The Examiners: Discharge Private Student Loans, But Federal Loans Ha...

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

The bankruptcy code should be amended to make it easier for borrowers to discharge private student loans, but not federal student loans.

Unsecured debts are presumptively dischargeable in bankruptcy. Student loan debt, however, is different from other types of unsecured debt in one critical way: Most of it is owed to the federal government. The government’s position as creditor counsels against allowing the ready dischargeability of federal student loans both because it creates problems of distributional fairness and because it means there are alternative formal channels available for managing loan repayment.  By the same token, however, there is no basis for special treatment for private student loans, which should be freely dischargeable, as they were prior to 2005.

Allowing the ready discharge of federal student loans creates distributional problems because federal student loan pricing is not risk-based; it is one-size-fits-all pricing. If existing federal student loans were to become dischargeable in bankruptcy, the costs would be borne by either future borrowers or taxpayers. Neither outcome would be desirable.

It’s unfair to ask future borrowers to subsidize the earlier borrowers. Changing student loan dischargeability creates a serious intergenerational equity problem. If federal student loans were dischargeable only prospectively, this intergenerational equity problem wouldn’t exist, but the motivating policy concern is existing debt.

Likewise, taxpayers shouldn’t be asked to subsidize the costs of discharged student loan debt except in cases of true hardship caused by factors beyond the debtor’s control.  The bankruptcy discharge functions as a form of mandatory social insurance. Mandating such social insurance makes sense for risks consumers cannot avoid, such as illness, accidents and business cycle fluctuations. Thus, to the extent that a consumer cannot repay his or her student loan debt because of incapacity or the like, due to factors beyond the consumer’s control, discharge makes sense. But taxpayers shouldn’t be asked to fund mandatory insurance against poor educational and career decisions.

Because most student loan debt is federal, there are formal channels other than bankruptcy for loan repayment and forgiveness. In particular, the federal government has for several years offered unlimited loan forgiveness of federal loans after 10 years of income-based repayment for those who go into public service (government and nonprofit) jobs. (The budgetary consequences of this generous deal are a separate issue.) Going forward, the Public Service Loan Forgiveness Program means that federal student loan debt shouldn’t present a major policy problem: There is readily available income-based repayment and debt relief for many borrowers. Federal student loans have a built-in safety valve without bankruptcy.

While there are good reasons for the current treatment of federal student loan debt, private student loans should be freely dischargeable, like most other unsecured debts.  There are no distributional concerns with discharging private student loan debt. Competition should reduce intergenerational cross-subsidization in private lending, and taxpayers have nothing at stake with private student loans. Likewise, private student loans lack the safety valve of formalized loan repayment and forgiveness programs. The bankruptcy code should be amended to allow for easier discharge of private student loans.

Adam J. Levitin is a professor of law at Georgetown University Law Center in Washington, D.C.