Bankrupt Policies on Student Loan Debt

Last week you may have seen my brother Dave grimacing on the cover of Bloomberg Businessweek. He was the posterboy for Peter Coy's cover story, "Student Loans: Debt for Life," about the more than $1 trillion in student loan debt owed by US borrowers.

The article provided a sobering look at the problems facing young adults graduating into a terrible labor market, and the shameful state of higher education finance in the United States. But I was most affected by the comments section.

For some reason articles about student debt bring out a really ugly strain of pro-creditor moralizing. Lots of people apparently hold creditors and policymakers harmless for the current state of affairs, and want to place all the blame on the borrowers. The typical excuses you see for not helping student borrowers take a few predictable forms. Either the student is to blame because she picked a bad major, or because she should have realized at the time she took out the loans that she wouldn't be making enough money to afford the monthly payments, or maybe she is just unworthy of our pity because she owns a cell phone or a laptop.

I'm not going to argue that students bear no responsibility for their choices, but I think that sort of moralizing misses the critical point that student borrowers are not to blame for the awful labor market conditions they are graduating into. The problem isn't that graduates don't have the skills to do the jobs that are out there. The problem is that there simply aren't enough jobs out there.

Let's bring it back to my brother. Dave went to the School of Visual Arts for photography. He learned real skills that have real value in the market. Photography and design skills are in high demand these days, especially in New York, so it's not the case that he got some impractical degree. Dave turned out to be a really talented photographer and has been fairly successful at selling his work to some impressive clients. The reason he's on the cover of Bloomberg is because he's done some freelance work for the magazine this year.

The problem Dave is having is not that he can't find any work, but that the volume of work in demand right now is too low. That's not his fault -- he can't control how much money companies have available to spend on photography. Ensuring that there's enough demand in the economy is the job of Congress, and the Federal Reserve. If members of Congress and the Federal Open Market Committee were doing their jobs, and not refusing to use all the tools at their disposal to return the economy to full employment, Dave would be in a more sustainable position.

There would be enough demand for his labor, he would be able to make his loan payments as scheduled, and while it'd be annoying that his monthly payments would eat up more of his disposable income than if he had gone to a cheaper school, he'd recognize that it's the price he pays for choosing the School of Visual Arts.

But since members of Congress and the FOMC have apparently given up on the goal of full employment, the demand for Dave's photography and design services is slack, and the volume of available work is not sufficient for him to earn enough to cover his debt payments. Thankfully my parents, who are by no means well-to-do, are able to help him cover his student loan payments while he gets on his feet.

The other policy issue where we ought to blame Congress instead of Dave is bankruptcy law. Public policy on bankruptcy has become much more friendly to creditors in recent years, and this is one reason why borrowers have no negotiating power against Sallie Mae. They start trying to collect on the debt six months after graduation, and if you need to defer, you have to pay. For obvious reasons that's going to be problematic for kids graduating into the Little Depression.

Rather than acknowledging the realities of the labor market and working with borrowers to establish monthly payments they can afford, or as a percentage of the borrower's income, Sallie Mae demands the full monthly payments right away. Without the threat of bankruptcy on their side, borrowers have no leverage to negotiate lower payments. And there's no point in making partial payments in good faith, since you'll still end up in default. Perversely, for many people who want to make a good faith effort to pay, but can't afford the full monthly payment, defaulting and waiting for wage garnishment is the only option.

Usually what happens when external economic events force people or businesses into circumstances where their debt obligations greatly exceed their income is that they declare bankruptcy. That is the process that we have established for almost every other kind of debt that goes bad. The lender loses money, the borrower faces some shame and takes a huge hit to his credit score, and then everybody moves on. The reason we established this process is because we as a society recognize that sometimes in life debts go bad, and this generally shouldn't be allowed to ruin people's lives.

Policymakers were perfectly fine applying this principle to non-profit student loans until 1998, and to for-profit student loans until 2005. The idea that people should never be allowed to discharge student loans in bankruptcy is a very recent development in our political history. If Dave had taken out his loans prior to 2005, he could be on a much more manageable path right now. Instead, creditors will probably be garnishing his Social Security checks.

The best reason for a policy intervention here is that high levels of student debt and debt default aren't just a problem for Millenials -- they're a problem for the broader U.S. economy.

There is some evidence that student debt is hurting the housing recovery, which is serious business for the country since sluggish residential construction is one of the biggest factors behind the weak recovery.

The other reason is that we need to be trying to set young workers on a path to strong lifetime earnings, so that they can afford to pay for the Baby Boomers' health care and Social Security. Young workers already face a significant wage penalty for graduating into a recession, for no better reason than that they had the misfortune of being born at the wrong time. Policymakers are already hurting Millenials' ability to pay for the country's future obligations by failing to deliver full employment today, and the debt problem is only going to make this worse. As Matt Yglesias has pointed out, one reason we have bankruptcy is that it makes good economic sense - debt peonage is like a tax on workforce participation, in that it makes it more difficult for people to increase their disposable income by working more.

President Obama has come out in favor of allowing some private student loans to be discharged in bankruptcy, but not those issued by the federal government. So far there has been little support among members of Congress for doing anything that could be characterized as a bailout. But bankruptcy is not a bailout. It is a tool that young people need to effectively negotiate affordable monthly payments with their creditors. Demos recently put out a strong plan for reforming bankruptcy rules that, among other things, would help grads drowning in student loans and deserves a close look in Congress. 

One of the most important lessons of the downturn is that most people want to do the right thing. A lot more underwater homeowners could be strategically defaulting on their mortgages, but they're not. Most of them continue to make their mortgage payments even if it's financially irrational to do it. I can't prove it, but I suspect the same is true of folks who are delinquent on their student loans -- they want to make good on their promises, but are going delinquent because they genuinely can't make the full payments, and lenders won't meet them halfway. That has got to change.