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 has to be 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 and (2) it solves nothing.

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, and graduate and undergraduate students. But, keep in mind:

  • Most people, particularly those who received their undergraduate education at a state college, did not over-borrow and while it 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 misled by college financial aid offices.

Those loans are ineligible for income-dependent repayment plans and would be 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:

  • used their life savings instead of borrowing?
  • took out a second mortgage to pay for their kids’ education?
  • are facing housing foreclosure, eviction, or loss of their business due to COVID?
  • are stuck with large uninsured medical expenses?
  • were gouged by their electric utility in Texas during a blackout?

Are these people less worthy of debt relief than those who over-borrowed to go to college? Why cancel some debts but not others?  I wouldn’t want to be the Solomon who has to answer those questions.

Student loan debt relief may have only 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 — the cost 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 unaffordable, 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.

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 give people a fresh start. It worked well for Donald Trump, AIG, and GM; let’s use it for student loan borrowers.

The result would be dramatic. Providing a path to bankruptcy would offer a safety valve for suffering borrowers. Importantly, re-enabling bankruptcy protection for student loans would not spark a backlash — just loud squeals from the same bankers that Obama bailed out. For once, ordinary people would get relief and the bankers would take a hit. Bankruptcy is not a joyful process but, as Trump knows better than anyone, it’s the classic American story of redemption and second chances.

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