Student Debt: Private Loans, Bankruptcy Get Attention on Hill

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By Diane Davis

Accelerating student loan payments in bankruptcy may be one way to help distressed borrowers achieve the fresh start offered by debt restructuring and address a mounting consumer credit problem nationwide, a former bankruptcy judge told Bloomberg BNA.

Eugene R. Wedoff, who oversaw the bankruptcy of United Airlines, said the idea is likely to be considered by the leading bankruptcy research and education group he now heads and could be recommended for congressional action, he said in an interview.

Allowing individual debtors to repay their student loans more quickly through Chapter 13 restructuring plans could “theoretically benefit everyone,” Wedoff said. There, debtors repay their creditors through a plan over a three-to-five-year period.

His comments Sept. 5 came as legislation in Congress to tackle surging student debt has made little headway amid political acrimony in Washington, and more pressing priorities. But some proposals have begun to percolate this year.

Mostly proposed by Democrats in the congressional minority, they’ve attracted more cosponsors and at least one bill is bipartisan. Americans, regardless of political affiliation, seem to want solutions to a problem widely viewed as a crisis and a drag on the U.S. economy.

Specifically, congressional interest in the private student loan market has grown, as well as the idea of reviving standard bankruptcy protections to federal and private student loans, according to an analysis of proposed legislation from key players.

Looking to move things along, a leading consumer bankruptcy legal group plans a Capitol Hill lobbying push around the student debt issue in October.

Scope of Problem

Forty-four million Americans hold roughly $1.4 trillion in federal and private student loan debt, according to the Consumer Financial Protection Bureau. It has surpassed both auto loans and credit cards, making it the nation’s largest consumer debt outside of mortgages.

More than 8 million borrowers, or about 11 percent of those with loans underwritten by the federal government, are in default, the U.S. Education Department estimates. For private loans from banks and other financial entities, the figure has been dropping and is roughly 2 percent, according to the MeasureOne Private Student Loan Consortium.

The MeasureOne cooperative of lenders and holders of private student loans reported in December 2016 that this type of financing comprises roughly 7.5 percent, or $102.3 billion of total student loans outstanding. The remaining 92.5 percent are federal loans. The cooperative includes Citizens Bank, N.A., Discover Bank, Navient, PNC Bank, N.A., Sallie Mae Bank, and Wells Fargo Bank, N.A.

Overall, graduates of the class of 2016 had average debt of more than $37,000, according to the Washington-based Consumer Bankers Association, a trade group that represents the policy interests of large retail banks.

“Unlike the housing market bubble, student loan debt is a chronic problem,” Wedoff said.

“Student loan debt will prevent people from being able to get married, buy a house, and other things. Bankruptcy needs to be promoted as a way out,” he said.

Although getting them wiped out in bankruptcy isn’t impossible, a petitioner has to show that continuing to pay the debt “will impose an undue hardship on you and your dependents.” That means you can’t pay them off and meeting that standard can be extremely tough.Not all federal courts agree on details of the hardship standard.

Wedoff, who served two 14-year terms on the bankruptcy bench in Chicago, is president and director of the American Bankruptcy Institute. ABI is the largest multi-disciplinary, nonpartisan organization dedicated to research and education on insolvency matters.

The group’s 15-member consumer commission plans to take a close look at consumer bankruptcy issues , including student loans, and make formal recommendations to Congress and directly to judges by December 2018, Wedoff said.

The commission wants input from the public at upcoming meetings. One is scheduled for Oct. 10 at the National Conference of Bankruptcy Judges in Las Vegas. Additional meetings will be held in November in Chicago, and in December in Palm Springs, Calif.

Debtors need that “fresh start” that bankruptcy gives them, Wedoff said.

Edward C. Boltz, a consumer advocate and partner with the Law Offices of John T. Orcutt, P.C., Durham, N.C., believes bankruptcy needs to be part of the solution. But he told Bloomberg BNA, it would take congressional action to loosen the bankruptcy discharge standard or possibly a review by the U.S. Supreme Court.

Boltz is the former president of the National Association of Consumer Bankruptcy Attorneys (NACBA), which has worked with legislators like Rep. John Delaney (D-Md.) and Sen. Richard Durbin (D-Ill.) on proposed legislation. He’s also a member of the bankruptcy institute’s consumer commission.

Legislation Needed

Wedoff believes that Congress will get around to passing legislation on student debt at some point. Although, he thinks it will take a major downturn in the economy or a party balance change before congressional leaders become more open to providing relief.

The question is what legislation is needed to fix the problem?

Legislation could take a “radical approach” by repealing the undue hardship provision in Bankruptcy Code Section523(a)(8) for all student loan debt, Wedoff said.

A bill Reps. John Katko (R-N.Y.) and Delaney introduced (H.R. 2366), which would return standard bankruptcy protections to both federal and private student loans, is one such example.

Congress could also tailor legislation to establish time limits, like five or seven years, after which time debt could be discharged, or it could only remove private student loans from Section 523(a)(8), Wedoff said. Durbin’s legislation, S. 1262, and Rep. Steven Cohen’s (D-Tenn.) bill, H.R. 2527, are more tailored and focus on discharging private student loans only.

Private Student Loans

While most student loans are backed by the federal government, those seeking financing for higher education also tap private credit sources. These private student loans are also frequently used to “fill the gap” between available federal aid and what borrowers can afford to pay out of pocket for college.

Private loans frequently “lack the more affordable, fixed rates and flexible payment options” that federal student loans offer and borrowers should try to exhaust federal grant and loan options first before considering private student loans, according to the National Consumer Law Center’s student loan borrower assistance website.

Until 1978, student borrowers could discharge federal and private student loans in bankruptcy, but Congress began to treat federal student debt less favorably than other types of loans based on a few anecdotal stories of graduate students borrowing and then declaring bankruptcy. In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act made private student loans nondischargeable unless undue hardship is shown.

Durbin, the No. 2 Senate Democrat, told Bloomberg BNA via email Sept. 11 that he was “proud to have reintroduced” legislation — ‘The Fairness for Struggling Students Act,’ (S. 1262)— to restore the Bankruptcy Code’s pre-2005 treatment of private student loans and take “an important step toward addressing the student debt crisis in America.”

Durbin has introduced similar legislation every year since 2005, but has never had any Republican support.

“This bill would make it so that, once again, private student loans would be treated like nearly all other forms of private, unsecured debt and be permitted to be discharged in bankruptcy,” he said. “Congress had no good reason to make private student loans non-dischargeable in 2005. It was a provision that was quietly slipped into a broader bankruptcy reform bill with little debate and no justification,” Durbin said.

Same Treatment

Mark Huelsman, a senior policy analyst with Demos in Washington, told Bloomberg BNA that it doesn’t make sense to treat private or federal student loans differently than credit card or medical debt, which can be discharged in bankruptcy. Durbin’s legislation would be a “welcome step” to struggling households and would recognize that borrowers would receive the same protections on these loans as they do on any other consumer loans, Huelsman said.

Bankruptcy isn’t an easy process, and claims would still be subject to court approval, which would reduce any worries about “gaming the system,” he said. The cost of allowing student loan debt to be forgiven in bankruptcy wouldn’t be prohibitive, according to a 2015 Demos analysis. It would cost the government $3 billion, which represents 3 percent of the amount of loans it hands out each year. This cost, however, wouldn’t apply to the discharge of private loans.

‘Long-Term Initiative’

Private student loans are a “relatively new phenomenon,” and Durbin’s bill is “responding to a problem that never really existed before 2005,” Huelsman said.

Given the current makeup of Congress and the numerous issues on the forefront like tax reform, Huelsman doesn’t view this legislation as being a high priority.“Few politicians and leaders want to make bankruptcy a huge part of their cause,” Huelsman said.

John Rao, an attorney with the National Consumer Law Center in Boston who specializes in bankruptcy and mortgage servicing, sees student loan legislation as a “long-term legal initiative.”

An ABI consumer commission member, Rao told Bloomberg BNA that he hopes there will be a “greater acceptance” in Congress for bankruptcy reform over time.

‘Cruel Policy Trap’?

Some groups would argue that there isn’t any sound rationale for an undue hardship bankruptcy standard, especially when most students have to borrow money to get a bachelor’s degree. “To simultaneously require that students take on debt while making that debt extremely difficult to discharge is a particularly cruel policy trap,” according to Demos. The average undergraduate now takes 6.2 years to get a college degree, Alan Collinge, founder of StudentLoanJustice.org,told Bloomberg BNA Aug. 3. The average annual cost of attending a four-year college in 2015 was $25,409, according to the National Center for Education Statistics. That cost means many students and families must take out loans to go to college. Others argue that making student loan debt dischargeable in bankruptcy like most other debt would force banks to lend money only to people who have a reasonable chance at succeeding at the educational institution they choose. It wouldn’t be a bad thing if students were forced to make better college choices and economize on how much they borrow, Ike Brannon, visiting fellow at Cato Institute and president of Capital Policy Analytics,told Bloomberg BNA Aug. 10.

CBA, the banking trade group, says the “root cause of our nation’s student loan debt problem” is over-borrowing, and is promoting its “know before you owe” initiative that focuses on federal borrowers.

“Rather than focusing exclusively on how to help borrowers after they are already in debt, policymakers and regulators should empower borrowers to make sound financial decisions before they take out federal student loans,” it says in a policy brief.

Private borrowers, the group said, are required by law to disclose information like costs and terms before a loan is granted. “This information allows borrowers to make informed decisions about the loans that are appropriate for their higher education needs.”

Progress Hopeful

Although the immediate path forward for student loan legislation looks uncertain, Collinge said he is “hopeful” for the advancement of Katko and Delaney’s bill.

It’s a rare display of bipartisanship, he said, noting there are 22 cosponsors and more may be added.

“This is a good chance for Republicans to seize this opportunity to reform student loans,” he said.

Rao noted it was the the first time a Republican has cosponsored a student loan bill in some time.

NACBA supports the Katko-Delaney bill and is planning a stepped up Capitol Hill lobbying campaign in October.

Most student loan discharge cases are settled out of court, Collinge said. But a legislative fix like the Katko-Delaney measure is needed to restore standard bankruptcy protections to federal and private student loans and restore confidence in the system, he said.

To contact the reporter on this story: Diane Davis in Washington at DDavis@bna.com

To contact the editor responsible for this story: Jay Horowitz at JHorowitz@bna.com

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