If it sometimes feels like student loan borrowers are treated like criminals — that’s because they are. It literally took an act of Congress to make it so.
Student loans are different from almost any other form of borrowing. Unlike credit cards or other unsecured debts, they are almost impossible to discharge in bankruptcy. Legally, it’s better to think of college and grad school debt as akin to a child support payment owed by a deadbeat dad.
The $1.3 trillion student loan crisis has many causes, but the slow erosion of consumer rights to gain student debt relief ranks right up near the top. That $1.3 trillion debt — larger than all credit card debt ?in America — is truly an anchor for life to the 44 million Americans who owe it.
It wasn’t always this way.
The trouble started in the mid-1970s, as student loans became common and urban legends around “deadbeat” former students started to spread. In 1976, Congress considered a dramatic change to the nature of student loans — taking them out of the bucket that makes them similar to credit cards or personal loans, and moving them into the bucket that governs criminals like deadbeat dads or tax scofflaws. Back then, Congress was wise enough to commission a Government Accounting Office study making such a step permanent. The study came back showing that fewer than 1% of student loan borrowers had declared bankruptcy. That led Rep James O’Hara (D-Mich) to say it would be grossly unfair to lump them in with deadbeats. If you are struggling and are planning on declaring bankruptcy, you are not alone. A lot of people do it in the hopes that it will give them a fresh start. If this is something that you are considering then you might be interested in getting yourself a lawyer. Why not take a look at someone like this bankruptcy attorney san diego?
Doing to would be “treating students, all students, as though they were suspected frauds and felons,” he said.
Soon after, the U.S. Senate voted to strip the provision from a proposed bankruptcy reform bill that made college debt non-dischargeable. But for reasons unknown, a group of Congressmen in the House led by Rep. Allen E. Ertel (D-Pa.) held firm to their conviction that student loans were creating a moral hazard, and re-inserted the provision. They won the day, and non-dischargability of student loans was included in the Bankruptcy Reform Act of 1978. Student borrowers were now permanently “suspected fraud and felons,” to use O’Hara’s words.
Let’s take a moment to recall the nature of modern U.S. bankruptcy law. That dates to 1934, when the U.S. Supreme Court ruled for a debtor and against an Illinois state law that would have prevented a borrower from getting relief in federal bankruptcy court. Justice George Sutherland wrote in the decision explaining the rationale behind giving debtors a second chance in America.
“This purpose of the act has been again and again emphasized by the courts as being of public as well as private interest, in that it gives to the honest but unfortunate debtor who surrenders for distribution the property which he owns at the time of bankruptcy, a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of pre-existing debt,” he wrote.
After 1978, student loan borrowers no longer had the same rights to a “new opportunity in life” as other borrowers.
As University of Connecticut law professor Philip Shuchman had warned during Congressional testimony, student loan debtors were now “singled out for special and discriminatory treatment.”
Still, the initial rules weren’t nearly as onerous as they are today. The 1978 limitation meant students had to try to pay their loans back for at least five years before they could seek relief in bankruptcy court. Even today, critics of the way bankruptcy laws work don’t find fault in that notion – to prevent someone from leaving school and immediately erasing their debt before making an honest effort to earn an income. But the 1978 law opened the door for further tightening of the debt noose on borrowers, which happened methodically during the next several decades. A brief timeline:
In 1990, the repayment period before a discharge was extended to 7 years.
In 1991, Federal law cleared the way for wage garnishment of student loan debtors.
In 1996, the Debt Collection Improvement Act of 1996 allowed Uncle Sam to “garnish” even Social Security checks. Five years later, the Department of Education had the right to take up to 15% of a Social Security check.
Then in 1998, with the reauthorization of the Higher Education Act, the seven-year ban was turned into an infinite year ban. Loans made or guaranteed by Uncle Sam to students could never be discharged.
And here is where the history of student loans and bankruptcy gets interesting. There is a rationale for members of Congress who want to be tough on student loan borrowers — the former students owe money to the American public. Congress wants to appear to be a tough debt collector when the money is being returned to taxpayers.
But in 2005, the most recent overhaul of federal bankruptcy law, the permanent ban on bankruptcy for student borrowers was extended to private student loans, too — those that have nothing to do with Uncle Sam. Private banks lending teenagers money for college now hold a “til death do us part” contract.
The “discrimination” warned by Prof. Shuchman in Congress nearly 30 years prior had become complete. And it had been separated from its rationale as a taxpayer protection.
Steven M. Palmer, a Seattle-based bankruptcy attorney who has written about the history of student loans, says it’s important to keep some perspective about what Congress might have been thinking back in the 1970s. In 1976, tuition, room and board cost an average of $2,275, according to the Department of Education (in current dollars).
By 2015, it was $21,728.
In the 1970s, a student could cobble together savings and earnings from a part-time job to go to college. Not now.
“Back then the cost of education was so much less. The total amount of debt was a tiny fraction of what it is today…The system has led us to where we are now, where everyone has to take out student loans,” he said. “And then they are getting out of school and not able to find jobs.”
For the completely desperate student borrower, there is one exception in the bankruptcy code: known as “undue hardship.” Practically speaking, that’s legalese which can loosely be translated as “nearly impossible.” An attempt to discharge a student loan requires a separate legal process from a traditional bankruptcy — called a Complaint to Determine Dischargeability — an adversarial process that can require discovery, depositions, and even arguments in court against Department of Education lawyers.
Practically speaking, this can cost the debtor 10 times the price of a standard bankruptcy, Palmer said. An attempt to get free from student loans can easily cost $20,000-$30,000 in fees — and the risk that it doesn’t work. Remember, declaring Chapter 7 bankruptcy (the kind that erases debt) requires a married couple to prove they have no more than $120 in monthly disposable income. Not the kind of family who can pay $20,000 to attempt a student loan discharge.
Also, says Palmer, it’s critical to remember that declaring bankruptcy is hardly easy, nor does it erase all a family’s problems.
“Many of my clients have so much they still need to end up paying after bankruptcy, my counseling is often to ask, ‘How will you be better off?’ In some cases, they are really in a terrible spot…really still pretty well screwed after the bankruptcy,” he said.
There have been plenty of calls through the years to reform student loan bankruptcy laws.
In 2007, Michigan Professor John A. E. Pottow wrote the definitive history of the issue in an academic paper titled “The Nondischargeability of Student Loans in Personal Bankruptcy Proceedings: The Search for a Theory.” From the name, you might guess he concluded that it’s hard to justify the existing bankruptcy laws.
“This is harsh and dramatic treatment, and it is worthy of scholarly attention,” he wrote. “It will be helpful to remember that non-dischargeability is an extraordinary rule, often held out for extraordinary debts (such as, for example, an intentional tortfeasor’s debt for a damages or restitution award to her victim). Thus a theory of non-dischargeability should make a case for treating student debt not just harshly, but exceptionally – different from all other debts.”
Pottow dispenses with most operating theories using data – that bankruptcy encourages students to commit fraud, or that Uncle Sam is merely protecting taxpayers, for example.
“In critiquing this collection of possible theories, it suggests that the most attractive ones seem to be the ones least reflected in many of the current bankruptcy laws, just as the ones most recognizable in today’s statutes seem grounded in confusion and myth,” he wrote.
He ultimately suggests some kind of income-contingent test which ties bankruptcy eligibility to a calculation that takes into account school costs and potential post-school income.
“In addition to being attractive theoretically, income contingency could also help a troubling trend,” he wrote.” Apparently certain “sub-prime” schools target a financially vulnerable client base by upselling classes and educational programs of dubious worth, confident that they will have repayment leverage through non-dischargeability in bankruptcy. An income-contingent approach might dry up this unwelcome market.”
More recently, the Consumer Financial Protection Bureau raised the idea in a 2012 report, calling on Congress to make bankruptcy again available to about 15% of student debt holders.
“(It would be) prudent to consider modifying the code in light of the impact on young borrowers in challenging labor market conditions,” the bureau wrote.
Palmer, the bankruptcy lawyer, notes that giving such debtors a fresh start wouldn’t only help the former students. College debt has been tied to delayed household formation, which has a domino effect – young graduates are getting married later, starting families later, buying homes later, and so on.
“I would be good for the economy as a whole,” he said.
“If there’s a way of a society committing mass suicide, what better way than to take all the youngest, most energetic, creative, joyous people in your society and saddle them with, like $50,000 of debt so they have to be slaves?” he said during a talk in 2013. “There goes your music. There goes your culture. There goes everything new that would pop out. And in a way, this is what’s happened to our society. We’re a society that has lost any ability to incorporate the interesting, creative and eccentric people.”
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