Last month, the Center for American Progress—a progressive think tank—published a report that calls for “a bolder approach” to making student loans more responsive to the needs of financially distressed borrowers.
Briefly, the center is advocating for the creation of two new student loan designations: qualified and nonqualified. Qualified loans would be priced in accordance with the Bipartisan Student Loan Certainty Act of 2013. They would also be structured to incorporate the various distressed borrower relief programs that are currently offered through the government’s Direct Loan programs—such as the Pay As You Earn Repayment plan—and more widely available deferment and forbearance arrangements. These loans must also have a “reasonable likelihood of repayment,” which suggests there would be a link between borrowing amounts and employment outcomes—a move that’s intended to hold schools accountable for the quality and cost of the education they provide.
Loans that fail to meet these standards would be designated nonqualified and thus subject to discharge in cases of Chapter 7 bankruptcy—an action that has become virtually impossible to take because of the limitations imposed by the curiously named Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.
A Deeper Dive Into the Problems
On the surface, the center’s recommendations appear reasonable. They’re intended to promote responsible lending and borrowing practices, which the center believes will also lead to more affordable college costs.
Unfortunately, they don’t go far enough.
To start, it’s unclear how this will address the $1.1 trillion in student loans that are already on the books. Would the qualified/nonqualified designations be retroactively applied? If so, you can imagine the intensity of the lobbying effort that’ll ensue as lenders stand to lose significant sums of money on unsecured (uncollateralized) education loans.
What about the schools? Shouldn’t they also be held financially accountable for their culpability in the making of this economic disaster? Would it not make sense to compel the colleges to disgorge a portion of their prior earnings to cover their fair share of the losses? Perhaps the schools’ cohort default data could be used to determine the value of those chargebacks.
An Issue of Fairness
But let’s focus on the crux of the center’s report: the dischargeability of student loan debt in bankruptcy court.
That all student loans—both government and private—are virtually bankruptcy-proof has become a focal point of distressed borrower anger. It’s also become a bubbling cauldron of resentment for those who’ve not experienced these same difficulties either because of lower debt levels or more favorable employment outcomes.
I happen to fit that particular demographic.
I worked and borrowed my way through college and grad school, and repaid my loans on time and in full. What’s more, my professional background is on the lending side of the financial services industry and I teach part time at a local university. So it stands to reason that I am opposed to reforming the bankruptcy code as the center recommends. After all, I repaid what I borrowed, I’m a lender by trade and, if that weren’t enough, I’m also on a college’s payroll—a virtual trifecta of anti-leniency sentiment.
But it’s exactly because of these factors that I am in favor of modifying the code—although not to encourage mass loan defaults. Indeed, I would argue that we are already experiencing that condition, contrary to the absurd manner in which education lenders report payment performance.
What’s Reported Doesn’t Represent Reality
It is absolutely mindboggling to me as a lender that student loans are not categorized as defaulted until they are nine or more months past due. Nor does it make sense for these loans not to be categorized as impaired when deferment after deferment and forbearance after forbearance is granted, just so the borrower can continue to hobble along while the interest rate clock keeps on ticking.
Not only are these practices inconsistent with the manner in which just about every other type of loan I can think of is handled, I would argue they’re also predatory because the borrowers are at a distinct negotiating disadvantage. But before I get to that, here’s some insight into how a lender approaches a problem-loan workout.
When a loan heads sideways, the lender will update the borrower’s credit bureau report and, perhaps, FICO score, in order to determine how widespread the problem is (and because no lender wants to be the only one granting relief). The lender will also compile employment, payroll and tax information along with household budgets and updated personal financial statements (assets owned versus debts owed) so it can begin to devise an exit strategy for the loan—whether through a modified repayment plan or by forcing the borrower to sell certain assets.
Motivation Toward a Solution
So what if the borrower is truly up against it? What if his or her debt obligations have become completely unmanageable and there are no savings accounts to tap or assets to liquidate? You would think the lender would figure out a way to extract from the borrower all that it could for as long as it can because, as my banking buddies like to say, “A rolling loan gathers no loss.”
Unless the loan is not dischargeable in bankruptcy.
When an unsecured borrower has the ability to pull the plug in court, the lender is powerfully motivated to craft a solution that’ll minimize the hit it would otherwise take if the borrower were to go that route. When that’s not the case, the lender is equally motivated to take a much tougher stance—which is what appears to be happening with education loans.
Student lenders know that their borrowers are stuck. So rather than restructure the debt in a constructive (and potentially profit-eroding) manner by extending the term, abating the interest rate and/or reducing the principal balance, the lender offers temporary salves in the form of negatively amortizing payment deferments and forbearances that end up increasing the borrower’s loan balance and future payment amounts.
Not only is this hardnosed approach shortsighted and unproductive, it’s also immoral. That’s why I believe it’s time to restore student loan dischargeability. We need to return to a more balanced and constructive distressed debt-negotiation process. Otherwise, we’ll never clean up the mess we’ve made for ourselves.
This story is an Op/Ed contribution to Credit.com and does not represent the views of the company or its affiliates.
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