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Why It's So Hard to Declare Bankruptcy on Your Student Loans

Allie Conti

Allie Conti

As Sallie Mae and Navient are accused of pushing subprime loans, one activist-expert says we're missing a much bigger point about how student debt works.

Image by Lia Kantrowitz

Two nights ago I couldn't sleep because I knew my student loan payments were about to skyrocket. This is actually a sort of annual ritual for me and, I suspect, plenty of other Americans: Each year around summertime, I get a bill from my loan servicer for something that's more than half of what I make in a month. In response, I always go through the same nightmare: call up FedLoan, beg for mercy, and stop making payments entirely until they readjust the amount to be something that won't make me homeless. The problem is, I never get any advance notice about when I need to reapply for this relief, which is called income-based repayment, and there are only a certain number of times you can go into deferment—a.k.a. delay your payments—before the servicer won't let you anymore.

I sometimes worry that the time will come when I'm forced to debt-dodge in Europe.

Reading through a recent set of lawsuits filed against Sallie Mae and Navient made me realize that I'm not insane––that it's actually impossible to figure this shit out, and it may have been set up that way on purpose. As the New York Times reports, the attorneys general of Washington and Illinois allege that the loan company and servicer, respectively, routinely engaged in predatory practices that mirror those behind the housing crisis of 2008. The gist of the allegations is that Sallie Mae gave money specifically to people they knew stood little chance of repaying them, and that Navient deliberately obscured information about repayment options that would have made their lives bearable. (The Consumer Financial Protection Bureau, which is championed by Elizabeth Warren and endangered by Donald Trump, is also involved in the litigation.)

For its part, Navient has vigorously denied the lawsuit's allegations, while Sallie Mae told the Times its spin-off has "accepted responsibility for all costs, expenses, losses and remediation arising from this matter."

Student loan activist Alan Collinge isn't surprised by the idea that America's student loan system is preying on the vulnerable. When I called him up to talk about the lawsuits, he told me the only way to dig ourselves out of this mess––and to make sure that no one ever stands to profit by making borrowers default––is to restore bankruptcy protection to student loans, which existed prior to 1976. (Right now, only extremely rare cases where the borrower demonstrates "undue hardship" are eligible for bankruptcy protection.) He also surprised me by arguing that the absence of this protection is unconstitutional, suggesting this is a reform that might be won in court or Congress, even if President Trump isn't too concerned about it. Here's what we talked about:

VICE: Okay, so what would the outcome be if these lawsuits succeed?
Allan Collinge: In the past we've seen class actions like this result in settlements that by and large were very small. They ended up being a few dollars per borrower. So people would unknowingly get like ten bucks in the mail as result of similar action. This one may be just another one of those, where the government, the CFPB may get millions of dollars, but the borrowers themselves see almost nothing in terms of real dollars. That is probably the most likely outcome.

But truly, the heart of this problem goes directly back to the absence of bankruptcy protections. So in a perfect world, Congress would pay attention to this and other cases that follow and recognize that it is the unconstitutional removal of bankruptcy protections that lies at the core of this entire fiasco. It would be very easy for Congress to return standard bankruptcy protections to student loans, and make student loans the same as all other loans. That would be the most obvious, most just, and most fair outcome for this.

I've never heard anyone use the term 'unconstitutional' to describe student loans.
Thomas Jefferson, George Washington, many of the founding fathers were slammed in debt by British banks and merchants. So when they fought the Revolutionary War, it was as much for economic emancipation as anything. It was more because of the way debtors were treated than it was for the religious persecution. British banks and merchants had treated the Founding Fathers like crap, so when they finally declared independence and wrote the Constitution, if you look at Article I, Section VIII of the Constitution, where all of the Congressional powers are listed, you will see––and this surprised me, I really was stunned when I saw this––but bankruptcy is actually mentioned near the top of the list of Congressional powers. Not in the Bill of Rights, but actually in the body of the Constitution itself.

Really?
Something like 17 powers are mentioned: the power to declare war, the power to raise an army, the power to create a judiciary, the power to coin currency. Well, the requirement for a uniform system of bankruptcies appears above all those powers I just mentioned on the list. That really freaked me out, I was like, why would the Founding Fathers care so much about bankruptcy, enough to put it in the Constitution? Like, I mean that just seems really weird. But if you actually think about it it's not weird at all. The Founding Fathers realized that the people who controlled the gold, so to speak, ran a huge risk, ran a huge temptation, of just badly abusing the borrowers. And that's exactly what England and the English banks were doing to the settlers of the new world. So the Founding Fathers felt so strongly that they put it ahead of the power to declare war, the power to raise an army, and all those other things. Now, bankruptcy protections exist for every loan in this nation's history except for student loans. Student loans is the one and only counter-example, the only example where bankruptcy protections have been essentially taken away.

How did that come to be, anyway?
In the 1970s, some people like Sallie Mae trotted out these stories of people fleeing, of going directly from graduation to bankruptcy court, and wiping their hands free of student loan debt. So these stories were trumped up in the media––no pun intended––but they were trumped up. So Congress put a five- year waiting period on bankruptcy discharges specifically for student loans. Well, over time this was extended to seven years, and by 1998, that was extended to infinite years. So today it is for all intents and purposes it's impossible to get your student loans discharged in bankruptcy.

And look what's happened. So, the counter example is the wisdom of the Founding Fathers in spades. Because we have never seen any market that has exploded in price like we have with higher education. I mean the price of college has increased way quicker than the price of healthcare, accelerated way more dramatically than the price of, you know, of real estate, back when the subprime mortgage scam was going on. The price of college has just blown that out of the water. Around the beginning of the century we owed about $250 billion in student debt. Today we owe about $1.5 trillion. You know, bankruptcy is a very essential mechanism for keeping the lenders honest, for keeping them in acting good faith rather than acting in bad faith, and for keeping the price of the commodity in question rational. So student loans are the sort of guinea pig on that, and now we see the consequences.

Given Trump's singular action on student loans so far has been further deregulation, it seems unlikely that we're going to see bankruptcy anytime soon, right?
Oh, no, no, no, no. I think it's quite likely that it's going to be restored. I've been doing this for 12 years, and in the past there has only been one attempt to get bankruptcy returned to private student loans, and it failed narrowly. In the last legislative session there were three bills that popped up that would have literally repealed one line of code. If you delete just that one line, student loans go back to being treated like every other sort of loan in terms of bankruptcy. And one of those bills actually got bipartisan support. Now in the current session my prediction, and I'm usually pretty good at predicting these things, is that if bankruptcy protections are not returned to student loans this session, my best guess is that literally the entire lending system is going to quite literally evaporate into a mist of illegitimacy. I think I told you about how defaults—we're now seeing the defaults skyrocket. If that trend continues by the end of this year we're gonna have 12 million people defaulted on their loans. I think the overall true lifetime default rate is probably approaching 50 percent as we speak. The numbers have gotten so stupid––the average borrower has $37,000 in loans today, where it was like half of that seven years ago.

How is that going to motivate the lenders to stop? Isn't that ideal for them?
The fact of the matter is, people are not stupid. People realize when something is an obvious ripoff. And at some critical mass people are gonna get together and student loans are gonna become one large national joke. And to me I think that would be highly appropriate, and in fact we may be going down that path as we speak. At some point people throw up their hands and say this is ridiculous, I'm not paying, this is just silly. And I think we are teetering on the brink of that right now. And I think if Congress was actually smart they would realize that and they would at a minimum return the standard bankruptcy protections that they should have never taken away. It is only through an orderly constitutional mechanism like bankruptcy that they will have any chance of restoring public confidence in the lending system generally.

Has anyone challenged the student loan industry on the basis of unconstitutional practices?
Well, the sitting members of Congress really don't pay a lot of attention to student loans generally, and the ones who do, and certainly any of the Congressmen who know anything about the Constitution, anybody who looks at this who knows what they're talking about with respect to the Constitution, red flags go up immediately all around the student loan system. It can't not. But the student loan system threw a lot of money around on Capitol Hill. Sallie Mae was born on Capitol Hill. And so the clouds they carry around, and the money they throw around to both Democratic and Republican members of Congress goes a long way to perpetuating this system. But even the big guys like Sallie Mae have acknowledged publicly that yes, okay, the bankruptcy protections, or the bankruptcy laws, probably need to be revisited. I frankly think that they're stunned that they've been able to perpetuate the absence of bankruptcy protections for so long.

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