The Big Gun in the Loan Industry’s Arsenal
One of the reasons our debt-based college aid system puts up barriers to college access is that student loans are treated differently under the law than any other unsecured debt.
In the case of a defaulted student loan, student-loan guarantee agencies can garnish your wages without even taking you to court, and the government can seize tax refunds, federal disaster relief payments, and Social Security retirement and disability benefits without a court order.
The big gun in the student lender’s collection arsenal is the bankruptcy exemption. Since 1998 federal student loans have been not been dischargeable in bankruptcy except in extremely rare circumstances of “undue hardship,” determined at the discretion of a judge.
Moreover, since 2005, with the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act (the “intellectually and linguistically insolvent” bankruptcy reform bill largely penned by the credit card industry lobby), even private student loans cannot be relieved in bankruptcy.
The wisdom of providing the exemption on private student loans — which was awarded to the loan industry without any debate or discussion in Congress — is beginning to come under question. In a hearing on Wednesday that the Senate Banking Committee held on private loans, the panel’s chairman, Sen. Chris Dodd (D-CT), minced no words when describing his opinion of the exemption, and of the scare tactics banks are using to defend it.
Sen. Dodd:I opposed the Bankruptcy Act. I thought it was a dreadful piece of legislation…Do you think the bankruptcy law is appropriate or inappropriate?
<br /> <strong>Peter Tarr, General Counsel of the First Marblehead Corporation:</strong></em><em> My personal view is that it's appropriate...If there's a change to the bankruptcy act it will have an impact on the availability of private student loans to fill that gap. <br /> <br /> <strong>Sen Dodd: </strong>Are you serious about that answer??<br /> <br /> <strong>Mr. Tarr: </strong>Yes, I am sir.</em> </p>
The original rationale for such exemptions was to prevent the case of a budding lawyer, let’s say, who files for bankruptcy to get rid of his law school debt before going on to a lucrative career. But a 2005 empirical study published in the University of Cincinnati Law Review found that bankruptcy filers who sought relief from student loans were generally in severe financial distress. The study also found that there was little statistical difference between filers who were found to meet the standard of “undue financial hardship” and those who weren’t. The former group, it seems, were simply luckier in their choice of judges.
Last week the Chicago Sun-Times reported that the Illinois Student Assistance Corporation, a major nonprofit lender and guarantee agency,
is considering granting a break to borrowers in default who file for bankruptcy. After hearing the stories of borrowers who are part of advocacy group Student Loan Justice, Andrew Davis, the agency’s executive director, asked his staff to determine whether the agency could forgive all of the interests and fee that had been charged to defaulted borrowers who declare bankruptcy. Requiring these borrowers to pay only the principle back would be a great deal because currently there are no practical limits on capitalized interest, penalties and fees that defaulted loans are chargedthey can quadruple or quintuple the original loan amount borrowed.
“If you leave them so thoroughly in debt even after bankruptcy that they can’t get back on their feet and they are driven into the underground cash economy and not into the career they trained for, the taxpayers don’t get anything,” Mr. Davis told the newspaper. “By being reasonable, we can reach a situation where the person might be re-employed in the formal economy. Ultimately, they and society may be much better off.” Reasonable indeed.
Most of the recent talk about student loan reform, and all of the bills and proposals currently in Congress, focus on policy changes affecting new borrowers. But it’s equally important to think about the effects of the system on borrowers in college now and those whose school days are far behind them. The students who need the most help getting to college are also taking the biggest risks when they take out student loans. Fair payment assurance and bankruptcy protection for student loans are essential to protect borrowers from falling prey to worst-case scenarios.
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