The Examiners: Bankruptcy Reform Could Actually Aggravate Student Lo...

Should the bankruptcy code be amended to make it easier for borrowers to seek forgiveness of student loan debt through a bankruptcy filing?

Currently, the bankruptcy code makes it very difficult to discharge (walk away from) student loan debt, often leaving new graduates in debt to the point at which it negatively impacts their decision to make major purchases such as real estate or cars, take jobs they want as opposed to jobs simply for a higher salary or any paycheck at all, or even marry or leave home. Although it appears that the current state of the student-loan market begs for reform, simply relaxing the barriers to student-loan forgiveness in bankruptcy may actually aggravate the issue and leave the underlying problem of rising higher education costs unresolved.

This isn’t to say that the market itself is not reacting. Perhaps in recognition of the skyrocketing cost of higher education, recent reforms do provide payment alternatives including grace periods to delay or prevent defaults, reduced repayment terms during periods of unemployment, or repayment plans tied to a percentage of the recent graduate’s salary.

But the limitations on forgiving student loans help lenders reduce the cost of student financing. Making it easier to simply not repay a student loan on graduation through bankruptcy would require private lenders to reconsider and likely raise the cost of borrowing that money. Allowing discharge or nonpayment in bankruptcy means added lender risk, which translates to increased loan pricing and higher interest rates. This type of change could actually work to increase the cost of higher education for student borrowers.

Further, easier discharge may trigger more than just higher-cost loans. The perceived low risk of investing in student loans is based on the limitations on discharge. Retroactive reform, making it easier to walk away from outstanding private student loans, increases the risk and volatility of existing student loan-backed securities, in turn likely making them less attractive and riskier for pensions and other large investors. This added risk actually may chill private student loan investments and reduce loan availability to students.

The bankruptcy code in its current form addresses the issue of student-loan forgiveness, striking a balance between the perceived potential for abuse by new graduates and the need for forgiveness for those truly experiencing an undue hardship with respect to repayment terms.

Blaming the bankruptcy code for crippling student loan debt perhaps sidesteps the real issue: the high cost of higher education. Relaxing student loan debt discharges, even if it does make life easier for those current graduates carrying this burden, doesn’t solve the problem of balancing the actual cost of higher education with the inability for those without independent means to access it.

Sharon Levine is vice chair of Lowenstein Sandler LLP’s national bankruptcy, financial reorganization and creditors’ rights practice. Follow her on Twitter at @LevineSharon