Congress has been making it harder for borrowers to get out of their student loan obligations since the late 1990s. But in the face of concerns about student loan debt's impact on individuals and the broader economy, lawmakers are facing growing pressure to ease the burden of repayment.
Policymakers have good reason to be worried about student debt. The total debt outstanding for students in the United States exceeds $1 trillion, and this debt loan may be inhibiting growth in the housing market.
Some leading proposals in Congress would allow borrowers to erase private student debt while preventing the discharge of government student loans. But the recent history of bankruptcy law suggests there's a better way to provide relief to student borrowers while minimizing concerns about moral hazard.
Current bankruptcy law permits the elimination of any student loan if repayment would be an undue hardship on the debtor and the debtor's dependents. In a court decision from 1987 referred to as the Brunner case, a federal appeals court ruled that proving "undue hardship" requires borrowers to meet two requirements. First, borrowers must be able to show that they cannot maintain a minimal standard of living if forced to repay student loans. Second, they must show that they have made a good-faith effort to improve their financial status but that financial hardship is likely to continue for an extended period.
The policy question for Congress and the public is whether to allow borrowers to discharge student debt even when repayment would not be an undue hardship. In considering this question, it's important to note that prior to 1998, borrowers could eliminate all of their student loans if the loans had been in repayment for at least seven years without regard to the undue hardship standard.
Several proposals now circulating in Congress seek to override the undue hardship test, but only for private student loans. In my view, these proposals are problematic for two reasons.
First, wiping out student loans with no questions asked raises serious moral hazard concerns. Under such an approach, surely some borrowers who could afford repayment would take advantage of the new law to skip out on their obligations to pay off student debt.
Second, and perhaps more important, limiting bankruptcy relief to private student loans and not government-backed student loans will provide negligible relief to most student borrowers.
Private student loans make up just 7.8% of the $1.18 trillion student loan market in the U.S., according to analysis by data company MeasureOne. In other words, proposals to allow borrowers to erase only private loans would leave roughly 92% of student loans unaffected (although they could still be wiped out if the borrower can show an undue hardship).
A better approach would be to revisit the seven-year standard after which student loans can be discharged. If Congress were to resurrect this approach, bankruptcy could offer meaningful student debt relief.
A seven-year period is too long to encourage significant gaming of the bankruptcy system. And imposing this requirement, rather than giving student borrowers a carte blanche to use bankruptcy, would significantly reduce the government's potential revenue losses. Yet this standard would still provide helpful relief to overburdened borrowers.
John McMickle is the founder of JDM Public Strategies, a consulting firm that works in financial services and government relations. He served as the bankruptcy counsel to the U.S. Senate Judiciary Committee from 1994 to 2001. Follow him on Twitter @jdmpsllc.