Bankruptcy

For-Profit Student Lenders Win Again

By Bob Lawless

Yesterday, the U.S. House of Representatives passed H.R. 4137, College Opportunity and Affordability Act of 2007. Reading that, you might query whether the House has a calendar, but the main point of the bill is to make some reforms to the market for student loans. I'll leave those details to the N.Y. Times story reporting on the bill's passage. Readers of this blog are likely more interested in the fact that the bill left the House of Representatives without changes to how student loans are treated in bankruptcy.

Bankruptcy experts will be familiar with the following history. Really serious bankruptcy experts also may recognize that I am gliding over a few nuances, but the general frame of the history is correct. In 1976, Congress first added an exception to the bankruptcy discharge dealing with student loan debt. That exception was continued in the 1978 Bankruptcy Code, and the exception was expressly limited to student loans from a governmental unit or nonprofit institution. Even then a student loan could be discharged if more than five years had passed since the loan first became due (typically after graduation) or if the debtor could show payment of the student loan would cause undue hardship, which is a difficult burden to show.  In 1990, five years was changed to seven years and in 1998 was dropped altogether, leaving undue hardship the only reason a court could discharge a student loan from a governmental unit or nonprofit institution. As part of the 2005 changes to the U.S. bankruptcy law, Congress again amended the student loan discharge exception to allow even loans from for-profit lenders to be excepted from the bankruptcy discharge.

Before H.R. 4317 left the House of Representatives, Rep. Danny Davis (D-IL) offered an amendment that would have subjected for-profit student loans again to the bankruptcy discharge if they had become due more than five years before the bankruptcy filing. Student loans that were less than five-years old would still only be dischargeable upon a showing of undue hardship. The House defeated Davis's amendment 179-236 with 52 Democrats and 184 Republicans voting against it.

On its merits, the amendment should have been adopted. The idea behind the student loan discharge exception is that student loans are essentially a loan against future human capital. The lender is looking to the debtor's increased earnings potential for repayment. The concern was that such a relationship is especially subject to abuse by a debtor who refuses to take advantage of the increased earnings potential the student loan might have afforded. We can't force the debtor to work at a higher paying job, but we can deny the debtor the benefit of discharge if he or she refuses to do so. As it was originally enacted, five years was viewed as enough time to avoid most concerns of abuse, and it would make sense to reenact the rule to all student loans. Student loans from for-profit lenders, however, have the biggest potential for abuse, and they should have to play by the same rules as all other for-profit loans.

In any event, those horses have left the station after the ship has sailed. H.R. 4317 passed the House with a veto-proof margin, and the bill is in the Senate without the Davis Amendment. Perhaps Credit Slips readers might have a sense of the prospects to add something like the Davis Amendment in the Senate?

The vote in the House, however, shows the continuing power of the consumer financial services lobby to work with sympathetic legislators to block legislative changes. Is the vote on the Davis Amendment perhaps an indication of what might happen to legislation that would help alleviate the mortgage crisis, especially bills to give bankruptcy judges power to amend home mortgages? One is tempted to think it might be, but I wonder whether that is correct. The mortgage crisis obviously has a lot more visibility than this student loan issue. Representatives or Senators who stand in the way of home mortgage relief legislation should pay a heavier political price and thereby might not be so able to resist legislative reforms.

Full post as published by Credit Slips on February 12, 2008 (boomark / email).