Two Steps Toward Tackling Our Current Student Loan Problems

Because of legal choices we’ve made in how to set up our rules surrounding debt, student loans stay forever, are virtually impossible to discharge under hardship, churns fees when they goes bad, and creditors can get to anything, including Social Security, to get them repaid. This is significantly more strict than how other debts work. Here’s a great way to describe the legal frame we use to treat student loans, from Elizabeth Warren in 2007: “Why should students who are trying to finance an education be treated more harshly than someone who negligently ran over a child or someone who racked up tens of thousands of dollars gambling?”

With student loans very much on the minds of Occupy Wall Street and policy wonks, what’s the solution? There’s a short-term and a long-term problem. The long-term problem, in my mind, can only be solved by unapologetically embracing the promise of a “public option” – free public universities that are capable of constraining cost inflation. This requires us to also face and resist the corporatization and privatization of our existing public universities.

But that doesn’t get us out of the current problem. What can be done? I’m going to propose two things.

1. Party Like It’s 1989.

Instead of being so bold and asking that people trying to invest in themselves, and ultimately the country, are treated as fairly as someone who negligently ran over a child by our legal codes, I’m going to just suggest we just do a mulligan on the 1990s and 2000s student loan “reforms.”

Quick, high-level history of student loans and the bankruptcy code, courtesy of University of Illinois law professor Bob Lawless:

In 1976, Congress first added an exception to the bankruptcy discharge dealing with student loan debt. That exception was continued in the 1978 Bankruptcy Code, and the exception was expressly limited to student loans from a governmental unit or nonprofit institution. Even then a student loan could be discharged if more than five years had passed since the loan first became due (typically after graduation) or if the debtor could show payment of the student loan would cause undue hardship, which is a difficult burden to show. In 1990, five years was changed to seven years and in 1998 was dropped altogether, leaving undue hardship the only reason a court could discharge a student loan from a governmental unit or nonprofit institution. As part of the 2005 changes to the U.S. bankruptcy law, Congress again amended the student loan discharge exception to allow even loans from for-profit lenders to be excepted from the bankruptcy discharge.

Let’s put that in a chart, adding Social Security and no statue of limitations we talked about here:

Why not just undo the rules from the 1990s and 2000s? It is hard to see these as anything other than a giant subsidy to private agents. If you look at Sallie Mae’s leaked lobbying documentation, you’ll find that “The number two item…wasn’t increasing federal student loan limits or beating back the loan consolidation companies…It was bankruptcy; specifically, preserving the special status that private student loans gained in the broad changes to bankruptcy laws that Congress enacted in 2005. To Sallie Mae, that provision is the key to its version of ‘private credit economics.’” There’s little evidence these reforms increased access for anyone and functioned more as an easily captured subsidy.

We can keep nondischargeability for 5 years if people are very concerned about moral hazard. A lot of these concerns from the 1970s started with stories of doctors declaring bankruptcy the day after they graduated medical school. This will at least stabilize and formalize the system of indenture that is required for people to fully develop their talents and abilities in our country, instead of the system that currently keeps people for life. Let’s regraph what it looks like when we go back to 1989:

That looks way better. But how do we deal with the current affordability crisis? Getting unemployment down and incomes up are an obvious solution. Sarah Jaffe suggests mass debt forgiveness, Justin Wolfers disagrees. I have a suggestion that splits the difference.

2. Deathbed Convert the American People into a Bank, Open the Discount Window.

A miraculous thing happened in late September, 2008. Goldman Sachs and Morgan Stanley were reborn from investment banks into bank holding companies by a decree of the Federal Reserve. Normally getting a license like this takes a year and a half, and requires following extensive regulatory rules. The Federal Reserve did it over a weekend for Goldman, Morgan Stanley and a host of other financial firms.

This allowed them many banking privileges that helped them during the crisis, including access to the discount window – but none of the scrutiny that normally comes with that. As Alan Grayson and others noted, Goldman’s CFO bragged that “our model never really changed” – they got to escape normal banking regulatory rules during the subsequent time period. These “deathbed conversions” from investment bank to bank holding company were yet another part of the extensive way the bailouts worked beyond TARP, and they were proof that the firms were Too Big To Fail.

Since regular Americans are also in crisis mode and Too Big To Fail, why not symbolically declare regular Americans a bank too? Why not also do a “deathbed conversion” on those who are suffering under the burden of heavy student debts and low incomes and let them immediately refinance all their student loan rates at the current ultra-low discount window rate? Mass refinance all student loans into the current low rates the financial sector enjoys. This would give the 99% of Americans just a hint of the kind of total government support places like Goldman Sachs have gotten.

We’ve thrown open the floodgates for the financial sector – why not for regular Americans? There have been past congressional efforts to lower the interest rate, ones that passed the House, so this can be done. And this would be the logical conclusion of what we’ve just gone through crisis-wise, delivering stimulus to the economy and reducing the burden of debts on those trying to rebuild the economy. Open the discount window.

Crisis Economics

For the economics people, this two-step helps with the liquidity problem (cheaper refinancing), the solvency problem (bankruptcy) and the balance-sheet problem (lower rates, more purchasing power) – the three problems one needs to deal with in the aftermath of a financial crisis. In terms of monetary policy, the actual people who have been carrying out QE have been begging for policymakers to find ways to get ultra-low rates to the front-lines as quickly as possible, most notably housing policy. Bernanke at his latest press conference:

One area where monetary policy has been blunted, the effects have been blunted, has been the mortgage market where very tight credit standards have prevented many people from purchasing or refinancing their homes and therefore the low mortgage rates that we’ve achieved have not been as effective as we had hoped. So, monetary policy maybe is somewhat less powerful in the current context than it has been in the past but nevertheless it is affecting economic growth and job creation.

That’s Fed speak for the administration dropping the ball on the mortgage market (HARP, especially) has in turn screwed up their ability to do their jobs of helping the economy. But what is good for housing is also good for student loans. Aggressive monetary policy flowing into student loans would have a similar amplification, which makes targets more credible and gets more money being spent, which makes balance-sheet repair easier and has a general virtuous cycle on demand.

Wins all around. So what are the problems?

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33 Responses to Two Steps Toward Tackling Our Current Student Loan Problems

  1. I like these two points a lot. Sadly, nominal Democrat Ben Nelson (and his Blue Dog pals) and the Republicans would never let this happen.

  2. Dan Kervick says:

    Mass refinance all student loans into the current low rates the financial sector enjoys.

    Mortgages too?

  3. Steve Roth says:

    Just a general comment comment/question in response to implications here: Sumner says that Fed policy can (will?) always trump fiscal. But in the same vein (reversed), can’t fiscal/non-Fed govt policies give the Fed the flexibility they need to manage the dance between their dual mandates? (Especially in a zero-interest-rate, low-inflation environment?) Isn’t that what Bernanke’s asking for?

  4. and no debt accrual when the student is out of work to go along with the low interest rate charge.
    Of course if Goldman Sachs ran such a program, how much in executive bonus pay would this generate?

    The Goldman Sachs thought process…(note, sarcasm alert), “one for you, two for me, one for you, three for me, four for me, who are you?”

  5. kms says:

    Heavily indebted, unemployed recent graduate here (degrees in biology and business).

    Wonderful idea, but- maybe you haven’t noticed- they don’t care about us. We are in the streets in droves and the government still doesn’t care about us. Isn’t it obvious? Goldman matters. We don’t.

  6. Steve Roth says:

    Worth noting: in The Great Depression, bank loan books were flat. Government (Reconstruction Finance Corporation) stepped in to make loans that banks wouldn’t, didn’t:

    http://www.asymptosis.com/banks-who-needs-em.html

  7. Frank says:

    This is very smart, and clarifies a lot re the “tradition” of nondischargeability. A few thoughts:

    1) What about the income based repayment (IBR) alternative? Is a better battle to try to reduce the amount expected as a percentage of income, and the years it takes to end the obligation? I think it’s an easier political sell, particularly if it mirrored the sliding scale of income we see in the subsidies for health insurance (premium assistance tax credits) in PPACA.

    2) On the other hand, if you combine the PPACA insurance subsidy rules with IBR here, you create really big incentives not to work more, between $20K and 50K or so of income (or to get married, as this blog post shows: http://thehealthcareblog.com/blog/2011/11/04/another-unpleasant-surprise-from-obamacare/

    • Patrick Earnest says:

      1. I don’t think this needs to be an either/or situation. IBR has already come down to 10% of gross income and 20 years forgiveness. There are ways to lower that down to 10 years, if you work in public service. But not everyone is eligible for those terms, and the push on that should be to make all loans on IBR have those terms.

      With regards to 2: I’m extremely skeptical of the numbers there, and that is mostly because there doesn’t appear to be any consideration of the individual with employer sponsored health insurance from buying coverage through his employer for the rest of the family, something that would be much cheaper than buying individual plans for everyone else. Like everything else affiliated with the Manhattan Institute, that bit of analysis stinks to high heavens.

      • Waingro says:

        “I don’t think this needs to be an either/or situation. IBR has already come down to 10% of gross income and 20 years forgiveness. ”

        It’s important to realize this only pertains to future borrowers (post-2013, I think). Current borrowers are stuck with the 15%/25-year plan. Any decent loan forgiveness program would extend this to current borrowers

  8. Patrick Earnest says:

    First proposal, party like it’s 1989, great. Suddenly all those entities that loaned student loans privately will have to eat that risk that they didn’t think was coming their way. This may hit a few financial firms, but the big banks have (I think) mostly moved that off their balance sheets.

    Second proposal, open the discount window, is a good idea, but you have the problem that most people who need that help will, by default, not get it, because most people aren’t savvy enough to do so. There’s so many people already with student loans who haven’t converted to income-based repayment plans who would benefit, and so many who don’t consolidate their student loans when consolidation would help them. The program would need an easy way to get those with student loans to borrow from the Fed to pay off the student loans.

    Here’s a few alternative proposals to think about:
    1. Have the Fed buy up the student loans. Banks and non-bank entities are looking for liquidity – one thing still left are student loan portfolios and student loan asset backed securities. Have the Fed buy up the student loans and student loan ABS at (preferably) market or (possibly) face value so as to restructure the loans/unwind the ABS. This would allow them to unilaterally waive terms of the loans, like the interest rate. Allow them to do this for defaulted loans as well. For the most part, this should only affect the private loan market, but it would still be something.

    2. Default student loan repayment plans to IBR. This at least delays problems and should keep many from delinquencies and default.

    3. Change the Direct consolidation program so that the interest rates are lowered to the Fed discount window interest rate, and allow any loans to be consolidated. That would take Congressional action, though, so it would be much more difficult.

  9. Herb says:

    Go back earlier. I attended college from 1970 – 75(It was a 5 year program. At that time need based grants (NOT LOANS) from a state agency covered about half of the tuition cost for the whole five years. The state agency received funding from the federal government. I would never have been able to afford college if I had been stuck with the terms today’s students face. We need to get back to that kind of grant to loan funding ratio.

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  12. I’m forwarding this to my in-debt-up-to-her-eyeballs daughter (27, degree in family studies, working as a social worker among the aged in the Bronx). The thing is, she and the rest of her generation are going to have to lobby like hell to get this debt relief passed. OWS is just the beginning. Good ideas + incredible effort = halting social progress.

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  15. Walter Lee says:

    Mike,
    Great suggestions! My take on the first–restore the laws as of 1989–is that it is too screamingly rational and obvious–rather like restoring Glass-Steagall as a remedy for “too big to fail”. (And you saw how far that got: to my knowledge, it was never even discussed.) Regarding the second– turning student loan debtors into bank holding companies–I find this breathtakingly brilliant and and, moreover, positively reeking with poetic justice–and real justice too! I propose that Occupy Wall St adopt adopt it as a rallying cry: “Just treat us like a bank holding company!”

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