Senators Debate Discharging Private Student Loans Through Bankruptcy

Congress should reinstate a provision in the bankruptcy code to allow borrowers to discharge private student loan debt in bankruptcy said Sen. Dick Durbin (D-IL) at a hearing held Tuesday by the Senate Subcommittee on Administrative Oversight and the Courts.

Last year, Durbin proposed the Fairness for Struggling Students Act to eliminate the 2005 provision that amended the bankruptcy code to prohibit private student loans from being discharged in bankruptcy.

"While the overall growth in student indebtedness is troubling, the most pressing concern is private student loans," Durbin said.

NASFAA reiterated support for legislation to allow private student loans to be discharged in testimony submitted to the subcommittee.

"Allowing the discharge of private student loan debt in bankruptcy is critical to ensuring fairness for American consumers and to provide a way for some struggling private student loan borrowers to establish financial stability," said NASFAA President Justin Draeger in the testimony.

Sen. Mike Enzi (R-WI) asserted that the effort to allow private student loans to be discharged skirts the real issue - the rising cost of higher education which he says is caused by increases in student aid. Others at the hearing argued that rather than allowing the discharge of private student loans, Congress should enact protections for private student loan borrowers similar to those available through the federal student loan program.

In his testimony, Kentucky Attorney General Jack Conway said he became acquainted with the non-dischargeabiltiy of private loans during his investigation into Decker College and Barkley School of Law in Kentucky, two schools that closed and filed for bankruptcy, leaving their students bearing millions of dollars in institutional and private student loan debt and an inability to transfer credits or find gainful employment. Though his office has been mostly successful in discharging the institutional debt those students incurred, eliminating the private student loan debt has not been as easy.

"The Trustees in the Decker and Barkley bankruptcies began efforts to collect on the private loans the schools had extended to students," Conway said in his testimony before the subcommittee. "But, ironically, the students who were living on the financial edge, saddled with tens of thousands of dollars in student loans, likely would not be able to discharge their student loans in personal bankruptcy."

Conway said private borrowers need more protection including the option to discharge, particularly in cases where a school closes. He also noted that the federal government needs to do more to enforce existing consumer protection laws and prevent fraud and abuse of taxpayer funds. 

"The more we learn about the private student loan market, the more concerns we have," Conway said. "We have seen borrowers manipulated both by lenders and unscrupulous institutions that are in a fiduciary relationship with these borrowers."

Consumer advocate and attorney Deanne Loonin argued that the 2005 provision was "built on the false premise that students were more likely to ‘abuse’ the bankruptcy system." Loonin said such an assumption lacked evidence, particularly since so few student loans were actually discharged in bankruptcy at the time.

"When first considering this policy, Congress commissioned a Government Accountability Office (GAO) study on the topic which found that only a fraction of 1 percent of all matured student loans had been discharged in bankruptcy," Loonin said.

Arguments that student borrowers are more likely to file bankruptcy or that the availability of the option will lead them to irresponsible borrowing were sufficiently addressed by other changes Congress had made in the 2005 law, Loonin argued.

"Congress added a number of new elements to the personal bankruptcy system in 2005, such as a means test and counseling requirements that make it more difficult for all consumers to file bankruptcy, especially those who have assets to pay their debts," she said, adding that the Bankruptcy Code has always included safeguards to prevent discharge in cases where a debt is obtained through false pretenses or fraud.

Yet, Stanford Law Professor and bankruptcy law expert Marcus Cole argued that allowing private student loans to be discharged in bankruptcy would result in higher private student loan interest rates. 

"Without the assurance of repayment afforded by the exemption from discharge, there is little a student can use to assure a lender of repayment," Cole said. "Removal of the exemption removes every student’s ability to make a credible commitment regarding their willingness and ability to repay from their future earnings. The resultant increase in the risk premium could make student loan interest rates usurious."

Sen. Sheldon Whitehouse (D-RI) questioned Cole’s theory, arguing that interest rates did not substantially change when the 2005 law was enacted.

"It’s very important economically for people to be able to restart, rather than be saddled with debt forever," Whitehouse said.


Publication Date: 3/21/2012

Daniel R | 4/11/2012 7:9:10 PM

This article makes it quite clear that the government shoudl allow borrowers to discharge student loan debt in bankruptcy. I'm all for it.

Tami S | 3/30/2012 4:58:18 PM

This could be part of the reason we have seen two private lenders drop out, Chase and U.S. Bank.

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