Blood from a Turnip: Overburdened Student Loan Debtors Should Have Access to The Bankruptcy Courts

In early October, Congress passed a $700 billion federal rescue plan to aid the nation’s banks in an effort to solve a global financial crisis (Landler & Andrews, 2008). Some of this money will benefit student-loan companies, which have been squeezed by the current economic downturn and forced to diminish their lending activities (Perry, 2008). This is good news for the college-loan industry. But none of the $700 billion will go directly to student-loan borrowers.

Perhaps this is a good time to ask whether Congress should rescue individuals who are suffering financially—and not just the lending institutions. How about the people who borrowed to pay for higher education? This year, Americans will borrow about $80 billion to finance adult education; and many will not be able to pay back the money.

How many will default on their college loans? No one really knows. The U.S. Department of Education reports an annual default rate of about 5 percent—but DOE keeps its books about the way Fannie Mae and Freddie Mac kept theirs—with cheerful but unrealistic optimism. DOE measures the percentage of student borrowers who default during the first two years of their repayment period—but most borrowers default after two years. A recent study found that about 10 percent of college graduates defaulted on their student loans within ten years of beginning repayment (Choy & Li, 2006). Ten percent! And if that is the default rate for college graduates, the rate is surely higher for students who borrowed money but failed to obtain a degree or who borrowed money to attend for-profit vocational schools.

Right now, there are hundreds of thousands of people with massive student-loan debt who are not making enough money to reasonably pay off their loans. Our nation’s current economic downturn will undoubtedly make it even harder for some of these individuals to make their monthly college-loan payments. In the months and years to come, many will become candidates for personal bankruptcy.

Unfortunately, under current federal law, it is almost impossible for student-loan borrowers to discharge their debts by filing for bankruptcy. To discharge a student loan in bankruptcy, the debtor must show “undue hardship” (11 U.S.C.A. • 523(a)(8)). In most cases (probably 90 percent or more), the bankruptcy judges rule that student-loan debtors do not qualify for bankruptcy relief under the “undue hardship” test.

What is life like for these overextended debtors? If you want to know, just read some of the bankruptcy court decisions that chronicle these people’s plight. Take Susan Robinson, who accumulated $119,000 in student loans and accrued interest and filed for bankruptcy in 2006 (In re Robinson, 2008). Robinson, a single woman, borrowed money to obtain an Ed.D. degree in Applied Educational Studies in Health Promotion from Oklahoma State University, which she received in 2000 at the age of 45. Seven years later, at the age of 52, she was working as an “educator and mentor of state employees in a ‘comprehensive Lifestyle management program’” (p. 730). Her take-home pay was a little more than $2,000 a month.

An Oklahoma bankruptcy judge refused to discharge Robinson’s student loans in bankruptcy, ruling that she had not made a good faith effort to pay off the debt. The judge suggested Robinson should have availed herself of the federal loan program’s “Income Contingent Repayment Plan.” At her current salary, the judge calculated, her student-loan payment would be $295 per month, payable over the next 25 years.

Let’s think about the judge’s reasoning for a moment. Does the judge believe that a 52-year-old single woman who brings home $2,000 per month should pay $295 per month until she is nearly 80 years old to pay off a debt acquired to obtain a degree that is—so far at least—almost totally worthless to her financially? Does the judge think blood can be gotten from a turnip?

Of course there are good reasons why Congress made it difficult for people to discharge their student loans in bankruptcy. If the process was too easy, some people could acquire prestigious undergraduate and professional degrees that would vastly enhance their earning potential and escape the cost of obtaining their education merely by strolling down to the bankruptcy court. Some legal mechanism is needed to keep that from happening.

And it certainly is true that many people accumulated far more student-loan debt than was prudent or necessary or chose educational programs with little potential for raising their incomes. Robinson, for example, may regret her decision to pursue an Ed.D. in Applied Educational Studies; the degree apparently did not enhance her income.

But people, like banks, make financial mistakes every day. The bankruptcy courts were created to give such people a fresh start. If the wizards of Wall Street who wrecked the national economy suffer an economic calamity and face personal financial ruin, they can file for bankruptcy. They will get a fresh start. It is hard to understand why Susan Robinson and thousands of other unfortunate student-loan debtors are not entitled to the same opportunity to start over.

References

Choy, S. P., & Li, Xiaojie (2006, June). Dealing with debt: 1992-93 bachelor’s degree recipients 10 years later. Washington, DC: National Center for Education Statistics.

In re Robinson, 390 B.R. 727 (Bankr. W.D. Okla. 2008).

Landler, M, & Andrews, E. L. (2008, October 4). Bailout plan wins approval; Democrats vow tighter rules. New York Times, p. A1.

Perry, N. (2008, October 10). Young, educated, drowning in debt. Seattle Times.