Student Loan Debt Forgiveness

Joe Biden wants to cancel $10,000 of federal student loan debt per borrower while the progressive wing of the Democratic party (apparently, now including Chuck “Wall Street” Schumer) wants to raise the ante to $50,000 of relief.

I understand the urgency of the issue but this is one of the dumbest financial policy ideas of the 21st century, right up there with:  (1) Bush’s attempt to privatize Social Security and (2) Obama’s 2009 Wall Street bail-out without extracting a pound of flesh in return. Arguably, one could draw a nearly straight line from the resentment toward Obama’s generosity to the bankers to the horror of four years of Trump.

Why is student debt cancellation such a terrible idea? Well: (1) it’s unfair, (2) it solves nothing, and (3) there’s a better approach.

Let’s take each in turn:

Background

Certainly, many people are suffering under the burden of unpayable student loans. It’s a complex mix of young and old, parents and children, federal and private loans, graduate and undergraduate students, and higher and lower income earners. But, keep in mind:

• Most people, particularly those who received their undergraduate education at a state college, did not over-borrow and while their debt may be burdensome, their incomes can likely support repayment.
• Some people, particularly those who financed a graduate school education with federal loans, have large loan balances but, if they have high incomes or if they opt for an income-dependent repayment plan, they can usually afford their loan payments.

A smaller, but nonetheless important, cohort borrowed too much money to finance their education and did so with mostly private student loans. Many were teenagers at the time and/or badly misled by college financial aid offices.

Those private loans are ineligible for income-dependent repayment plans and are ineligible for Biden’s federal debt relief. These borrowers are experiencing deep financial stress and are typically the ones described in media accounts. These loans are not realistically repayable and currently they have no escape.

Student debt relief is unfair.

If you cancel some portion of federal student loan debt for some subset of borrowers, it raises obvious questions of equity. For example, what about those who paid for college with:

• their life savings
• a second mortgage
• private, not federal loans

Are these people less worthy of debt relief or federal support? Why cancel some debts but not others? I wouldn’t want to be the Solomon who answers those questions.

Student loan debt relief has limited political support. While it’s a terrible situation for those caught up in the debt vortex, most of America is not affected by unpayable student loans (though many are burdened by other financial stresses). If student loan borrowers are bailed out — but not others — this could spark a backlash. According to Brookings,

A very small fraction of all student loan borrowers have very large loans. Six percent of borrowers owe more than $100,000 in debt, with 2 percent owing more than $200,000. This 6 percent owes one-third of the outstanding $1.5 trillion of debt. At the other extreme, 18 percent of borrowers owe less than $5,000 in student loan debt. They collectively owe 1 percent of the debt outstanding.

Student debt relief solves nothing.

Offering debt relief to a portion of existing federal student loans won’t help those with the biggest burdens. Their private student loans will still be unpayable with no escape valve.

It also does precisely nothing for present and future students as they will face the exact same dilemma — college is unaffordable. Should they over-borrow and hope that the next president will bail them out?

When all is said and done, over-burdened borrowers will still face unpayable loans, college will still be too costly, and other indebted citizens who got no relief will be resentful.

There’s a better approach.

A college education needs to be more affordable but, I’m going to dodge that question and instead focus on the immediate issue of what to do now for the millions of people with unpayable student loan burdens?

There’s a simple fix — allow student loans to be dischargeable in a bankruptcy proceeding, just as all other consumer debt can be. Since 2005 changes to the bankruptcy laws, student loan debt, with rare exceptions, is ineligible for bankruptcy relief. A history of student loans and bankruptcy eligibility is here.

Because of this unfair exception (supported by Senator Biden), student loans, along with the fees and penalties that accumulate from missed payments, follow borrowers to their graves. This can lead to garnishment of wages, tax refunds, and even Social Security benefits, and the inability to borrow for other purposes. There is no way out.

Instead of giving some borrowers an arbitrary amount of debt relief, Biden should give everyone access to the bankruptcy court. In most cases, they would not get fully released from these obligations but instead the court would reorganize the debts into an affordable payment plan. Furthermore, just the threat of bankruptcy would make lenders willing to negotiate a reasonable adjustment and probably keep many people out of court.

And, having access to a bankruptcy discharge would moderate the cost of college over time. Private lenders would be more wary of making student loans and this would put cost pressure on colleges to make the fees affordable.

Bankruptcy is not a gift — it is a traumatic experience and rarely means a full discharge of all debts. Our society moved beyond debtors’ prisons long ago and this is the process we’ve chosen to restructure debts and provide a fresh start. It worked quite well for Donald Trump, AIG, and GM; let’s use it for student loan borrowers.

The result would be dramatic. Allowing a path to bankruptcy would offer a safety valve for suffering borrowers. Importantly, re-enabling bankruptcy protection for student loans would not spark a political backlash — just loud squeals from the same bankers that Obama bailed out. For once, people would get the relief and bankers would take the hit. That would be a sight to see.

Bankruptcy, as Trump knows better than anyone, is the classic American story of redemption and second chances.