This is the third part in a weeklong series.
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While no one ever wants to file for bankruptcy, the reasons for bankruptcy protections are well founded. Bankruptcy protection affords citizens with insurmountable debt a legal mechanism for resolving their debts, and continuing on to be productive citizens. Most consumers who file for bankruptcy do so for reasons beyond their control. This is seen by most as a critically important freedom to have, and serves as a protection against human rights abuses that frequently occurred for debtors in centuries past, including slavery, involuntary servitude, and debtor’s prison. Bankruptcy protections are also seen as a critical freedom for a nation to provide its citizens in order to encourage and foster entrepreneurship, risk taking, and creativity. For example, notable Americans including Thomas Jefferson and Henry Ford went bankrupt multiple times during their lives, yet contributed greatly to society through their creative and societal endeavors.
The rationale for the restriction, and ultimately, the removal of bankruptcy protections for federally guaranteed student loans was predicated largely on undocumented anecdotal examples promulgated by the lending industry of students who filed for bankruptcy upon graduation. In fact, most of the examples involved credit card debt, not student loan debt. Instances of this type of activity were reported widely in the media, and in 1978, Congress added a 7-year repayment requisite before student loans could be discharged in bankruptcy. The amendments to the Higher Education Act in 1998 went much further, and removed bankruptcy protections completely for the majority of borrowers.
Interestingly, the language that exempted student loans from bankruptcy discharge in the 1978 overhaul of bankruptcy laws- which reportedly came up "at the last minute" was opposed by both the primary co-sponsor of the bill, Rep. Don Edwards, and the Chairman of the House Subcommittee on Postsecondary Education, Rep. James O’Hara. Edwards’ opposition was strong. He said that Congress was "Fighting a ‘scandal’ which exists primarily in the imagination."
The statistics on bankruptcy filings, moreover, painted a far different picture from the one used as a premise for removing bankruptcy protections from student loans. People graduating from college, and then promptly filing for bankruptcy protections for the sole purpose of erasing student loan debt simply did not occur in numbers large enough to warrant such draconian legislation. In fact, it was shown by the Government Accountability Office that prior to the 1978 legislation fewer than 1% of federally guaranteed student loans were discharged in bankruptcy proceedings. Thus, the initial basis for the removal of bankruptcy protections is highly suspect and evidently without firm grounding in fact.
Another rationale given for the removal of bankruptcy protections for student loans is the fact that the federal government guarantees these loans. However, there is no precedent for this. There are no other federal loan guarantees in existence in the United States- secured or unsecured- that enjoy bankruptcy exemptions. From Farm Loans, to FEMA Loans, to SBA Loans, and all other government loans, and government loan guarantees, not a single one- with the exception of student loans- enjoy exemptions from bankruptcy discharge.
In general, higher education provides the nation with a public benefit. As such, student loans should, at least conceptually, be more agreeable to the borrower in terms of consumer protections than loans that do not contribute to the public good, such as credit cards gambling, or other debts. Yet, with student loans, we find that exactly the opposite is true. For the purposes of bankruptcy, student loans are in a class with criminal debt, unpaid child support, taxes, and alimony. It should be obvious to any logical thinker that this is wrong.
For private student loans, the lending industry argued that removal of bankruptcy protections would allow for greater accessibility of student loans to individuals with lower credit scores by allowing the lenders to relax the underwriting criteria. Two years after the removal by Congress of bankruptcy protections for private loans, however, no evidence could be found to show that the lenders followed through with their promise, based on disclosures by the largest private lenders in the prospectuses for private student loan securitizations. A study conducted by Mark Kantrowitz, Publisher of FinAid.org, found that since the removal of bankruptcy protections for private loans in 2005, the percentage of borrowers with low credit scores receiving private loans from Sallie Mae, for instance, increased by a mere 0.2% .
Sallie Mae Acknowledges Need for Bankruptcy Protections
In 2007 there was public and congressional outcry over the removal of bankruptcy protections for private loans, and even Sallie Mae executives conceded publicly that perhaps bankruptcy protections need to be revisited. In June of that year, Sallie Mae spokesperson Martha Holler told Paul Basken of the Chronicle of Higher Education that "...We agree that it may be appropriate to revisit how to handle private student loans in bankruptcy". Similarly, Conway Casillas, Sallie Mae public affairs director, told Time Magazine in September 2007 that it might be appropriate to revert to the previous laws regarding bankruptcy of student loans, where discharge was possible, given a 7 year repayment history by the borrower .
These acknowledgements from Sallie Mae are hugely important. After all, the Sallie Mae lobbying machine went to great lengths to support legislation that took these rights away in the first place. Indeed, a December 2006 internal strategy memo regarding federal government relations from Sallie Mae made public in 2007 showed that of the 7 objectives for the company on this front, the second was to "protect private credit economics (including bankruptcy)".
Canada Relaxes Bankruptcy Restrictions
The Canadian government also changed bankruptcy protections for student loans at approximately the same time as the United States Congress. In 1997 a two year window was placed on the debt after the student graduated, during which time the loans were not dischargeable. In 1998 this window was extended to 10 years. In 2007, however, legislation was approved and is currently pending passage that would reduce the 10 year window to 7 years for all borrowers, and 5 years for those facing hardships.
Bankruptcy Legislation for Federally Guaranteed Student Loans
In May 2006, Sen. Hillary Clinton (D-NY) introduced the Student Borrower Bill of Rights Act of 2007 (S.511). This legislation had a plethora of important modifications to the Higher Education Act, not the least of which was the reinstatement of bankruptcy protections for student loans. The act provided for the return of bankruptcy protections for federally guaranteed loans, with the restriction that borrowers be in repayment status for 7 years- effectively rolling back the law to pre-1998 conditions. The legislation was reintroduced in March 2007.
The Student Borrower Bill of Rights prefaced its language regarding bankruptcy by stating that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) affords sufficient protections to prevent fraud and abuse in the carefully regulated discharge of student loans in bankruptcy.
There are two problems with this legislation. First, it only applies to loans made on or after the enactment of the legislation. Second, if a borrower is in such desperate financial condition to warrant a bankruptcy filing, having to wait as long as 7 years to file, does nothing for their immediate financial distress. In other words, this legislation provides no relief for borrowers who have already seen their student loan debt explode. Congress needs to enact legislation that restores full bankruptcy protections for all student loans and all borrowers, regardless of when the loans were made, and puts them on an equal basis with all other types of consumer credit.
Bankruptcy Legislation for Private Student Loans
In February 2008, Rep Danny Davis (IL) introduced an amendment to the Higher Education Act Reauthorization that would have restored limited bankruptcy protections for private student loans. This amendment, like the Durbin legislation, was seen by student advocates as a long overdue correction to language that the republican Congress had slipped into the 2005 Bankruptcy bill that made private student loans (loans not guaranteed by the federal government) non dischargeable in bankruptcy. The amendment apparently passed by a voice vote, but by the time the vote was cast, the amendment no longer had the necessary support, and it failed.
It turned out that many "Blue Dog Democrats" had voted against the amendment after being lobbied heavily by the Consumer Banker's Association, and other student loan interests on the Hill. Fully 29 of the 37 Blue Dog members voted to kill this amendment. Easily enough to make the difference between success and failure for this initiative.