannot maintain a “minimal” standard of living for herself and her dependents if forced to repay the loan, (ii) circumstances exist indicating this state of affairs is likely to persist for a significant portion of the repayment period [a period of decades], and (iii) the debtor has made a good faith attempt to repay the loan.  This is an exceptionally difficult standard to meet – especially the second prong – which means that discharging student loan debt in bankruptcy is now nearly impossible.)

The Effect on Higher Education Costs
Now, I’ll admit that this part of my argument is fairly speculative.  I’d like to see some actual research on the issue, but it does seem to me that in 1998 when the government made nearly all student loans completely nondischargeable in bankruptcy that action would have substantially increased the amount of money available for college. 

After all, if I am a lender and have the chance to lock in a guaranteed 7 – 10% interest rate (or even, according to that CRS report, rates as high as 20%) on a loan that carries no actual risk of default then I’d start making loans like crazy.  And in fact just after Congress changed the bankruptcy code to make most student loans nondishargeable total student loan debt in the United States quintupled.  Via Mother Jones, here is what the real explosion in student loan debt looks like since 2000:

(Note:  a previous version that was flying around the web a few weeks ago and that you may already have seen was in error.  That error has been corrected in the visual representation reproduced here.)

This reminds me very much of what we saw happen in the housing market once mortgage originators found out they could sell their mortgages on to Wall Street investment banks, and the Wall Street investment banks found out they could, in turn, use those mortgages to secure bonds that they could sell on to their investor clients.  Suddenly there was a huge demand for mortgages, which meant more mortgages were being written, which meant the amount of money flooding the housing market helped drive up house prices.  This resulted in a vicious cycle:  as housing prices rose uninterruptedly, the perceived safety of buying mortgages made demand for mortgages skyrocket, which in turn meant there were more mortgages issued to buy houses, which meant housing prices continued to rise, which meant buying mortgages continued to look safe, etc., etc.  It all worked well until, suddenly, it didn’t.

Similarly, with tons of new credit flooding the student loan industry as a result of that credit’s new “risk-free” nature, one would naturally expect to see the price of higher education go up; after all, that sudden increase in new credit would be increasing demand for what is at any given time – especially for the high-demand schools – a limited service.  I would expect this to bid up the price for enrollment in the upper-tier schools, and to have had a cascading effect on the rest of our colleges and universities.

And, in fact, this is exactly what we’ve seen happen.  In recent years education costs have far outstripped the rate of inflation:

Now, obviously, not all of this increase can be laid at the feet banks suddenly making risk-free (to them) loans available.  According to the data above, the cost of higher education went up about 200% in the fifteen years between 1985 and 2000, which is fairly significant.  However, those costs went up another 300% (measured from the base costs in 1985) in the eleven years between 2000 and 2011 – the same period during which the nation’s outstanding student debt load quintupled after being declared nondischargeable in bankruptcy.

Of course correlation does not necessarily imply causation, but common sense, our past experience with the housing bubble, and the fact the data does line up fairly nicely at least indicates that part of the reason the cost of higher education has increased so rapidly is because loan money has flooded the market, and one of the reasons loan money has flooded the market is because Congress eliminated any risk of default for creditors.

By amending the bankruptcy code, Congress may very well have created a “college bubble” similar to the housing bubble.  Eliminating default risk on student loans means more money is now available to chase a college education, which artificially drives up the cost of higher education, which prices it out of the reach of many people who now have no choice but to take on greater and greater student loan debt.  Upon graduation these new debt slaves learn that they cannot earn sufficient money to pay off their loans, but they cannot get out from under that debt by declaring bankruptcy either.  They are in effect a credit crop that never stops paying off for the banks that loaned them money back when many of them were only teenagers.

Congress Already Knows This Doesn’t Make Any Sense
One of the things I found most interesting when I started looking into the history of student loan nondischargeability is that from the very beginning government studies have recognized that student loan debt should continue be dischargeable in bankruptcy.

For example, in 1977 – after the original 1976 bankruptcy amendments had been adopted but before they went into effect – the House Judiciary Committee issued a report that the nondischargeability provision should be repealed:

The House Report stated that [the 5-year nondischargeability provision] was targeting a perceived problem rather than a real one and that less than 1% of all federally insured and guaranteed educational loans were discharged in bankruptcy.  The House Report came to the conclusion that anecdotal evidence of a few serious debtors caused the [legislative] movement for educational loans to be nondischargeable in bankruptcy.  H.Rept. 95-595, at 132 – 33 (1977)

Unfortunately, this report was rejected by Congress and the 5-year nondischargeability period remained on the books.

Something similar happened in 1997.  By then the 5-year nondischargeability window had been stretched to 7 years, and Congress was thinking about just flat out making student loans completely nondischargeable.  But it was required by law to submit its proposals for review by the Bankruptcy Review Commission, which issued a report indicating that the nondischargeability provision in the bankruptcy code should be scrapped altogether and that student loans should be treated the same as any other unsecured debt in bankruptcy.

Unfortunately, while Congress was required to run its proposals by the Bankruptcy Review Commission it was not required to accept that Commission’s conclusions.  Even though the Commission recommended making student loans fully dischargeable in bankruptcy just as they had been prior to 1976, Congress went the opposite way and made student loans completely nondischargeable in bankruptcy.

So we are stuck with a situation in which the government’s own review commissions recognize that student loans should still be dischargeable in bankruptcy as a matter of policy, but Congress refuses to allow students to take advantage of bankruptcy protection.  This smells of banksters.

Amending the Bankruptcy Code Is Doable and Is the Right Thing to Do
Like a lot of other people, I’m fairly convinced that we are going through a balance-sheet recession marked by high private debt levels and a resulting liquidity trap in which people devote themselves to paying down debt rather than spending money in the economy. 

Accordingly, I doubt we’ll see any real economic recovery until after our aggregate private debt level is significantly reduced.  This can be accomplished only by (i) paying off that debt, which will take many years during which economic growth will continue to be sluggish, or (ii) canceling at least some private debt so private income can once again be plowed into the real economy rather than used to pay off creditors.

The problem with the last option is that – politically – Americans hate the idea that some debt peons might not be held fully accountable for what they owe.  Two and half years ago, when President Obama proposed doing something to help out average Americans who were underwater on their homes, Rick Santelli famously went nuts on TeeVee and the next thing anyone knew we had Teabaggers living amongst us.  Brrrrr!

But amending the bankruptcy code is not quite the same thing as simply forgiving debt.  It’s technical and when one hears the word ‘bankruptcy’ one’s eyes tend to glaze over.  Plus, declaring bankruptcy comes at a price – it isn’t a get out of jail free card.  And amending the bankruptcy code to once again make student loan debt dischargeable would not result in an automatic cancellation of debt – which is what seems to rile up the Teabaggers – it would only discharge debt for those people who decide the cost of bankruptcy is worth getting out from under their onerous student loan burdens.  In short, I think amending the bankruptcy code is a way to write off some significant private debt that would not necessarily result in a huge political backlash from the easily confused Teabaggers.

Moreover, as those congressional studies and reports indicate, prior to making student loan debt nondischargeable there was no student loan debt problem to be fixed.  Only a very few student loans were discharged in bankruptcy; the vast majority were in fact repaid.  I don’t think that would be the case today, but then I also think that the reason so many students have been forced to take out onerous student loans is because of those loans’ nondischargeability. 

Without Congress having told the banks, in essence, “go ahead, make a risk-free loan, we’ve got your back,” loans wouldn’t have issued, demand for college education wouldn’t have increased as rapidly, and people wouldn’t be in as much debt as they are now.  I think that if people can discharge their student loans in bankruptcy again we will in fact see a lot of people taking advantage of that option (which, again, is the point), but only because of the artificial debt loads that directly resulted from making such loans default-risk free in the first place.

And y’know what?  I have absolutely no moral qualms about what is likely to be an initial and staggering loss to the banks on this debt.  I can imagine the banksters arguing that it would be unfair to subject them to default risk when they were setting loan terms predicated on the fact that there was no risk of default.  But if you think about it this is an insane and – quite frankly – immoral argument.

If the banks would not otherwise have issued a loan to someone because they thought that person was unlikely to be able to pay the loan back, then the bank should not have issued the loan period.  What the banks would be admitting to, were they to make this argument, is that they knew they were issuing loans to people unlikely to pay them back but they figured without the risk of default those people would simply remain trapped in debt to the banks for the rest of their lives.  And I’m fairly certain the banks never explained that to the people to whom the banks were loaning the money.  So, no, I have no qualms about changing the rules of the game in such as way as to hurt an institution that planned to profit by turning their debtors into a permanent credit cash crop.

Finally, bringing back the risk of default in student loans would force lending institutions, the government, and our universities to take into account the real cost of higher education.  I fully expect that were student loans once again dischargeable in bankruptcy we would see a lot less loan money available for college.  I also expect we’d see a slowing of the rate of increase in the cost of college. 

But all that would do is underscore that – perhaps – we should as a people be making college education more affordable, either by directly underwriting the costs of education or else by making more government loans available at interest rates no greater than the rate of inflation.

Allowing private lenders to make risk-free loans obviously made a lot of student loan money available, but at prices too high to be sustained.  That is a broken system, one that should be fixed by amending the bankruptcy code, and something that the Occupy movement – which has always expressed concerns about student loan levels anyway – should be able to get behind.

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