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Are Student Loans the Next Debt Bomb?

Meg Handley

An increasing number of Americans are buckling under the weight of mounting student loan debt and the fallout could look a lot like the nation's catastrophic mortgage meltdown, experts say.

Total student loan debt has surged to more than $1 trillion over the past few years and with it the number of people seeking help handling their debt. More than 80 percent of bankruptcy attorneys surveyed by the National Association of Consumer Bankruptcy Attorneys reported a "major" jump in student loan borrowers seeking help, according to a study released Tuesday.

"Take it from those of us on the frontline of economic distress in America: This could very well be the next debt bomb for the U.S. economy," said NACBA president William Brewer. "What we are worried about is that we are looking at the next mortgage-style debt threat to the United States."

But in most cases, attorneys' hands are tied, according to the report: 95 percent of attorneys surveyed saw little chance of relief for those sagging under the weight of unmanageable student loan debt. "Few student loan debtors are seen as having any chance of obtaining a discharge as a result of undue hardship, which is their only way for relief under the current law," Brewer said.

[See a collection of political cartoons on the economy.]

And it's not just kids shouldering huge student loan burdens; parents who cosigned loans to help pay for their children's education are also facing financial trouble. Dave Ingham, a disabled veteran, cosigned his son's loans (now in default) and has been sued by a collection agency representing student loan corporation Sallie Mae. He's scheduled to appear in court next week.

"The situation seems very bleak to us and we are very worried about our future," Ingham said in a conference call. "As parents we always want to do what we can to help our children and until the last few years the job market seemed fine. Parents had no reason to think their children would not be able to get a job and pay back their loans."

But that's just what happened to Ingham's son, who has been unable to find work since October 2009. Now Ingham stands to lose everything, he says, including his family's condominium in Minneapolis.

The fact that cases such as Ingham's are becoming more common troubles experts. In its quarterly survey of bank risk professionals, FICO--an analytics company that provides credit scoring--found growing concern for the stability of the student loan market. "Evidence is mounting that student loans could be the next trouble spot for lenders," said Andrew Jennings, chief analytics officer at FICO and head of FICO Labs, in a NACBA paper released Tuesday.

Even more troubling are the similarities to mortgage finance problems seen right before the foreclosure crisis torpedoed the nation's housing market and contributed to a global financial crisis. "Just as the housing bubble created a mortgage debt overhang that absorbs the incomes of consumers and renders them unable to engage in consumer spending that sustains the economy, so too are student loans beginning to have an effect, which will be a drag on the economy for the foreseeable future," said John Rao, an attorney at the National Consumer Law Center and vice president of NACBA.

[Read: 6 Things That Could Derail the Economic Rally.]

The effects of a student loan crisis could have equally disastrous effects, according to experts, especially since the economy remains fragile and vulnerable to shocks.

"This concern is echoed by bankruptcy attorneys from across the country who report that what they are seeing at the ground level feels too much like what they saw before the foreclosure crisis crashed onto the national scene: more consumers seeking their help with unmanageable student loan debt, and with no relief available," Rao added.

So can the impending student loan debt disaster be avoided?

"We need to make some common sense reforms, something like creating an escape valve to relieve some of the pressure before the whole thing blows sky high," Rao said.

Bankruptcy attorneys want to see student loans fall under the same eligibility as other debt for "discharge" through bankruptcy proceedings, Rao said, adding that most courts are very stringent when determining whether a student borrower qualifies. Also, a statute of limitations should be established, limiting how long the government can pursue borrowers for debt collection.

"There's no way to diffuse this bomb if the status quo remains the same," Rao added.

mhandley@usnews.com

Twitter: @mmhandley

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