A Bankrupt Argument
Allowing desperate borrowers to discharge their private loan debt through bankruptcy "is unlikely to result in a significant decrease in private student loan availability to prospective borrowers with low credit scores."
Mark Kantrowitz
Publisher of FinAid.org
Higher Ed Watch
Topics:
Education E-mail, Print or Share this Blog Post:
In 2005, Congress tucked into the bankruptcy bill a provision making it virtually impossible for borrowers to discharge private student loans. That provision -- which was added in a secret conference committee, received no public debate, and had no named Congressional sponsor --represents a glaring example of politicians serving corporate interests over regular people.
Momentum is building on Capitol Hill, however, to change the law before it does too much damage. Sen. Richard Durbin (D-IL) has introduced legislation that would reverse the 2005 statute for private loans, providing much-needed relief for borrowers who have found themselves in severe financial distress.
For most unsecured loans, the debtor who runs into difficulty can file for Chapter 7 liquidation or Chapter 13 reorganization, so a judge can sort out the appropriate treatment of the various loans. But there is a short list of debts that the law subjects to a different status, allowing for discharge in only the most extreme circumstances. The government, for example, makes it especially difficult for people to escape child support responsibilities, overdue taxes, and criminal fines. Federal student loans also can't be discharged. There is at least some justification for providing federal student loans that status: they are backed by taxpayer dollars, and they come with some borrower protections in cases of economic hardship, unemployment, death, and disability.
But there is absolutely no good reason that private student loans should be accorded any heightened status, much less the exalted category that competes with criminal fines, child support, and taxes.
The student loan industry, of course, is fighting Mr. Durbin's measure, warning that eliminating the exemption private student loans have from bankruptcy protection would ultimately hurt low- and moderate-income students. Without the absolute guarantee that the loans will be repaid, lenders, the argument goes, will be reluctant to lend non-federally guaranteed, private student loans to low-income borrowers. Without being able to obtain these loans, these students may not be able to afford to go to college at all.
Never mind that these are high interest loans with variable rates that go as high as 20 percent for the riskiest borrowers, who also tend to be those with the greatest financial need. Never mind that colleges are increasingly loading up poor and working class students with private loans, while devoting greater shares of their institutional aid dollars to attracting the "best and the brightest" students who also tend to be the most affluent.
The real question is whether the lenders’ claims are true. According to a new study by FinAid.org, a website about student aid, the answer is "No."
To tackle the issue, the study examines the FICO scores of Sallie Mae’s private loan borrowers before the passage of the 2005 bankruptcy legislation and after. The breakdown of FICO scores – which measure the probability that a borrower will repay his or her debt, with the highest possible score being 850 – are contained in the loan giant’s prospectuses for securitization.
Looking at Sallie Mae’s prospectuses from 2002 to the present, the study found that there was only a "negligible increase" of 0.2% in the "availability of private student loans to borrowers with low credit scores" after the new law went into effect. Only 7.5 percent of Sallie Mae's borrowers had FICO scores equal to or below 650 before the bill was passed, and only 7.7 percent had such scores afterwards. Surprisingly, the average weighted FICO score was 718 both before and after the bankruptcy legislation was approved.
In other words, allowing desperate borrowers to discharge their private loan debt through bankruptcy "is unlikely to result in a significant decrease in private student loan availability to prospective borrowers with low credit scores," according to Mark Kantrowitz, finaid.org's publisher.
Looks like the loan industry will have to go back to the drawing board and try to come up with better arguments to protect private loans' heightened status. Absent any compelling argument, Congress ought to swiftly and publicly consider Mr. Durbin's student loan borrower relief legislation.
Read The Fine Print
But it is also unlikely to provide much relief to borrowers, as many private student loans were non-dischargeable even before BAPCPA because of the involvement of a nonprofit entity in making the loans (e.g., First Marblehead loans are guaranteed by TERI).
The above puts the whole analysis into question. If the loans were non-dischargeable before the BAPCPA then one would not expect to see significant increases in availability of funds to lower credits after the BAPCPA.
This report does not analyze whether the BAPCPA lead to any changes in the cost of private student loans, such as guarantee fees.
Dischargeability in bankruptcy means lower default recoveries for lenders which increases the chances for those additional costs ultimately will be borne by those who actually pay back their loans.
Response on Non-dischargeability
As noted in www.finaid.org/questions/bankruptcyexception.pdf, whether a private student loan is exempted from discharge depends on the nature of the association of the loan with a nonprofit institution. This Higher Ed Watch post focuses on private loans made by Sallie Mae, a for-profit company. As I noted in my study, private loans issued by Sallie Mae and other for-profit entities were dischargeable in bankruptcy before Congress acted in 2005 to make the loans nondischargeable. Yet, as my study shows, there has been virtually no change in the availability of these loans to borrowers with low credit scores since the law was changed.
The excerpt that Patrick Bott includes in his comment refer to loans issued by First Marblehead. This is more complicated because TERI, a nonprofit guarantor, guarantees First Marblehead's loans. The law appears to indicate that if a nonprofit institution funded the loan, it was excepted from discharge. If the nonprofit institution merely guaranteed the loan against default, it was not excepted from discharge. However, in First Marblehead's case it seems clear that First Marblehead believed that its loans were excepted from discharge due to the TERI guarantee. What matters is not whether the loans were in fact excepted from discharge, but whether the lender believed them to be so, since lenders set underwriting policies based on perceived risk, not actual risk.
While eliminating the exception to discharge for private student loans might increase costs, the public policy argument in favor of an exception was and still is focused on increasing the availability of education financing. There has also yet to be any credible accounting of the potential financial impact of such a change, such as a disclosure of the percentage of private student loan borrowers who file for bankruptcy.
In practice, borrowers with FICO scores less than 620-650 do not get private student loans. Private student loans, as opposed to federally-guaranteed loans, have as their primary focus profitability, not access to higher education. Default rates on private student loans are much lower than on federally-guaranteed loans, in part because federally-guaranteed loans are available to more students than private student loans.
From 2002-A (one of the SLM deals cited in your analysis)
Risk of Default of Private Credit
Student Loans
Private credit student loans are generally
dischargeable by a borrower in bankruptcy
unless they have been made under any
program funded in whole or in part by a
governmental unit or non-profit institution. While
we believe the trust student loans are nondischargeable
in bankruptcy, there can be no
assurance that a bankruptcy court will not take
a contrary position. If you own any notes, you
will bear any risk of loss resulting from the
discharge of any borrower of a private credit
student loan to the extent the amount of the
default is not covered by the trust’s credit
enhancement.
S-21
Looks like SLM had the same opinion as FMD with regards to non-dischargeability.A Bankrupt Article - more balanced discussion needed
Mr. Burd’s “reporting” reminds me of a hammer looking for a nail, any nail, to justify its use. Even if he is well intentioned, he is uninformed.
It is indisputable that, at a minimum, removing bankruptcy protection will increase private loan costs for students. Because private loans do not enjoy a federal government guarantee, when the loan defaults, the lender (or guarantor) pays for defaults that cannot be recovered. Private student loans are long-term, unsecured credit with no collateral to back them up. As a result, removing bankruptcy protection will mean that there will be fewer defaults recovered and higher losses. Higher losses will lead to higher pricing – and drive it disproportionately to those who can least afford it – those in the highest risk categories. This is because higher risk borrowers are far more likely to default on their loans than lower risk borrowers (in our case 2400 percent more likely). This is how financial markets and prices work, plain and simple.
If Mr. Burd were to provide an honest policy discussion (which I believe is New America’s charter) rather than a simplistic sound-byte blog entry, he would discuss the policy choice the country faces with bankruptcy protection for private student loans.
This choice is simple: remove bankruptcy protection and have everyone pay more for loans that will carry more risk (and have the highest risk borrowers paying the largest increase in cost) or keep bankruptcy protection in place which provides today’s lower relative prices to everyone and keep the heavier burden on those who actually default on their loans.
George Pappas
Senior Vice President
EduCap, Inc.
Ranting Without A Solution
Mr. Burd's ranting would be productive if he squarely addressed the policy choices that have to be made and came down on one side or any side with a proposed solution.
It wasn't that long ago when college and professional school graduates just walked away from their student loan obligations. It wasn't that long ago when Stafford default rates were around 20 percent.
Is across-the-board, unconditional dischargability a good idea? I don't think so. Is some kind of conditional dischargability a good idea? I think so.
Defaults are still >10%
Post new comment