A Gaping Hole

The leaders of the House Committee on Education and Labor introduced legislation on Friday that would go a long way in addressing consumer advocates' biggest concerns regarding private student loans. The Higher Education Act reauthorization bill would, for instance, bar colleges and lenders from making deals in which institutions of higher education directly profit from their students private loan debt. The measure would also ban lenders from branding private loan products with a colleges name or logo in a way that implies that the school has endorsed the loan.

In addition, the legislation would increase transparency in the private student loan market. Lenders would be required to provide clearer information about the interest rates and fees they charge and to inform potential applicants about the availability of cheaper, safer federal loans. Borrowers would have up to 30 days, after a private loan offer is made, to decide whether or not they want to take out the loan, and another 3 days, after the loan is consummated, to cancel it. And the measure would bar lenders from penalizing borrowers who pay off their high cost private loans early. All good.

Still, the bill has at least one big, gaping hole in its approach to private student loans: it doesnt provide relief for borrowers who have taken on unmanageable levels of private student loan debt and now find themselves in severe financial distress. To address this oversight, we at Higher Ed Watch believe House Members can and should add a provision to treat private student loans the same as other forms of consumer debt when it comes to bankruptcy claims.

As we have noted previously, Congress in 2005 tucked a provision into its infamous bankruptcy bill making it virtually impossible for borrowers to discharge private student loans. That special provision was added in a secret conference committee, without any public debate and with no named Congressional sponsor.

To be clear, we're not advocating allowing borrowers to claim bankruptcy willy nilly in order to avoid student loan repayment. Our view though is that private student loans should not be treated any differently from other forms of consumer debt when it comes to bankruptcy. Right now they are, and that's wrong. Folks who borrow private students loans are trying to better their lives. They certainly shouldn't be treated more harshly than those who rack up credit card debt at the mall.

For most unsecured debt, a borrower who runs into difficulty can file for Chapter 7 liquidation or Chapter 13 reorganization, so a judge can sort out the appropriate treatment of various loans. But there is a short list of debts that the law subjects to a different status, allowing discharge in only the most extreme circumstances. The government, for example, makes it especially difficult for people to escape child support responsibilities, overdue taxes, and criminal fines.

Federal student loans also can't be discharged. There is at least some justification for providing federal student loans that status, since they are backed by taxpayer dollars and come with borrower protections in cases of economic hardship, unemployment, death and disability. But there is no good reason for private student loans to be accorded the harshest bankruptcy status given to criminal fines, child support, and back taxes.

Shielding private loans from bankruptcy in almost all circumstances means that repayment demands extend essentially forever, leaving even the most destitute borrowers with no way out. And bankruptcy exemption makes private student loan providers less cautious about peddling high cost loans to students who might never be able to afford them. In other words, it promotes reckless subprime lending, which as we have seen in the mortgage industry, is fraught with danger. Treating private student loans like other forms of unsecured debt would at least cause lenders to think twice before providing high-interest loans to people who they know will have trouble paying them back.

The House Education and Labor Committee is expected to debate and approve the Higher Education Act reauthorization legislation this week. The bill is then likely to go to the House floor for a vote within the next month before Congress adjourns for the winter holidays. We are hopeful that on House floor, Education and Judiciary Committee leaders will recognize the need to eliminate the bankruptcy exemption for private student loans.

Perhaps the easiest course of action would be for House leaders to embrace legislation that Sen. Richard Durbin (D-IL) introduced in the Senate that would reverse the 2005 bankruptcy statute for private student loans and allow borrowers to discharge their debts after attempting to repay them for five years. But the latest version of Mr. Durbin's bill makes the suggested change only for new borrowers. That's not good enough. We shouldn't abandon those already in severe financial distress. They need help now.