Friday, July 31, 2015

A Plum Ripe for Picking

What if I told you there was a product that you could invest in that was in high demand by a large number of people, that would bring high returns for 10 to 20 years, and was guaranteed safe from risk from default by the Federal Government itself?  It would be a no-brainer to get in on this, wouldn't it?  Who wouldn't scramble to pick such a ripe plum?  You might think there is no such risk-free investment with guaranteed returns in our capitalist economy, but you would be wrong.  Such is the state of our current student loan marketplace.

It is estimated that there is approximately $1.2 trillion of outstanding student loan debt, and it has been projected that the increasing  likelihood of default by many people in the near future (given the changes in our economy in the past 7-8 years) will be the next economic crisis to face this nation. 

Student loan debt holds a unique place under the federal bankruptcy code -- it is presumed non-dischargeable.  Unlike most other unsecured debt, the only way to have it discharged in bankruptcy is to show that payback of the debt would create an extreme financial hardship for the debtor.  Courts almost invariably apply the standard set forth under the so-called "Brunner" test, or some slight variation of it: the court looks at your income, your past attempts to pay the loan, and the likelihood that the conditions causing your financial distress and inability to pay the loan will last through the duration of the repayment period.  Usually, this is possible only in the case of debtors who have suffered some kind of disability that would make them unable to ever provide enough income to repay the debt.  For most others, the debt is non-dischargeable.

Has this state of affairs always existed?  No.  In fact, before 1978, all student loan debt was dischargeable in bankruptcy.  That year, the legislature pass a law providing that a student loan debtor must have been paying on the loan for at least five years before listing it in bankruptcy.  This payback period was extended to seven years in 1990, and ultimately, in 1998, student loan debt was exempted from discharge under bankruptcy.  However, throughout all this, an exception to the code stated that only loans made under a “program funded in whole or in part by a governmental unit or nonprofit institution” were protected against bankruptcy discharge.  Meaning that only government guaranteed student loans were protected.  The rationale here was that guaranteed student loans have many different options for payback that take the debtors' income into consideration, and also, that the lender is protected against loss in the event of default.  However, there were numerous eligibility restrictions to qualify for such loans.

Finally, in 2005, the legislature gave the banking industry a huge gift, and made ALL student loans, regardless of source, non-dischargeable in bankruptcy.  This gift was unwrapped by some of the most predator lenders in the industry.  These lenders were now able to extend student loans to all comers at rates up to 12%, regardless of financial ability to repay -- although most will require a cosigner, usually a parent who is also then later dragged into financial distress.  In my practice, I see debtors who have a mix of private and government loans (the Federal government took over the afore-mentioned student loan guaranty program in 2010, and now administers student loans directly).  Invariably, it is not the government loans in deferment or adjusted payback status that cause my clients the greatest concern; it is the student loans from Wells Fargo, Citibank, and others that lead to judgments, wage attachments, and threats of property seizure.  These creditors can now be as aggressive in their collection activities as they wish, because they know that, however miserable they can make a debtor's life, the debtor must bend over and take it, because bankruptcy, usually the last option available to a destitute debtor, is not an option for them.  All this grief, because one wanted only to improve her station in life, and found too late that education is no longer a value-added asset for the throng of wage earners in our post-recession economy.

My advice to people contemplating returning to school is to keep your educational goals within your means.  Don't take out private loans!  A great number of people are eligible for the government Direct Loan program, and most state-funded colleges and universities are within reach utilizing these resources exclusively.  There are a great many highly acclaimed state institutions that can be attended using government loans -- such as my graduate school alma mater, Temple University.

But of course, most often I see people after they have strapped this monkey to their back. It is the most disheartening situation I see.  In at least one instance, a middle-aged client had to relinquish  the home and move back in with a parent, just to be able to have enough cash flow each month to pay for the student loans that were co-signed for an ex-spouse's education.  What kind of relief is that?

There are some recent developments that provide a glimmer of relief for student loan debtors.  In June 2014, the Eighth Circuit Court of Appeals issued an unpublished opinion in the case of Conway v. National Collegiate Trust.  In Conway, the Court rejected the notion that the court should consider different possibilities that might allow for repayment at some future date, deciding that such an exercise is "speculation."  The Court then based its decision to allow the discharge of student loan debt based on current circumstances. 

Another effort is now underway in the US Senate right now to revert bankruptcy exclusion for all student loan back to include only those made under government programs.  The bill, sponsored by Senator Durbin and twelve others, is an amendment to strike the phase, "or any other educational
loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual" from 11 USC sec. 523(a)(8).  Time will tell how much pressure Wall Street will put on our legislature to kill this effort, and let live their goose that lays the golden eggs.

But still, it seems that their is an inherent inequality built into the current status quo.  Why are some kinds of borrowers treated differently than others?  Specifically, why are student loan borrowers denied equal protection under the bankruptcy code, whereas mortgage and credit card borrowers are not?  Could this distinction withstand a rational basis review under an equal protection examination?  Perhaps there is good public policy for exempting government-based student loans from discharge -- but can the same truly be said for private for-profit student loan lenders?

So I throw this question out for thoughtful discussion:  does the current bankruptcy code, which denies bankruptcy protection for student loan debtors (or at least, private student loan debtors) violate the Equal Protection clause of our Constitution? 


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