The Examiners: Everyone Suffers Without Bankruptcy Reform for Studen...

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

It’s not exactly “breaking news” that student loan debt has become an insurmountable issue for many recent graduates. The problem is now so widespread that we must reform the bankruptcy code to help alleviate the burden on individuals and the U.S. economic future.

Borrowers rarely try to discharge student loan debt because of the bankruptcy code’s stringent requirements that apply to forgiveness of such obligations. Since 2005, all qualified educational loans, including private loans, are impracticality non-dischargeable. However, treating student loan debt this way impacts not just individuals, but the economy as a whole. The staggering rate of growth of educational debt will ultimately have rippling (and crippling) effects on other financial sectors.

As the level of student-loan debt continues to steeply increase, recent graduates—and even not-so-recent graduates who continue to carry the burden of such debt—are unable to participate in and stimulate the economy in a meaningful way. Many degree-holding individuals are unable to find jobs commensurate with their educational levels, and even if they do, they do not have the liquidity or credit fundamentals to purchase homes, vehicles and larger hard assets. Twenty- and thirty-somethings overburdened by student-loan debt end up adrift and adding little to the economy because of their inability to spend.

Increasing borrowers’ ability to expunge student loan debt through bankruptcy could lead to two beneficial outcomes: (1) Lenders concerned about dischargeability of their loans may make credit decisions that ultimately drive borrowers to more practical educational and career paths; and (2) many borrowers may be able to once again participate fully in the consumer markets, particularly housing, which can be an engine for growth of the economy. Further, there is an unquantifiable cost to millions of Americans of employment age that are unable to make any financial progress in life, which negatively impacts levels of innovation, political engagement and decisions that traditionally rest on financial security (e.g., marriage and childbearing).

The vast majority (81% of the most burdened borrowers) have private loans with interest rates of 8% or higher, according to the Consumer Financial Protection Bureau. Such debt is often difficult to refinance, and the bankruptcy code should be amended to include the ability to more easily discharge all educational loans.

This may force private lenders to make wiser decisions if they are concerned at the outset about discharge as a viable option. If lenders are forced to take a more cautious approach, borrowers may be compelled to consider more carefully their educational expenditures—possibly choosing vocational studies or two-year programs in lieu of a four-year degree, or foregoing a second degree that leads to few job prospects.

This isn’t to say that the bankruptcy code should be amended in such a way that discourages individuals’ desired career paths. There are many educational options that provide skills across a broad range, and not all require four-year degrees.

Some may be concerned that allowing student loans to be discharged will lead to a race to the courthouse. While there may be an uptick in bankruptcy courts handling such cases (as that is the goal of such reform), the benefits would far outweigh any additional burden. We haven’t yet seen all of the consequences of the inevitable bursting of the student-loan bubble. While the effects may not be as catastrophic as those following the housing-bubble burst, dramatically rising levels of student debt must be addressed at the policy level.

The economy and society as a whole will shoulder the weight of burdensome student loans if we fail to act.

Shaunna D. Jones is a partner at Willkie Farr & Gallagher’s business reorganization and restructuring practice. She is based in New York.