The purpose of student loans is to give young people without money a chance to get ahead through education. The purpose of bankruptcy is to allow those who have made bad choices or had catastrophic bad luck a chance to start anew. But by largely barring bankruptcy for student loans, federal law currently puts these two policy objectives at odds.
Back in 1976, Congress clamped down on student loan bankruptcy, fearing that students would game the system by piling on student debt and then filing for bankruptcy after leaving school, before they begin their careers. Congress further tightened rules on student loans over the years, culminating in 2005, when it made even private student loans non-dischargeable.
“Legislators fear that opportunists could run up large debts they never mean to repay, and then declare bankruptcy just as they finish college, when they still have few assets but strong career prospects,” Rajeev Darolia, a public policy professor at the University of Missouri, told the Deseret News. But Dariola closely scrutinized bankruptcy filings before and after the 2005 changes, finding no evidence that students had been gaming the system.
One group that has gamed the system are the many colleges — whether public, private or for-profit — that charge steep tuition for often dubious degrees. In fact, many struggling former students are not gaming the system: they are actually victims of a system that encourages them to acquire debt for programs they are unlikely to finish or, if they do finish, do not offer realistic career options.
Two objectives could be reached with one simple policy change, argues Alex J. Pollack, a fellow at the American Enterprise Institute, who proposes that colleges be held accountable for 20 percent of the cost to the taxpayer of student loans that default, are discharged in bankruptcy, or are written down in income-based repayment plans.
Giving colleges some financial exposure in bankruptcies would better align incentives with opportunities for change. Any college taking in loan-based tuition would need to think carefully about finding a good fit for high-risk students, giving them counseling throughout their studies, steering them to majors likely to produce jobs, and helping them with transitions to the workforce.
Some have expressed fears that holding colleges partly responsible will discourage them from serving high-risk students with the greatest need for financial support. This could be addressed with corresponding incentives for schools that judiciously serve at-risk students, including waiving liability for schools that follow certain standards.
In the meantime, it is worth noting that, under existing hardship exceptions, student loans are already more dischargeable than most people realize. Jason Iuliano, a doctoral candidate in political science at Princeton and a Harvard Law School graduate, has found only 1 percent of bankruptcy filers who have student loans attempt to get them discharged, but of those who do try, 25 percent obtain a complete discharge while 14 percent get a partial discharge.