Last week, the Chronicle of Higher Education reported on an internal strategy document from Sallie Mae listing the companys goals in lobbying the new Congress. Not surprisingly, at the top of the list was the need to "Protect FFELP economics" -- in other words, to preserve the excess government subsidies that lenders receive on federal student loans. (These were discussed in yesterday's blog item, which was written by Higher Ed Watch staff).
The number two item on Sallie Maes list might surprise some readers. It wasnt increasing federal student loan limits or beating back the loan consolidation companies that have been trying to steal away Sallie Mae's borrowers. It was bankruptcy; specifically, preserving the special status that private student loans gained in the broad changes to bankruptcy laws that Congress enacted in 2005. To Sallie Mae, that provision is the key to its version of "private credit economics." The company doesn't have to think twice about providing high-interest loans to people who will likely have trouble paying them back because this 2005 provision allows the lender to go to the front of the line in bankruptcy court, leaving other creditors in the dust.
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 standard, allowing for discharge in only the most extreme circumstances. Generally the items on this special list make intuitive sense; for example, it seems appropriate for it to be especially difficult for people to escape child support responsibilities, overdue taxes, and criminal fines.
Federal student loans dont quite seem like they deserve to be on that same list, and until 1998 they were not. Instead, there was an intermediate approach: they had special treatment, but only for the first seven years in repayment. After that, they were treated like other debts. There is at least some justification for making federal loans hard to discharge: they are backed by taxpayer dollars, and they come with some borrower protections in cases of economic hardship, unemployment, death, and disability.
But private student loans? There is no good reason that they should be accorded any heightened status, much less the exalted category that competes with criminal fines, child support, taxes, and now federal student loans. How and why did they gain this status in the 2005 bankruptcy bill? No one seems to know. Like one of those earmarks without a known parent, there were no congressional hearings on the idea. There is nothing in the Congressional Record explaining the reasons behind the change.
Shielding private loans from bankruptcy means that repayment demands can essentially extend forever, leaving even the most destitute borrowers with no way out. This makes lenders less cautious about making high-cost private loans to people who may not be able to afford them, as well as to students at schools with low completion and job placement rates. Many of the private loan horror stories we have seen in the media are of exactly that type: high risk, high interest.
Treating private student loans like other unsecured debts would at lease cause a lender to pause before making some of those loans. For student and consumer protection advocates, removing the special treatment of private student loans in bankruptcy should be a top priority, just as preserving it is one of Sallie Maes chief objectives.