WASHINGTON — Call it part two of the Cramdown Wars.
Illinois Sen. Richard Durbin is mounting a strong push to allow private student loans to be discharged in bankruptcy, an idea that is fiercely opposed by the banking industry. The looming battle is reminiscent of a 2009 fight, which the banking industry won, over a Durbin plan to allow bankruptcy judges to cramdown mortgage debt.
But Durbin, one of the most powerful Democrats in Congress, is hoping he can succeed where he fell short in the last round, given the history of the issue and a renewed focus on the amount of student loan debt.
"There is no reason why private student loans should get treated differently from other private debt in bankruptcy," Durbin said at a hearing he convened last week. "In many respects, private student loans are just like credit cards — except unlike credit card debt, private student loan debt cannot be discharged in bankruptcy."
Durbin has scheduled a second hearing for this Wednesday, where he hopes to enlist support from Treasury Secretary Tim Geithner.
Durbin said he sees an opening now because the interest rate on federal student loans is scheduled to double in July, to 6.8%, and some in Congress want to take action to prevent the rate hike. The student loan bankruptcy bill may attract more votes if it gets attached to the interest-rate measure.
The student loan dispute also comes at a time when concerns are mounting that college students have taken on unsustainable levels of debt. Outstanding student loan debt now exceeds $1 trillion, the Consumer Financial Protection Bureau announced last week
In the eyes of private student lenders, that eye-popping total is a sign that the cost of college is rising too quickly, aided by the availability of government-backed loans.
Richard Hunt, president of the Consumer Bankers Association, said in an interview that 84% of outstanding loan debt is backed by the federal government, and only 16% is private loans.
"The reason people are borrowing so much money is that the cost of higher education has gone through the roof," Hunt said. "You don't go to the federal government or the bank unless you need to borrow money to cover expenses."
Since 2005, both federal student loans and private loans have been barred from discharge in bankruptcy, except in rare circumstances, as a result of a change in the law that put private lenders on the same footing as the federal government.
In a letter to Durbin last week, industry groups, including both the Consumer Bankers Association and the American Bankers Association, argued that changing the bankruptcy rules again would add risk to private student lending and restrict the availability of credit to college students.
The groups also argued that Durbin's bill would allow students to "run up thousands of dollars in private loans, carry them without having to pay interest while in school and then walk away without making a single payment even if the student in the future should be able to repay the loans in full."
But consumer advocates point out that federal student loans have lower interest rates and more protections for borrowers than private loans do, and government-backed loans should therefore be treated differently in bankruptcy court.
They also point to cases where students have been steered into higher-cost private loans even though they were eligible for federal loans, and instances where colleges have closed their doors, leaving students mired in debt and unable to complete their degrees.
One witness at last week's hearing, Danielle Jokela, said that by the time she pays off all of her student loans, she will have paid $211,000, nearly three-quarters of which is for private loans, on $79,000 in borrowing.
"I am literally losing my home so that I can continue to pay my student loans and other monthly bills," said Jokela, who attended a for-profit design college in Chicago.
Consumer advocates are pushing for more reforms than just changes to the bankruptcy rules. They would also like to see a requirement that private lenders certify with the school that the student is not taking on more debt than they need to pay for college, among other changes.
"Because bankruptcy is really the last resort, there should be other tools in addition to bankruptcy," said Pauline Abernathy, vice president of the Institute for College Access & Success, which seeks to improve the affordability of higher education.
Regarding the bankruptcy bill, Abernathy said that 90% of private student loans being originated today require the student to get a co-signer, usually a parent.
She said that those co-signing requirements would blunt the impact of a change to the bankruptcy rules, since both co-signers would have to file for bankruptcy in order to discharge the debt.
But lenders note that Durbin's bill is retroactive, and say that in the past, fewer private lenders required a co-signer. "You made those loans based on the rules set forth in the contract," Hunt said.
As Durbin looks to garner support for his bill in the Senate, there may be wrangling over the period of time that would need to elapse before students could seek to have their debts discharged in bankruptcy court.
"Were a measure to advance, we believe there would be a delay of at least five years after repayment begins before a student could assert this right," Jaret Seiberg, a senior policy analyst for Guggenheim's Washington Research Group, wrote in a note Monday. "That means the measure would hurt private student lenders, but it would not be fatal."