Opinion: Bankruptcy Is the Solution to the Student Loan Crisis

Allowing the debt to be discharged could tighten lending standards, put a lid on tuition increases and end shady for-profit universities. Bloomberg Opinion's Joe Nocera joins Quicktake to discuss.

To understand why we have a student loan crisis — and with $1.6 trillion in outstanding student debt, it surely is a crisis — just look at the U.S. bankruptcy code.

In 1965, Congress passed the Higher Education Act, part of President Lyndon Johnson’s Great Society. On the one hand, the new law established federal grants and loan programs to ease the monetary burden of attending college, especially for disadvantaged students. On the other hand, the bill included rules that made it difficult to discharge a federal student loan in bankruptcy. Over the next four decades, Congress added additional restrictions that made it not just difficult but impossible to shed a federal student loan, no matter how dire a borrower’s circumstances. In 2005, Congress crossed the final frontier: It added privately issued student debt to its no-discharge list.

We’ve all heard the horror stories that ensued. Students enrolled in for-profit colleges only to discover their “diplomas” didn’t get them the job they had been led to expect — leaving them only with an impossible debt overhang. Former students defaulted — only to have their wages garnisheed by the federal government, which was as ruthless as any collection agency. Loan servicers found reasons to pile on additional fees and charges. Nearly one out of five former students is in default, according to the Pew Research Center. The student loan burden has been debilitating for millions of people who hoped that taking on that debt would lead to a better life only to discover that, for one reason or another, it didn’t.

But there is another largely unacknowledged consequence of outlawing the discharge of student loans in bankruptcy: It ushered in a lot of moral hazard. Remember the subprime housing bubble, when brokers sold homes to anyone with a pulse, knowing their firms would offload the loans to Wall Street, so they didn’t care whether the borrowers would ever repay the money? The student loan industry is built on a similar premise.

The federal government gives student loans to just about anyone who asks, regardless of income or ability to repay, knowing the borrower can’t ever elude the debt. The same is true of private lenders. Universities raise the cost of tuition with impunity year after year knowing that loans will always absorb the increases. For-profit colleges wouldn’t exist if students could discharge their loans in bankruptcy; their entire business model is predicated on being paid up front by the federal government — which then becomes the entity that has to worry about being repaid. With student loans a risk-free venture for lenders and universities, is it any wonder that student debt has become the second-largest form of consumer debt in the U.S., trailing only mortgages?

As a general proposition, I’m sympathetic to those who are calling on President-elect Joe Biden to erase some of that debt once he takes office. According to Senator Elizabeth Warren, 42 million Americans have student loans; she has filed a bill to cancel $50,000 of that debt for each of them. That legislation has gained favor among progressives, who are pressing Biden to take action through executive order as soon as he is sworn in. (Biden has floated a more modest $10,000 relief plan through legislation.)

The rationale isn’t just to help former students unable to pay back their loans but to help the economy. Student debt is preventing many millennials from buying their first home; between 2005 and 2015, homeownership among people ages 25 to 34 dropped by 10 percentage points. It is making it impossible for former students to start small businesses or take jobs that don’t pay a lot of money. It makes it harder to get credit to buy other things. In other words, it holds back millions of young Americans from participating fully in economic life, which has a ripple effect across the entire economy. Canceling student debt would act as much needed economic stimulus.

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