Student loan debt in the U.S. is a growing problem, with college students graduating with an average debt load of nearly $20,000 as of 2006. In my last post, I pointed out a recent opinion suggesting a bankruptcy approach that might help students with these loans, even though the debts are nearly always nondischargeable. Comments to this post suggested that there is an underlying problem in the way U.S. bankruptcy law treats student loan debt. The comments are right: this treatment of student loans is very difficult to understand.
In last weekend’s debt symposium at the University of Illinois, Heidi Hurd presented a draft paper discussing the theoretical underpinnings of discharging debt. She noted that the dominant explanation for discharge is “utilitarian”—holding that discharge promotes the overall good of society by encouraging individuals burdened by debt to engage in productive activity that they would otherwise forgo, since it would only benefit their creditors. Professor Hurd also pointed out two problems with this rationale: it allows people who may be culpable in incurring debt to escape responsibility, and it imposes losses on individual creditors who may not be able to afford them.
The discussion following Professor Hurd’s presentation noted that U.S. bankruptcy law can be seen as mitigating these problems with utilitarianism. Some exceptions to discharge—e.g., for fraud or intentional injury—punish wrongful conduct in incurring debt. Others—e.g., for domestic support obligations—assure payment to creditors who may be in particular need. Priority of payment in bankruptcy similarly protects needy creditors. These considerations certainly help rationalize the U.S. bankruptcy system.
The treatment of student loans, however, can’t be explained using this modified-utilitarian rationale. Student loans are generally incurred in good faith; indeed, they are encouraged as wise investments. And providers of student loans are not in particular need of repayment; they can easily spread their risks either to other student borrowers (through higher fees and interest) or to society at large (through government subsidies). Moreover, if it were thought that repayment of student loans was necessary for the lenders, some sort of priority, even if not a requirement of full payment in Chapter 13, would be expected. But there is no such priority—which makes the treatment of this debt punitive, despite the absence of wrongful conduct by the debtor.
As originally enacted, the 1978 Bankruptcy Code provided that student loans could be discharged either if five years had passed from the time payment was first due or if the debtor provided for repayment during a three-to-five year Chapter 13 plan. This provision could be supported by the sort of “needs-based” rationale that underlies the means test: an intuition that while students might not be able to repay their loans immediately after graduation, they would likely be able to do so a few years later. But once student loans were made permanently nondischargeable, this rationale was lost.
If there is a way to explain current U.S. law on the dischargeability of student loans, it is not apparent.