Harkin Opens Door To Bankruptcy Option for Student Loans

A top Senate Democrat is set to unveil legislation Wednesday that would allow a small portion of Americans’ student debt to be discharged through bankruptcy proceedings, a measure that would likely hit the profits of private lenders.

The bankruptcy option is part of a long-awaited bill on federal higher-education policy from Sen. Tom Harkin (D., Iowa), chairman of the Senate panel on education.

Federal law currently prohibits, except in rare cases, private or federal student loans from being discharged in bankruptcy. Backers of the current law, including the banking industry, have argued it helps keep a lid on interest rates by reducing the risk that borrowers will walk away from their debts in court.

Consumer advocates say the prohibition is keeping some borrowers trapped under high debt burdens that they’ll likely never be able to repay. Most other types of consumer debt, including money owed on mortgages, credit cards and auto loans, can be discharged in bankruptcy.

Mr. Harkin’s measure would allow only student loans issued by private lenders — rather than the federal government — to be discharged in bankruptcy court. Private lenders hold only about 10% to 15% of the nation’s $1.1 trillion in outstanding student debt, with the U.S. Education Department holding the rest.

The measure, if it gained traction, could threaten the student-lending business at major lenders such as SLM Corp.’s Sallie Mae, Wells Fargo & Co. and Discover Financial Services.

The bill includes a series of other measures designed to ease lower student costs, toughen up against schools with high default rates and force colleges to publish more data on the outcomes of their students.

The bill isn’t likely to pass this year, given the midterm elections and broad partisan disputes over higher-education policy. But it sets a stake in the ground for Democrats in talks on a final bill.