Aaron Chan

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Bankruptcy and the Student Debt Crisis

“The pound of flesh, which I demand of him,

Is dearly bought; ’tis mine and I will have it.”

Shylock, The Merchant of Venice

Under the current state of the law, it is not possible to discharge student debt through merely filing for bankruptcy—an additional adversary proceeding must also be filed and won, behaving like a lawsuit within the larger bankruptcy case. The proceeding is necessary because, according to section 523(a)(8) of the U.S. bankruptcy code, the plaintiff must prove that not striking their student loans would “impose an undue hardship on the debtor and the debtor’s dependents,” a much higher bar than that imposed on most other kinds of debt (Fontinelle). This “undue hardship” is proven by application of the three-pronged Brunner Test, where a debtor must prove (1) based upon debtor’s current income and expenses, they cannot maintain a normal standard of living for themselves or their dependents if forced to repay the loans, (2) the state of affairs is likely to persist for a significant portion of the repayment period, and (3) the debtor has made good-faith efforts to repay the loans.

The issue has grown in relevance as the nation’s student debt balloons to dizzying new heights. Even after adjusting for inflation, the average college tuition has increased a staggering 130% since 2000, forcing Americans to borrow extensively to keep up, accumulating a total of $1.75 trillion in debt as of this year (Hanson). And with 12.4% of that repayment delinquent, the esoteric field of student debt in bankruptcy courts has attracted attention and debate over potential reforms to this area of the law.

Before discussing any potential amendments, it is important to note the massive repercussions that could result from even a seemingly minor tweak tilting the law more toward either relieving students or protecting lenders. After creation, most student loans are packaged into financial products called Student Loan Asset Backed Securities, or SLABS, and sold to private buyers, who get to reap the interest (Du). Making it easier for students to default on their debt would cause more loans contained in these SLABS to vanish, forcing the US government, who insures many of the bonds, to step in and pay investors, creating a system where taxpayers foot the bill for delinquent students. As for the part of the bond market not insured by the government, defaults would lower profits and deter future investors, resulting in less funds available for students to borrow. Institutions would then lend their limited funds only to the most creditworthy applicants, shutting out lower-economic-status students from the system entirely. Even worse, if large enough numbers of students were able to default, the trillion dollar SLABS market could collapse, triggering further consequences in the wider market like the 2008 crash, which was also caused by the failure of packaged bonds products.

On the other hand, changing the law to make defaulting more difficult would cause great personal suffering to people in unfortunate circumstances who are genuinely unable to pay their debt. Take two recent student debt cases tried in bankruptcy courts, Wolfson v. DeVos (2022) and Wheat v. Great Lakes Higher Education Corp (2022). In the first, plaintiff Ryan Wolfson owed $95,000 in student debt for a business degree he earned, but was unable to find a job due to epilepsy that worsened in the years after graduation. He bounced through 30 different minimum wage jobs to support himself, but even with the limited financial support his ailing father could give, he was barely able to break even on survival expenses each month, making it impossible for him to ever make a dent into his $95,000 debt (United States Bankruptcy Court).

In the second case, plaintiff Monique Wheat, a single mother of three, owed $110,000 in debt for a degree in criminal justice, but could not find a job in that field despite her best efforts. She worked a job for $10.50 an hour, struggling to feed her children, care for her daughter who had a rare blood disorder, and support her schizophrenic mother. The court found that based on their calculation of her necessary expenses against her income, she was actually making a negative income of -$1000 a month (United States Bankruptcy Court). She clearly had no capacity to ever clear her debt.

Thankfully, both cases passed the Brunner test, and the plaintiffs’ loans were discharged by the courts. These cases were clear examples of the intent of bankruptcy law—judging that repayment was not ever going to be possible, the courts acted to write it off rather than having the unfortunate debtors toil their whole lives with no hope of clearing their accounts. Yet, both cases were appealed by the Education Department of the supposedly-student-debtor-sympathetic Biden administration in a bid to reverse the ruling (Douglas-Gabriel). The appeals were withdrawn after public outcry, but they show just how much legal opposition there is to discharging student debt. Changing the law to make it even harder would lock ordinary people in difficult circumstances like Ryan Wolfson and Monique Wheat into a lifetime of indentured servitude to an endless debt, a disgrace to a free and civilized nation.

The law needs to strike a balance between protecting lenders and students, and after looking at the disastrous consequences that lurk on either side, I conclude that there is no good option for changing current bankruptcy laws surrounding student debt. Instead, action must be taken to ensure people who are eligible for discharge under existing law know their rights and use them. There is a public misperception that student loans are impossible to discharge through bankruptcy, and lending firms are happy to maintain this lie. Advocates should work to spread awareness that though it is difficult, it is not impossible, and people in circumstances that pass the Brunner Test can and should file for discharge. Furthermore, in Homaidan v. Sallie Mae (2021), the courts found that certain types of private student loans did not require proof of undue hardship to be waived, meaning they could be cleared through a simple bankruptcy filing without the additional adversary proceeding (Bello). However, because not every debtor is aware of this, many lending companies continue to collect payment on private student loans that already have been discharged, taking advantage of the misperception that student debt cannot be cleared through bankruptcy. The government must crack down strongly on such predatory activity, and work to ensure court rulings are clear about which of a plaintiffs debts are and are not discharged at the end of a proceeding.

Unfortunately, besides the above recommendations to create greater awareness and clarity about the current state of the law, I do not believe bankruptcy law has the potential to fix America’s student debt crisis. Declaring bankruptcy is a nuclear option, the last resort for a person with no where else to turn, and such a blunt instrument cannot effectively operate on the national cancer of student debt. Instead, our attention should be on the private SLABS market, on those who stand to make money from predatory lending practices. As long as there are people profiting off the problem, it stands to reason that there will be that much opposition to fixing it—and in this case, the opposition is worth trillions of dollars. Over the next decade, the government must taper down the amount of private interest pumping money into the higher education market, setting strict limits on the number of products lending companies are able to sell to investors, and decreasing that limit over time. To cover the shortfall that creates in available funds for students, the government should grant money directly to schools to support lower income students. Over time, this will reduce predatory practices as loan companies are forced to act responsibly by taking safer bets with their limited capital.

But ultimately, the solution does not lie in the courts or the federal government, but in we, the American people. At heart, the student debt issue is one of supply and demand—schools and lenders know we will pay anything to give ourselves a leg up in life, and so, they make us pay everything. They’ve set up a factory to saddle students with debt and turn us into the financial products of some hedge fund on Wall Street for life, and we walk in willingly. The day we take a look at the price tag for college and decide enough is enough, is the day their plunder ends. And perhaps that day has already arrived. In the last two years, after adjusting for inflation, the price of college tuition fell for the first time in 30 years (Trends in College Pricing). Why? Because in just one year, total enrollment in colleges fell by 631,000 (Cooper) —students are beginning to recognize higher education may not be worth the cost for everyone, and as they turn elsewhere, schools are forced to react. If you are considering taking out loans for college, don’t do it just because everyone else is. Take time to research your options, consider the cost carefully, and determine if you are able to shoulder the financial obligation. If you don’t, you might just find yourself in bankruptcy court one day, arguing with a lender over your pound of flesh.

Bibliography

“A History of Bankruptcy.” BankruptcyData, New Generation Research, 2021, https://www.bankruptcydata.com/a-history-of-bankruptcy.

Bello, Nancy M. “Second Circuit Affirms That Some Private Student Loans Are Dischargeable in Bankruptcy.” Kramer Levin, Kramer Levin Naftalis & Frankel LLP, 17 Nov. 2021, https://www.kramerlevin.com/en/perspectives-search/second-circuit-affirms-that-some-private-student-loans-are-dischargeable-in-bankruptcy.html.

Cooper, Preston. “Why College Tuition Is Falling for the First Time in Decades.” Forbes, Forbes Magazine, 10 Dec. 2021, https://www.forbes.com/sites/prestoncooper2/2021/12/02/why-college-tuition-is-falling-for-the-first-time-in-decades/?sh=7b5044fb5860.

Douglas-Gabriel, Danielle. “Biden Administration Promised Bankruptcy Reforms. so Why Is It Still Fighting Student Loan Borrowers in Court?” The Washington Post, WP Company, 17 Feb. 2022, https://www.washingtonpost.com/education/2022/02/17/biden-student-loans-bankruptcy-dispute

Du, Jack. “Student Loan Asset-Backed Securities: Safe or Subprime?” Investopedia, Investopedia, 5 Oct. 2021, https://www.investopedia.com/articles/investing/081815/student-loan-assetbacked-securities-safe-or-subprime.asp.

Fontinelle, Amy. “How To File for Student Loan Bankruptcy.” Investopedia, Investopedia, 4 May 2022, https://www.investopedia.com/how-to-file-student-loan-bankruptcy-4772237.

Hanson, Melanie. “Average Cost of College by Year” EducationData.org, January 9, 2022,

https://educationdata.org/average-cost-of-college-by-year

Irby, LaToya. “What Is A Bankruptcy Discharge?” The Balance, The Balance, 7 Apr. 2022, https://www.thebalance.com/bankruptcy-discharge-what-is-it-and-when-does-it-happen-960064.

Shakespeare, William. The Merchant of Venice, MIT.edu, http://shakespeare.mit.edu/merchant/full.html.

“Trends in College Pricing and Student Aid 2021.” Collegeboard, Collegeboard, Oct. 2021, https://research.collegeboard.org/media/pdf/trends-college-pricing-student-aid-2021.pdf.

United States Bankruptcy Court, District of Delaware. Wolfson v. DeVos. 14 Jan. 2022. Casetext, https://casetext.com/case/wolfson-v-devos-in-re-wolfson. Accessed 6 May 2022.

United States Bankruptcy Court, Middle District of Alabama. Wheat v. Great Lakes Higher Education Corp. 25 Jan. 2022, https://www.govinfo.gov/content/pkg/USCOURTS-almb-2_18-ap-03041/pdf/USCOURTS-almb-2_18-ap-03041-0.pdf. Accessed 6 May 2022.