How Changing Bankruptcy Laws For Student Loans Could Revitalize The Economy

By tweaking bankruptcy and student loan laws, Congress could neutralize one of the most harmful features of the growing load of student debt. A new report from the Center for American Progress (CAP) argues that bankruptcy should allow borrowers to get out from under loans that have unreasonable repayment terms or were borrowed to attend schools whose graduates struggle to find work.

Student debt cannot be “discharged” — that is, voided by a judge and removed from the borrower’s legal obligations — under current bankruptcy laws except in rare, extreme circumstances. Those laws date to 1976, when Congress decided that allowing student debt to be dischargeable would encourage graduates to declare bankruptcy without ever trying to repay their loans. In the decades since, bankruptcy rules for student loans have grown so strict that the debt may follow borrowers to the grave, as it did with Jermaine Jones in 2009 and Freddy Reynoso in 2008. Gambling and credit card debts are treated more favorably in bankruptcy than are student debts.

In Tuesday’s report, CAP higher education experts Joe Valenti and David Bergeron argue for a new system. Rather than simply repeal the laws that make student debt inescapable, they propose that only loans that are sustainable for students be protected from bankruptcy. If a loan offers “reasonable repayment conditions such as low interest rates and access to favorable forbearance, deferment, and income-based repayment options,” and the school where the loaned money was spent has a good track record on the employment rate of its graduates, then it wouldn’t be dischargeable.

But private lenders who charge double-digit interest rates would no longer enjoy the legal protections they do at present. Schools that fail to achieve reasonable rates of employment success for their graduates would find the flow of borrowed tuition funds to their accounts drying up. And the newly-designated “Qualified Student Loan” system would create “a race to the top for lenders and institution.”


By giving both schools and lenders an incentive to improve outcomes for students, the “Qualified Student Loan” system would help slow the inflation of college costs and encourage schools to refocus resources on programming that is closely connected to employment outcomes for their graduates. In general, the system would bring the typical student borrower’s level of debt more in line with the typical graduate’s ability to repay loans, reducing the likelihood of the sort of debt overhang that plagues the economy today. Less debt means more disposable income for students and graduates, which translates into stronger economic activity and opportunity nationwide.

But a glance at the present state of higher education financing makes it obvious that something is broken. One in eight student borrowers is in default, triple the rate from a decade ago. There is more than a trillion dollars in total outstanding student debt nationwide, an overhang that holds back broader economic growth and reduces future earnings of borrowers by $4 trillion. College costs have risen 27 percent in five years, yet Congress has cut overall student loan funding by tens of billions of dollars.