Student Loans Should be Dischargeable in Bankruptcy

Flipping channels over the weekend I stumbled on the fabulous Suze Orman’s TV show. I could only stand watching for a few minutes, but in that time I got to see her give an overwrought soliloquy on the outrage that student loans are not dischargeable in bankruptcy. She is working to fix this, she tells us.

I do not think she has as much pull in Washington as her followers imagine. But I am happy to throw my weight behind the effort too. I imagine that Suze would be alarmed at my motivations, but on this particular issue I find myself agreeing with her. Could be a first.

Discharging debt is the essence of the bankruptcy process. What the bankruptcy petitioner owes is either wiped out entirely (in Chapter 7) or has its terms and/or amounts modified (in Chapter 13.)

However, there are a few exceptions. Actually, more than a few.

Most obviously, mortgages and other loans that are secured with an asset get a claim on that asset. So if you owe $2K on the car you are not going to be able to make the debt go away and keep the car too.

And there is a list of types of unsecured debt, 21 of them to be exact, that you cannot get out from under in bankruptcy. Several forms of debt you owe to a government, including most taxes, are prominent on the list. Alimony and child support are also exempted. As are condo fees and what you owe for damages you caused while drunk. And student loans.

The list of non-dischargeable debts is not exactly coherent, so it is hard to back out consistent logic as to why something is or is not dischargeable. Before 1976 student loans were as dischargeable as credit cards. Then student loans made or guaranteed by the government became non-dischargeable. That fits with the no getting out of money owed to the government theme. (But even that is not entirely consistent. Income tax debts that are old enough can be discharged.)

Then in the mid-1980s Congress made all student loans, both government sponsored and private, non-dischargeable. How did this make sense? I am not sure it did. But then why condo fees are special is also beyond me. The truth is that non-dischargeable status is fairly arbitrary.

I suppose you could make the argument that student loans need to be a special case because most college students are, for most practical purposes, insolvent. In theory, they could declare bankruptcy late in senior year, point to a mountain of debt, with no income, and get the court to vaporize the whole thing.

On the other hand, in the 1970s and 80s student loans were typically much smaller, more like starting life with an extra car loan rather than an extra mortgage. Today new graduates routinely carry six figure debts which they often are still paying off in middle age.

Which is why Suze and I are against having student loans being non-dischargeable. Of course, I am pretty sure ol’ Suze has not quite thought this one all the way through. I think making them dischargeable in bankruptcy is a good idea because it will make them harder to get and more expensive. (Also, I think it would be wrong to change the rules on existing loans. That would just be stealing from lenders. I am talking about future loans.)

When Suze says that she thinks student loans should be dischargeable, she is saying that more of them should be allowed to default, meaning that the non-defaulters will need to pay higher rates. That is obvious, right?

I believe that the ease with which teenagers can borrow great heaps of money with only the vaguest of theories on how they will pay it back is a very bad thing. It is bad for the young person, who may soon regret spending what could turn out to be three or four years salary on that degree in history.

And it is even worse for the country as a whole. It is a major contributor to the increasingly absurd spiraling of college tuition. We have made university customers flush with cash. So of course prices keep going up. And it fuels the credentials bidding war, not just allowing but forcing ever more kids to get ever more degrees.

Making student loans non-dischargeable largely relieves the lender from worrying about the economic realities of what the money is being used for. $100K for a marketing degree from a middling school? Loaned to a kid with no credit history at all? Well, as long as he can never ditch the loan in bankruptcy and it will follow him around for the rest of his life until he pays it off, who cares if the degree is worthless? He will be around for another 50 or 60 years.

A while back I discussed the question of whether or not college was a good investment, even at the current astronomical prices. And the answer was yes, on average. Degrees for the top schools have clear economic value and thus loaning money to students to get them will probably always be good business.

But for the schools at the other end of the spectrum, the marginal ones that offer degrees of questionable value, it ought to be much harder to get those degrees financed than it is now. It is as if banks were happily writing mortgages on condemned houses.

Obviously, the primary responsibility for borrowing money to pay too much for something rests with the borrower. But these are kids, and kids often make foolish choices. No need to make that any easier for them.

[Photo – Kit]

College, Suze Orman | Frank Curmudgeon | June 13, 2012 8:59 am

180 Comments

By Don Gadda, June 14, 2012 @ 3:26 pm

Just a note, while a debtor can rack up a huge credit card bill for toys (auto’s motorcycles, atv’s etc . . .) and be assured that it will all be dischargeable he cannot borrow money to get an education and have it treated the same way. Does this sound like a rational policy for our country?
By Paul Williams, June 15, 2012 @ 12:12 pm

Well I guess you could always pay your tuition on credit cards, Don.
By Todd Transue, June 15, 2012 @ 1:19 pm

If the debt were dischargeable, what would stop kids from getting their education, not looking for a job, and then declaring bankruptcy right out of school?
By Lucas, June 15, 2012 @ 3:15 pm

Todd hit the nail on the head. Heck, who wouldn’t have loved to have gone to an Ivy League school, rack up a couple hundred thousand dollars in student loan debt, graduated, declared bankruptcy and walked away with a great free education and a great job due to the Ivy League education. There is no downside to doing this.

That is the biggest reason you shouldn’t be able to discharge the debt.
By Neil, June 15, 2012 @ 4:13 pm

@Todd/Lucas – you present a good argument for limitations on discharging student loan debt, such as not being able to discharge it within, say, 5 years of last attending school. But if someone is still insolvent long after the education should be paying off, I don’t see why the original purpose of the borrowed money should matter.

Besides, it’s not like other countries without a student loan exception have a rash of people attending the best schools and then declaring bankruptcy. Being unable to borrow money for an extended period of time isn’t exactly the best way to start your post-college life, and may interfere with the ability to present the required image needed to get those promised post-ivy-league jobs.
By JT, June 15, 2012 @ 10:33 pm

Or, you know, you could take the funds from a write down of public student loans and push through a personal finance curriculum for high school students.

Seems like a net gain. The only problem is that distrust in government seems to be directly related to a greater understanding of personal finance. Congress critters wouldn’t want to subsidize that.
By Frank Curmudgeon, June 19, 2012 @ 5:15 pm

Paul Williams:

That’s a brilliant strategy, assuming you could get a really big credit line. Or maybe several dozen cards.

Lucas:

In THEORY, the bankruptcy judge could look at the potential earning power of the new Ivy League grad and decide he could pay the loan off just fine over a few years and not discharge it. Having parents co-sign probably makes more sense.

Neil:

In other countries there is no problem with new grads declaring bankruptcy because 1) only the US has such liberal bankruptcy laws and 2) only the US has such crazy expensive colleges. So we are on our own on this one.
By jim, June 23, 2012 @ 6:02 pm

“Today new graduates routinely carry six figure debts”

Only 0.3% of undergrads end up with 6 figure debt. Only 10% carry more than $50k
By American, June 26, 2012 @ 1:40 pm

Student loan debt should be dischargable in bankrtupcy court like it was before the new bankruptcy law.

Sallie mae agrees: http://www.forbes.com/sites/peterjreilly/2012/04/30/sallie-mae-not-opposed-to-bankruptcy-relief-for-student-loans/
By Frank Curmudgeon, June 27, 2012 @ 9:54 pm

Stop confusing me with facts. My posts are full of truthiness.
By FC, January 29, 2013 @ 2:25 pm

While I agree with your point that students loans are too easy to get and that there is probably a higher education bubble, I disagree with you about the dischargeability of student loans. It would be far too easy for a student to rack up huge debts and then bankrupt out of them right after graduation. I suspect most people would not be able to get a loan for college at all. This is a bad thing. That is not to say that lenders should not be more careful about making loans or that the government should stop subsidizing them so much. Those, however, are separate arguments from if those loans should be dischargeable in bankruptcy.

Finally, while I agree that many low-end schools are probably a waste of money, some higher-end schools are too. There have been several studies which suggest that those who were accepted to the Ivy Leagues, but chose to go elsewhere did just was well as those who actually enrolled in the Ivy’s. The conclusion is that it is the actual skill, ambition, and intelligence of the student that matters the most, not the school.
By Andrew, February 17, 2013 @ 11:39 am

If student loans were dischargeable, many students would do what you suggest – declare bankruptcy, then look for a job.

As a result no institution would loan to students, and only the rich would go to school.
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