Grad PLUS Loan Disaster Sidelined by Stafford Interest Rate Hikes

If you didn’t know already, the Higher Education Act is up for renewal this year, but you have to dig deeper to get news about anything other than the Stafford loan interest rate hike that will destroy the lives of the undergrads or something. For those curious about law school tuition, here’s what’s been going on.

For one, you have the Bill and Melinda Gates Foundation dropping $3.3 million in grants on 14 organizations to produce policy papers aiming to improve college completion rates by changing the federal loan program. (How about, “Don’t send people to college who are unprepared or can be expected to fail, and create living wage jobs for young people instead”? Now can I get my slice of that $3.3 million?) I don’t know about Melinda’s education (and I don’t care), but I think it’s pretty funny that a wildly successful college dropout is trying to increase completion rates. Those Redmond engineers have to learn coding somewhere.

The policy paper that probably carries the most weight is the New America Foundation’s “Rebalancing Resources and Incentives in Federal Student Aid,” which tackles the graduate-level debt disaster with several proposals:

(1)  Terminate the Grad PLUS loan program.

(2)  Restore bankruptcy protections to private student loans.

(3)  Raise graduate and professional students’ annual Stafford Loan limit to $25,500.

(4)  Set all federal loans’ interest rates to the 10-year Treasury rate plus 3.0 percent.

(5)  Encourage debtors with guaranteed loans to switch them to direct loans with a one percent interest rate reduction.

(6)  Make Income-Based Repayment the sole repayment plan, revise it to protect against high debt, high-income debtors making a windfall.

If these six policies were enacted, it’s certain that average private law school tuition would drop, and it’s clear that the New America Foundation now realizes that IBR isn’t so much the problem as Grad PLUS loans. Recall that the foundation expended much effort last year arguing that an undetermined number of high debt, high income graduate and professional students would benefit most from the changes to IBR (an already generous program compared to the debtors with cosigned private loans that have to come up with four-figure monthly payments or else a megabank will foreclose on their parents’ houses) by showcasing a fly-by-night accounting firm’s advertizing that targeted graduates from a law school with awful employment outcomes.

As you can imagine, I still don’t understand the New America Foundation. Not its policy proposals, those are very crisp and largely unobjectionable, but it doesn’t seem to have much of an ideology, i.e. a coherent set of beliefs that explain why the social order should be one way and not another. “Let’s tweak these programs really well” is not an ideology beyond modifying the edges of an existing social order, which is what you’d expect from a paper using “rebalancing resources and incentives” in its title. This surprises me as its co-founder, Michael Lind, regularly writes reliably lucid liberal (anti-neoliberal!) articles for Salon, including not one but two contemplating taxing land values as a response to advancing technology.

Thus, I draw your attention to point (3), raising the annual loan limit to $25,500. It’s utterly inconsistent with the foundation’s goal of reducing graduate-level tuition:

[Unlimited Grad PLUS loans], especially when coupled with loan forgiveness and Income-Based Repayment, can discourage prudent pricing on the part of institutions and prudent borrowing by students.

“Prudent pricing” here is thinktankspeak for a tuition bubble. As for “prudent borrowing,” I don’t know about other programs, but in the law students’ defense there’s been no evidence that Grad PLUS loans plus IBR has led to an increase in law school applicants who are cynically trying to screw over the government.

(Source: LSAC)

That’s not to say that law schools and students don’t depend on Grad PLUS loans, but I think it’s more one-sided than the New America Foundation indicates. There are fewer law students but not fewer law schools. (Yet.)

We continue:

However, policymakers should increase the annual limit on Unsubsidized Stafford loans for graduate students from the current $20,500 to $25,500 to replace some of the borrowing ability graduate students will lose when the Grad PLUS loan program is eliminated. Although [eliminating the Grad PLUS loan program] will likely push some graduate students into the private loan market, this could ultimately be beneficial in addressing the high costs of graduate schools. If institutions can no longer rely on PLUS loans to fund their high-tuition programs and if the private market is responsive to the ability of borrowers to repay (based on changes to bankruptcy law recommended later), then graduate schools may have to set their pricing based, in part, on students’ expected earnings.

If uncapped Grad PLUS loans discourage prudent pricing, why would raising the cap on Stafford loans encourage it? If the private sector is more responsive to borrowers’ ability to pay, which still doesn’t mean they’re more productive thanks to their educations, then why replace the lost borrowing ability with non-underwritten loans? I don’t really expect the New America Foundations of the D.C. think-tank circuit to argue for doing away with the Stafford Loan Program entirely—there’d be less to tweak!—but without a theory of what causes tuition increases and how people can wind up taking on more debt than they can afford to pay, there’s an obvious contradiction.

The only reason I can think of for the $5,000 Stafford loan increase is to ensure that the proposal looks like it’s saving money. Otherwise, it’d much more consistent to leave the Staffords as they are because eventually the $25,500 loan limit will be eaten by inflation anyway, and the paper doesn’t discuss pegging any of the loan limits to inflation. The other problem with Stafford loans is that universities can increase their haul by setting their tuition at the loan limit and enrolling more students.

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Since the New America Foundation’s proposal is probably the most comprehensive one out there (I didn’t read the others, but I can live with it), then how is it faring against Congress’s dysfunctions?

Enter The Chronicle of Higher Education‘s Kelly Field, “House Panel Approves Market Approach to Student Loan Interest Rates,” May 17, 2013.

Here’s the outline:

• Obama proposes setting the interest rates on various student loans as follows:
  • Subsidized Staffords: 10-year Treasury note + 0.93 percent, with no cap
  • Unsubsidized Staffords: 10-year Treasury note + 2.0 percent, with no cap
  • Grad PLUS and Parent PLUS: 10-year Treasury note + 3.0 percent, with no cap
• The Senate is working on the “Student Loan Affordability Act,” which would hold the Stafford loan interest rate at 3.4 percent for two more years.
• The House will vote on a bill that sets interest rates as follows:
  • Subsidized & Unsubsidized Staffords: 10-year Treasury note + 2.5 percent variable rate, capped at 8.5 percent
  • Grad PLUS and Parent PLUS: 10-year Treasury note + 4.5 percent variable rate, capped at 10.5 percent
• The alternative Senate bill would set interest rates for all student loans at the “bond equivalent” of the 91-day Treasury note, capped at 8.25 percent. I have no idea what “bond equivalent” means in this context, probably taking the 91-day rate to the 40^th power or something like that to align it with a 10-year rate.

In short, expect more Grad PLUS loan carnage and more tuition hikes where they can be had.

Joseph Stiglitz is Still Soft on Higher Education

…But unlike last time, he’s clear about it now.

Joseph Stiglitz, “Student Debt and the Crushing of the American Dream,” New York Times‘ Opinionator.

Yesterday, Stiglitz argued that student debt is connected to inequality, and it’s “intertwined” with lack of housing demand. He writes:

It’s a vicious cycle: lack of demand for housing contributes to a lack of jobs, which contributes to weak household formation, which contributes to a lack of demand for housing.

I’m dead certain that student loans crowd out homeownership for individual debtors, but I don’t know to what extent that can be imputed to the whole economy. Stiglitz is arguing that but for student loans, people have the income to afford housing. I don’t think this is true. I think most student loan debtors lack the income period. Thus, the “lack of demand for housing” is caused by untaxed land rents, which isn’t related to student loans.

Stiglitz might be right, but I don’t think every student loan debtor is just a few hundred dollars away from homeownership. I do think, however, that he’s wrong about the value of higher education. Cue the Eloi lawyers and Morlock material movers who have law degrees:

Curbing student debt is tantamount to curbing social and economic opportunity … Our economy is increasingly reliant on knowledge-related industries. No matter what happens with currency wars and trade balances, the United States is not going to return to making textiles. Unemployment rates among college graduates are much lower than among those with only a high school diploma.

I have to credit Stiglitz for actually connecting the trade deficit to jobs to student loan debt. This connection is very real, but it’s not made often because economists know nothing about student loan debt, and student debt advocates know nothing about labor economics. Again, I disagree. If we flip the trade deficit, maybe the textile jobs won’t come back—I don’t see why they wouldn’t, the U.S. is still one of the world’s biggest cotton manufacturers—but the lump of labor fallacy doesn’t apply to individual industries. There’s only so much demand for lawyers, brain surgeons, advertisers, fashion designers, and other knowledge workers. At some point, technology will reduce the labor economy to trading simple services that can’t be automated, like haircuts, waiting tables, etc. These jobs will rarely pay well, which is one argument for taxing the land rent and redistributing it as a citizen’s dividend.

The other big problem with the article is that Stiglitz doesn’t believe that over-generous federal lending enables tuition increases. He makes passing mention to slashed government subsidies to public universities, which is correct, but he thinks the rest of tuition increases are due to “the banks’” and not higher educators trying to sell parents on multi-million dollar athletic facilities. Then, as expected, he attacks the for-profits as though nonprofits and public universities are guileless. He also doesn’t point out that for 85 percent of the debt, “the banks” are the federal government either directly or by guarantee.

As a result, Stiglitz’ policy prescriptions are a muddle. Yes, restoring bankruptcy protections is critical, but thanks to IBR, even for-profits won’t post very high default rates, unless they don’t tell dropouts how to fill out the forms. Consequently, they will likely have access to federal funding indefinitely no matter what federal judges say. Slashing interest rates to the Fed’s discount rate (that’s the rate it quotes for its direct lending to the banks) will reduce debt burdens, but it certainly won’t discourage people from taking out loans they don’t need for degrees that have little value.

Stiglitz supports adopting Australia’s income-contingent repayment system, but I think we should take the government out of higher education finance entirely.

IBR Makes Contact With the Bankruptcy Code

I have a confession to make: I like reading appellate court opinions and thinking about the issues they discuss. Maybe I should’ve gone to law school or something. I don’t collect them like comic books, but it’s a rare perk of blogging that I get to read one every once in a while.

Today’s adventure is Krieger v. Education Credit Mgmt. Corp., (7^th Cir. 2013) (No. 12-3592), a bankruptcy case appealed from federal district court. The district court reversed the bankruptcy court’s finding that denying discharge of plaintiff-appellant Susan Krieger’s student loans would constitute an “undue hardship.” In a compassionate move, the Seventh Circuit sided with Krieger, allowing her discharge.

The opinion was written by law and economics powerhouse Frank Easterbrook, who baldly opens with, “Susan Krieger is destitute.” There are other nuggets like when he echoes anti-neoliberal zealot Michael Hudson (somewhat uncharacteristic of a Chicago-school type):

[I]t is worth recollecting that Educational Credit concedes (as the bankruptcy judge found) that Krieger simply cannot pay. She is essentially out of the money economy and living a rural, subsistence life. She does not have assets or income and, the bankruptcy judge found, is not likely to acquire any. Krieger at 2.

Krieger (53), who lives with her 75-year-old mother, hasn’t held a job since 1986, and before then she’d only earned $12,000 in her lifetime. She owed $25,000 in student loan debt for a paralegal degree she obtained more than a decade ago, and she applied to 200 jobs since then to no avail.

Debts that cannot be repaid, will not be repaid.

This opinion exists because Congress never bothered to define the circumstances constituting an “undue hardship.” 11 U.S.C. § 523(a)(8) (2012). The pertinent statute reads:

(a) A discharge [in chapter 7, 11, 12, and 13 bankruptcy] does not discharge an individual debtor from any debt—

…

(8) unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for—

(A)

(i) an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or

(ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or

(B) any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual.

Why is “undue hardship” undefined? Because until President Clinton signed the Higher Education Amendments of 1998, section 8 read:

(8) for an educational benefit overpayment or loan made, insured or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution, or for an obligation to repay funds received as an educational benefit, scholarship or stipend, unless -

(A) such loan, benefit, scholarship, or stipend overpayment first became due more than 7 years (exclusive of any applicable suspension of the repayment period) before the date of the filing of the petition; or

(B) excepting such debt from discharge under this paragraph will impose an undue hardship on the debtor and the debtor’s dependents.

In other words, one only needed to show an “undue hardship” if her loan had been in repayment for fewer than seven years before the petition date. After that, student debt was treated no differently than credit card debt. Note also that nonprofit institutions (e.g. Access Group) were also shielded from debtors well before private institutions received the same protection in 2005.

The 1998 amendment was passed with extraordinary bipartisan support (Ron Paul voted against it), which suggests that no one bothered to think about the consequences of permanent government-backed student loan debt. The primary such consequence is that for student debtors who wish to include their student loans in their bankruptcy petitions, their fates are basically in the hands of a federal bankruptcy judge. Or Article III federal judges, going up the line, as is the case here. The circuits have, I think, three different tests for determining an “undue hardship.” The circuit you live in could mean the difference between discharge and debt peonage.

Thus, in Krieger, the debtor pretty much threw herself at the mercy of the federal courts, and thankfully they ultimately sided with her. In the trial over the dischargeability of the debt, the bankruptcy judge wrote:

Never has the Court seen such utter futility be the result of a debtor’s job search efforts. Krieger at 5.

(How many times have you read comments on scamblogs, Above the Law, and elsewhere of people who’d sent out 700 or more resumes in a handful of years rather than 200 in ten years?)

I don’t want to dive too deeply into the minutiae of the “undue hardship” test that the Seventh Circuit uses, but its third prong requires the debtor to show that she has “made good faith efforts to repay the loan.” The district court believed the debtor didn’t meet this requirement.

So law school gunner, answer me this lest I Socratic cold-call you: Does the debtor’s decision not to sign on to Income-Based Repayment mean she has failed to meet the good faith requirement?

.

.

.

No, writes Easterbrook, who argues that logically IBR’s existence does not repeal § 523(a)(8).

[T]he judge concluded that good faith entails commitment to future efforts to repay [i.e. IBR]. Yet, if this is so, no educational loan ever could be discharged, because it is always possible to pay in the future should prospects improve. Section 523(a)(8) does not forbid discharge, however; an unpaid educational loan is not treated the same as a debt incurred through crime or fraud. The statutory language is that a discharge is possible when payment would cause an “undue hardship”. It is important not to allow judicial glosses, [like the "undue hardship" test], to supersede the statute itself. Krieger at 4. [Emphasis original]

But what makes Krieger an even bigger bellwether over IBR is the concurrence by Judge Daniel Anthony Manion. It’s really only a concurrence in the loosest sense: He agrees with the bankruptcy judge’s determination that the loan is dischargeable only because the standard of review the Seventh Circuit is using requires a showing that the bankruptcy court’s decision was “clearly erroneous,” which Manion happens to believe is not the case.

Otherwise, Manion warns that a successful discharge of $25,000 by someone who is in good health “should be labeled as an extreme exception and an outlier” because with student debt growing to “crisis” (his words) levels, he’s afraid that debtors will flock to the bankruptcy courts instead of signing on to IBR. Krieger at 9.

What I don’t get is if Manion thinks people who are in good health and are IBR-eligible at $0 per month shouldn’t be able to discharge their loans, then why did he not find the bankruptcy court’s ruling “clearly erroneous”? How is Krieger an exception? Why is this not a dissent?

While I don’t think this is the first time a student loan bankruptcy case has encountered IBR, I’m pretty sure it’s the highest-profile example, so I’m going to call it Bankruptcy 1, IBR 0. Although it’s still a factual matter left to the mercy of bankruptcy judges, they have more leeway to side with a debtor than if the debtor were seriously injured but ineligible for an administrative hardship discharge by the Department of Education. Destitution is enough.

NY Fed: Young Student Debtors No Longer Taking on Other Debt

Meta Brown and Sydnee Caldwell, “Young Student Loan Borrowers Retreat From Housing and Auto Markets,” Federal Reserve Bank of New York

At last, a New York Fed research paper that doesn’t promote perpetual debt-financed education. In seriousness, this article is quite well done, so I don’t have too much to say about it. The only line I object to is the beginning when it states:

Student loans have soared in popularity over the past decade, with the aggregate student loan balance, as measured in the FRBNY Consumer Credit Panel, reaching $966 billion at the end of 2012.

“Popular” isn’t the word I’d use to characterize student loan debt.

The paper principally finds that young people without student loans are buying houses and cars—and they have better credit scores—than those with student loan debt, a stunning (if you didn’t stop to think about it) reversal from several years ago. The authors state two possible reasons: (1) Young debtors expect lower future incomes, which hampers their spending, and (2) Lenders will no longer loan money to people with high debt-to-income ratios. You can guess which one I think is more prevalent.

The only other observation I’ll note is that the average 25-year-old has less overall debt than several years ago, but more if it is student loan debt. This is a big deal because if the educations they purchased (if they completed them) increased their productivity, then there isn’t a lot to worry about. If we correct a few imbalances in the economy, we will expect them to be good drones.

On the other hand, if the debt did very little for their productivity, then it’s no worse than borrowing nondischargeable money to buy a large amount of lottery tickets.

**********

In other news, the hawk-eyed TaxProf refers us to a New York Times blog post informing us that President Obama’s proposed budget would remove the tax obligation accompanying canceled loans on IBR. So what’s the call debtors? A tax break potentially worth hundreds of thousands of dollars, or a cut to your Social Security checks that will amount to 12 percent in 40 years thanks to the wonders of chained CPI?

Good Recommendations From Illinois Bar Association Report

“Special Committee on the Impact of Law School Debt on the Delivery of Legal Services: Final Report and Recommendations,” Illinois State Bar Association.

Some good primary stuff:

Congress and the Department of Education should place reasonable limits on the amount that law students can borrow from the federal government. Student loans should also be made dischargeable in bankruptcy so private lenders have the incentive to properly screen loan applicants based on the chance that the school they attend will prepare them to be successful in the job market. That way, law schools will have an incentive to restrain costs to the level that students can borrow. If a school fails to do so, most students will not be able to afford to attend, and the school will close. (4)

And go diploma privilege:

Consider Ways to Reduce the Cost of Becoming Licensed: For example, supreme courts could allow qualified students to take the bar exam in February of their third year, thus avoiding the cost of studying for the bar exam after graduation, and reducing the delay before beginning work. Such a proposal should be careful not to restrict the time law students have in their third year to become practice ready. Alternatively, supreme courts should consider offering bar admission to qualified graduates of their state’s law schools without a bar exam. (6)

And some contradictory stuff:

Small Law Firms Face Challenges Hiring and Retaining Competent Attorneys… (1)

But:

The Committee heard testimony from many recent graduates who were unable to obtain any jobs in the private sector or elsewhere paying more than $40,000-$45,000. That fact makes the academic debate about the effect of debt on graduates’ choice between the public sector and the private sector, see supra note 25, somewhat misleading. There may be no significant difference in salary between the two sectors for the many graduates who are unable to obtain higher-paying jobs in the private sector. In addition, many graduates testified that jobs were so scarce that they would take any available job. (Footnote 38, emphasis added)

Because I really can’t ask for much more from a report like this that recommends restoring bankruptcy protections to student loans, curtailing the federal loan program, and easing licensing requirement, I’m not going to waste too much energy on it. However, if the executive summary is going to read, “Exessive Law School Debt Decreases the Quantity and Quality of Legal Services Available to the Public,” then it helps to make sure it’s arguing for the right policies for persuasive reasons.

Specifically, there are two theories of how debt relates to legal services. (1) The Special Committee says that poor people can afford legal services but lawyers’ debts are raising the lawyer labor costs to the point that it’s impossible for both parties to reach an agreement. (2) People like me say demand for legal services is scant because poor people can’t afford much of anything.

If (1) is right, then we’d see much higher employment rates for graduates with less debt than more, as small firms and clients would be able to pay them. Indeed, Southern Illinois’ and Northern Illinois’ 2011 graduates finished with a disbursed amount of debt below $70,000. Assuming none of this is Grad PLUS loans, we’re talking about a ballpark estimate of $6,250 per year in debt service on $75,000 over 25 years. It’s a lot, but it’s not irreparably impossible to service that on $40,000 in annual income (okay, there’s undergrad debt too, but did most NIU/SIU grads go to expensive private universities too?).

Do we see better employment outcomes for NIU and SIU than high-debt schools? Answer: Sometimes:

I think, though, that we’d expect much higher FT/LT lawyer job rates and much lower unemployment levels for the two public law schools. Instead, they’re no better than Illinois’ mid-range private law schools, and employers appear excited at the prospect of employing Chicago and Northwestern grads, even though they should cost quite a bit more. If theory #1 were true, the “market-failure” debt threshold at these schools would’ve been surpassed many years ago.

This is why I believe the second theory is accurate, for it explains how there can be graduates who would take any job no matter what their debt levels are.

As for IBR:

Many public interest attorneys are unwilling to enroll in IBR because, although it lowers an attorney’s monthly payment, any interest unpaid at that payment level continues to accrue. Moreover, the attorney’s debt will not be forgiven until ten years of service in public interest. Funding for public interest jobs is unstable, and an attorney who does not continue in public interest law may have her accrued interest capitalized, leaving the attorney in a worse position than before. In addition, IBR does not cover private loans, the program may penalize a lawyer for the earnings of the lawyer’s spouse, a lawyer’s credit score may still suffer while on IBR, and many attorneys do not expect funding for IBR to continue in a time of government austerity. In addition, some graduates were not aware of the intricacies of IBR and may not be taking advantage of all the features available to them. (2-3)

It’s implausible that people with high Grad PLUS loan levels are not on IBR. I think the Special Committee should have put more effort in determining how many graduates are in the program to bolster its points.

On The Am Law Daily: ‘How Grad PLUS Loans Sustain Zombie Law Schools’

“How Grad PLUS Loans Sustain Zombie Law Schools“

Also, Heather Christian has talent. She wrote the score and performed in a play I saw last year called Mission Drift, which told the story of America through land bubbles. Of course I liked it.

*****

Send a Comment to the ABA Task Force on the Future of Legal Education

A while back I wrote about how the ABA was convening a Task Force on the Future of Legal Education and how it has its work cut out for it. It’s asking for comments before its February 9 meeting in Texas, so if you feel like saying something, do so. I’m reprinting my comment here, with a couple of corrections to watch out for in the endnotes. I admit I didn’t plan on submitting a comment until I was asked to, but it helped me summarize my thoughts on what the problems are and how they should be solved. It also gave me an opportunity to dumpster-dive into the LSTB and find posts on topics that don’t come up often but lurk in the background. The LSTB crested 300 posts recently, so there’s a lot there.

I’ll add that some of the comments are quite good (UC-Hastings dean Frank Wu’s is getting some deserved attention), and I mentioned a few of the better ones. I’ve at least skimmed through all of them (not so much the one by the Canadian lawyers that spanned hundreds of pages), but of the ones uploaded after mine I recommend most the one by UC-Los Angeles law professor Richard L. Abel because it addresses the history of how lawyers are licensed in the U.S.

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Matt Leichter

[email]

lawschooltuitionbubble.wordpress.com

January 16, 2013

Task Force on the Future of Legal Education

c/o Art Garwin, Deputy Director

Center for Professional Responsibility

American Bar Association

futurelegaled@americanbar.org

To the Honorable Randall T. Shepard and Task Force members,

I write at the encouragement of Task Force member Thomas Lyons, and I thank you for considering outside opinions such as my own. The Task Force is to be commended for accelerating its timetable, for such eagerness reflects positively on the ABA’s willingness to take seriously the problems facing new lawyers and legal education.

Until now, legal education reform has primarily focused on what I consider “demand-side issues”: furnishing more accurate information about law school graduates’ employment outcomes to prospective applicants so they can hopefully make informed decisions about becoming lawyers. The ABA Section of Legal Education and Admission to the Bar responded quicker to the information deficit than I’d predicted, but the successes of demand-side reforms of legal education pale against those problems remaining on the supply-side of lawyer licensing: The barriers to obtaining a law license (which includes law school costs) are too high and arbitrary, and they harm both aspiring lawyers and the public the profession serves. I recommend the Task Force consider legal education as one of many practices that require reform.

The Task Force Should Encourage the ABA to Shift Its Position on Federal Student Loans and Bankruptcy Reform, Embrace Novel Education Financing Options

            That said, the education requirement for becoming a lawyer is obviously the most salient issue today, but recognizing that one of the Task Force’s subcommittees is dedicated to improving the delivery of legal education, I believe this is one of the last items that require revision. Overall, I find demands for “practice-ready” attorneys to be a distraction from more legitimate concerns. If employers want certain skills they should train their workers themselves and advocate simplifying the lawyer-licensing process accordingly. That’s how it works other industries, and asking educators to provide training for jobs that employers aren’t obliged to create costs students unfairly.

Rather, the dominating problem with law school is the over-generous Federal Direct Student Loan Program (DLP), which obligingly lends most students up to $20,500 in Stafford loans and the remaining total cost of attendance plus living expenses in Grad PLUS loans each year. I believe that access to unlimited student loans, well-intentioned as it may be, enables law schools to increase their tuition for as long as people are willing to attend them.[i] I suspect that without Grad PLUS loans and the restrictions on discharging private student loans in bankruptcy, both authorized in Congress’ 2005 bankruptcy reform,[ii] tuition at private law schools would have begun to level off or even decline by now because students would have been unable to finance it.

My views break with those long held by the ABA, which regularly supports increased lending to law students,[iii] and calls for ending the DLP are often met with hostile responses that the legal profession would only be accessible to the wealthy. I disagree. With the Bureau of Labor Statistics predicting a surplus of law school graduates into the indefinite future, I see no justification for the government to lend money to people to buy degrees for which jobs are unavailable.[iv] Nor am I convinced that legal education is a public good requiring government support. I further believe the often-made claim that legal education is versatile and opens job opportunities beyond law practice to be unsubstantiated and fallacious.[v] Cheaper lawyer training is possible, and the current system does not open doors to the poor but in fact creates poverty by saddling law students with large loan burdens.

Consequently, many of the people who will graduate law school in the future, to say nothing of those from the past, will have very large debts and no place in the legal profession commensurate with the effort they put into law school. Although the government’s Income-Based Repayment (IBR) plan will rescue these students from destitution, it will still require them to pay essentially an additional, regressive tax on their earnings for twenty years, which will be acutely felt if they are not working as professionals. IBR’s loan cancelation privilege (if it is not abolished in the near future)[vi] coupled with excessive loan burdens persuade me that the federal government will lose billions of dollars canceling money lent to law students. Law schools and the ABA ignore the approaching confrontation with legislators at their own peril.

The ABA’s most-recent response I know of to existing student loans is to advocate requiring private lenders to extend IBR-like protections to debtors.[vii] I think instead the ABA should shift its position towards reforming the bankruptcy code to restore full bankruptcy protections to all student loans and ending the DLP. It can also encourage state governments to require their public universities to offer, instead of debt financing, an equity option called “human capital contracts,” which obligate graduates to pay a certain portion of their incomes for a fixed time period back to their universities. Unlike IBR, this type of policy forces universities to internalize the costs of their own programs, and if their programs become insolvent, universities should terminate them.[viii] Embracing these policies would signal to the public that the ABA understands the causes of factors enabling law school tuition increases and excessive student debt, and it would begin to heal the generational rift forming between new law school graduates and the profession from which they are increasingly alienated.

As for the law schools themselves, the student loan system animates many of their frequently discussed inefficiencies, such as competition over U.S. News rankings, overcompensation of employees, needless new buildings, funding positions for graduates to improve their employment statistics, over-focusing on GPA and LSAT scores at the expense of other factors,[ix] and using fees from some students to attract well-credentialed students with scholarships. If possible, rather than regulating bad behavior, the ABA should address the incentives that encourage bad behavior.[x]

Even other reforms such as easing accreditation requirements or reducing the required number of credits for law school[xi] might not affect how law schools operate so long as their students are fully financed by the government. For example, many private law schools that do not rank very highly on U.S. News are nevertheless very expensive. Also, the lure of federal loan dollars is so powerful that many law schools in states that license graduates of non-ABA institutions forgo the option of delivering cheaper legal education in favor of national accreditation and the DLP loans that accompany it. For these reasons I believe the Task Force should take student loan reform as the most urgent priority for law licensing and legal education reform.

The Task Force Should Encourage Bar Authorities to Reduce Remaining Entry Barriers to the Profession

Student loans, however, are not the only problem the profession’s entry system faces. In recent years critics have used the discontent directed at law schools as an opportunity to advocate for deregulating the legal profession entirely. Many of their arguments are poorly researched, particularly those demanding reform by claiming without evidence that doing so would cure an attorney shortage in the United States.[xii] They are correct that the profession’s entry barriers are arbitrary, and the longer the profession defends them and the DLP, the more likely outside forces will unilaterally rescind its autonomy. Outside of the risk of incompetent practice, this might not be a bad thing, even if done for the wrong reasons, but rather than resisting calls for change, the Task Force should acknowledge the weaknesses in most states’ lawyer-licensing rules and encourage efforts to change them.

For instance, bar exams in their current form are not defensible entry barriers. They almost always occur long after bar petitioners have sunk enormous costs into legal education,[xiii] they are too hard for some people who might otherwise make fine lawyers (“false negatives”), they test many obsolete legal doctrines, and they also omit entire substantive practice areas to which many attorneys dedicate their entire careers. Although I agree that some showing of legal knowledge (especially of ethics and constitutional law) is justifiable, demanding too much is not. Streamlining bar exams along practice lines would greatly reduce the incidence of false negatives among bar petitioners and conserve resources for all test-takers.

Simplifying the bar would also reduce the possibility of law schools knowingly accepting applicants who probably lack the aptitude to pass the exam because of the correlation between LSAT scores and bar passage.[xiv] Perhaps between five and ten percent of ABA law school graduates who take a bar exam never pass. Some test-takers might take more than one exam, passing one and not another, but the ABA should do everything in its power to prevent law schools from enrolling students who will waste precious time and money for a license they probably will not obtain, even if it means tightening bar passage requirements for accredited law schools. It’s unfair to deny people a place in the profession because the exam wasn’t calibrated to the knowledge they need as practicing attorneys. It’s also unfair to the clients they could have served.

It’s also probable that the law licensing system allows too many “false positives,” people who by virtue of their LSAT scores and GPAs appear to make good lawyers but don’t.[xv] I’m not knowledgeable of data on firm associate retention rates or similar topics, but front-loading the legal education requirement makes it too easy for people who do not know if law practice suits them to enter the profession. It also widens the information asymmetry between law school applicants and law schools, which the latter has greatly used to their advantage by admitting applicants who serve law schools’ reputational goals before their students’.

The mandatory legal education requirement doesn’t serve potential lawyers well either. For instance, the aforementioned correlation between LSAT scores and bar passage rates disserves those on the opposite end of the bar exam aptitude spectrum as well, which raises the question: Why require someone who will likely pass the bar exam by self-study anyway to attend law school? If the principal benefit law school provides these individuals is signaling their competence for good job opportunities, then I believe the Task Force should consider eliminating the formal legal education requirement altogether.

Conclusion

Declining applications and hostility towards law schools and law practice are teaching the public that demand for legal education (or, rather, law licenses) is not connected to demand for legal services. If the near-term solution to many of legal education’s problems is curbing the government’s lending to law students, the longer-term solution is to align the profession’s licensing system to the public’s need for legal services. I believe adopting my suggestions will accomplish both goals.

Thank you for considering my thoughts.

Regards,

Matt Leichter

---

[i] For information on the theoretical basis of my beliefs, I recommend, Andrew Gillen’s “Introducing Bennett Hypothesis 2.0,” from the Center for College Affordability and Productivity. http://centerforcollegeaffordability.org/uploads/Introducing_Bennett_Hypothesis_2-1.pdf (PDF). I have yet to see a convincing author discredit Gillen’s analysis.

[ii] [Update: This is incorrect. Grad PLUS loans were authorized separately from bankruptcy reform by Congress in February 2006.]

[iii] See e.g. ABA president Carolyn Lamm, “Law School Debt Has a Manageable Solution,” 2009. http://www.americanbar.org/groups/law_students/initiatives_awards/advocacy/debt_solutions.html

[iv] Bureau of Labor Statistics, “Lawyers,” Occupational Outlook Handbook. http://www.bls.gov/ooh/legal/lawyers.htm

[v] Matt Leichter, “The Juris Doctor Is ‘Versatile’ Thanks Mainly to Numerous Logical Fallacies,” The Am Law Daily, August 14, 2012. http://www.americanlawyer.com/PubArticleALD.jsp?id=1202567415810&The_Juris_Doctor_is_Versatile_Thanks_Mainly_to_Numerous_Logical_Fallacies

[vi] One bill that may make its way through Congress proposes to end the loan forgiveness portion of IBR for future students, which will condemn many law school graduates to a lifetime of debt. http://www.bloomberg.com/news/2012-12-04/student-loan-collection-targeted-for-overhaul-in-congress.html

[vii] ABA Resolution 111A, Young Lawyers Division, http://www.abajournal.com/files/111a.pdf (PDF).

[viii] Similar ideas have been proposed by a student organization advocating reform of the University of California systems, called “FixUC,” which I wrote about here: http://lawschooltuitionbubble.wordpress.com/2012/01/23/fixuc-stumbles-onto-human-capital-contracts/.

[ix] One comment to the Task Force that illustrates law schools valuing incoming student credentials over applicants’ strengths is by non-traditional law student Elizabeth Paskiewicz, who has significant experience in the legal profession as a non-lawyer and performed very well in her paralegal education, but most ABA law schools overlooked her because of their mechanistic decision-making processes that exclude applicants with low undergraduate GPAs.

[x] For example, even without the student loan system, law schools still have an incentive to compete over their magazine rankings, which is fine, but they may still falsify student data they send to the ABA. If so, then auditing them is a good idea.

[Update: This sentence didn't come out right. Something more like "If possible, rather than regulating bad behavior, the ABA should address the factors that aggravate bad behavior." My point is that we might not be able to live in a world where law schools don't engage in needless competition (over their U.S. News rankings, for example). Regulations like auditing make more sense if addressing the loan program is insufficient.]

[xi] Although there have been growing calls (most recently in New York) to reduce the education requirement from three years to two, I discourage the Task Force from endorsing such proposals simply because the third year is expensive and not useful. This ignores the root cause of tuition increases, and one private law school in five has raised its tuition by 50 percent or more since 1999, meaning two years in 2011 buys a full degree then. Rather, I recommend the Task Force address the DLP but flip the question of usefulness around: How much formal legal education is necessary and why?

[xii] The primary example that springs to mind is Clifford Winston’s, Robert W. Crandall’s, and Vikram Maheshri’s book, The First Thing We Do, Let’s Deregulate All The Lawyers, 2011. A blurb from their Wall Street Journal article on the subject can be found on TaxProfBlog: http://taxprof.typepad.com/taxprof_blog/2011/08/its-time-.html. I’ve written more on the topic: http://lawschooltuitionbubble.wordpress.com/2011/08/23/wsj-op-ed-brings-shock-doctrine-to-law-practice/, http://lawschooltuitionbubble.wordpress.com/2011/09/02/the-economist-has-never-heard-of-the-bureau-of-labor-statistics/.

[xiii] One influence for this section are the sentiments expressed in the comment to the Task Force by Nicholas L. Georgakopoulos.

[xiv] Here are two examples documenting the connection: http://www.unc.edu/edp/pdf/NLBPS.pdf (PDF); http://academic.udayton.edu/thewhitestlawschools/2005twls/chapter2/Legaled04.htm (more recent, but hearsay).

[xv] I believe the “26 factors of lawyer effectiveness [plus one]” cited in Nancy B. Rapoport’s comment to the Task Force are the definitive factors for “true positive” lawyers.

A Bitter Boxing Day Op-Ed for Private Student Loan Debtors

John Hupalo, “Discharging Private Student Loans Is Counterproductive,” U.S. News & World Report.

Tagline: “For an overwhelming majority, it will impair their future ability to borrow.”

Hupalo is the CEO of Invite Education, LLC, which appears to be a college planning resource for prospective applicants and parents, but his cred comes from decades of experience in education finance.

Unfortunately, the arguments he makes in his op-ed do not benefit from his experience. He even contradicts himself within the same sentence early on:

Turning bankruptcy courts into turnstiles for the discharge of the least common form of student loan debt may temporarily assist some distressed borrowers, but the overwhelming majority will not be helped.

How does benefiting “some distressed borrowers” with the least common form of student loan debt who are not in the overwhelming majority of student debtors turn bankruptcy courts into “turnstiles”? Also, bankruptcy is not “temporary,” a discharge order is permanent.

Hupalo’s piece is concise, but I’m going to summarize the arguments and provide brief responses:

(1)  Bankruptcy appears on your credit report for 10 years and ruins your creditworthiness.

Defaulting on a loan is much worse for your creditworthiness (and sometimes job eligibility) than bankruptcy, and plenty of banks love lending money to people who can’t obtain another discharge for eight more years. They also know how to collateralize cars and houses for auto loans and mortgages. The credit hit from bankruptcy is a factor to weigh, but (a) it does recover, and (b) if the loan is large and unpayable, bankruptcy does more good than harm.

Also, I’ll add right now that debtors aren’t stupid, and moral hazard arguments are always overblown. People use the bankruptcy system as a last resort. Most of the time they file because they’ve lost their jobs, gotten divorced, or aren’t insured so they have to pay for their own radiation therapy. Included in the 2005 law that extended the “undue hardship” exception to dischargeability of private student loans was a provision that required Chapter 7 petitioners to show that their incomes were below their state’s median household income. If it’s above the median, they have to file in Chapter 13, which will require them to repay some of the debt in a 3-5-year repayment plan. With bankruptcy protections on their side, debtors can negotiate with their lenders and avoid using the courts, and bankruptcy fraud is very, very rare.

Now that we’ve got that out of the way, we continue:

(2)  Bankruptcy protections increase interest rates for private student loans.

Good.

Seriously, this is how lending works: Those who make large unsecured loans to people who can’t repay them should charge higher interest rates, demand co-signers, and not offer in-school deferments. If the loan is too risky, don’t make it. The alternative is a human capital contract, which may or may not work, but it’s a compromise option.

(3)  It’s not fair for the government to shield its loans from bankruptcy while not doing so for private loans. It’s also confusing to borrowers.

(a) Borrowers will always be confused. The federal lending system alone is very complicated, much less the bankruptcy code. (b) Aside from people who take out Parent PLUS loans, to my knowledge all other federal loans are IBR-eligible. Debtors who are on Social Security Disability can also petition the Department of Education for a hardship discharge, which the “Pay-As-You-Earn” rule-change made easier. Private loans don’t offer these options. (c) Honestly, I have slight sympathy for the fairness argument: Yes, the government is unfairly undercutting the private sector (and not even doing a good job of it). However, I think bankruptcy protections should be returned for federal loans too, and I won’t lose any sleep if the Direct Loan Program is repealed. I just don’t find Hupalo’s argument that incrementalism is unfair to be persuasive.

(4)  The seven percent private loans of all student loans are underwritten; the other 93 percent of federal loans aren’t. This is unfair.

It sure is. That’s a problem with the Direct Loan Program, but how is it relevant to private loans in bankruptcy?

(5)  Private student loan debtors can discharge their debts via the “undue hardship” exception, which is reasonably high to protect from moral hazard.

(a) The “undue hardship” standard is not defined in the bankruptcy code, leaving the statutory interpretation up to the federal appellate courts and the factual application to the caprice of bankruptcy judges. If you were worried about “confusion” before, how many people do you think know off the top of their heads if their federal circuit uses the Brunner test, the “totality of the circumstances” test, or some other one? How many people even know anything about the federal circuit they’re in? (b) Admittedly, many people who might have a shot at discharging their student loans don’t even bother trying to file an adversary proceeding against their student loan creditors, which leads the public into believing the loans are as nondischargeable as child support payments, but again, it comes down to the bankruptcy judge’s opinion. (c) When the “undue hardship” exception was first inserted into the bankruptcy code, it coincided with a five-year time limit on dischargeability, so the urgency for legislative clarity didn’t exist. With the time limit removed for federal loans in 1998, the law pretty much put debtors’ fates in bankruptcy judges’ hands. Hupalo doesn’t appear interested in discussing whether that’s a good idea.

IBR We Hardly New Ye?

John Hechinger, “Student-Loan Collection Targeted for Overhaul by Congress,” Bloomberg.

Speaking of the problems with IBR:

The bill would also eliminate income-based programs that forgive loans entirely after 20 or 25 years — and, after 10 years, for those who enter public-service careers, such as teaching or law enforcement. The new system would apply only to new loans.

This is a component nestled in WI Representative Tom Petri’s proposed bill. This isn’t a criticism. The bill itself, as I understand it, incorporates IBRish principles into how it changes how student loan repayment works. Instead of cutting checks or direct deposits to ED, student debtors’ employers would simply withhold 15 percent of their paychecks. Supposedly it avoids debtors defaulting and dealing with debt collection companies that don’t tell them about IBR because it means they don’t get paid.

Nevertheless, there are aspects that might miss the point:

In another boon to borrowers, the plan would cap interest owed at 50 percent of a loan’s face value at the time of graduation, giving a break to lower-income borrowers who take longer than the standard 10 years to repay loans. For a student who took out $27,000 in loans, about the national average for a graduate of a four-year program who borrowed, the interest couldn’t exceed $13,500.

Of course, if the interest isn’t repayable, then there’s a good chance the loan shouldn’t've been made in the first place, i.e. a large opportunity cost. It also doesn’t necessarily ensure that people who borrow for higher education in fact become more productive and work in a position that needed more than a high school education (or a legal education). Finally, anyone who borrows too much in principal alone will never pay their debts off.

Along with facing private debt collectors, students may also be sued by the U.S. Justice Department, which hires private attorneys to pursue debtors who default on decades-old loans, Bloomberg News reported in July.

Hey law grads! Here’s a job for you: Hunt down your deadbeat classmates!

Like the debt ceiling bill from last year, student loans weigh heavier on legislators’ minds than the government wants to admit. It’s a revenue stream that the government doesn’t have to call a tax while simultaneously ignoring forgone living standards.

*****

In other news, a couple of important tidbits about yesterday’s post.

(1) The ABA’s median public non-resident tuition isn’t accurate. I think I noted that the first time I used the tuition chart with the annual Stafford Loan limits. Here’s what all this stuff is in current dollars.

I have no idea why the ABA has gotten those numbers so blatantly wrong since 2008, but that’s what it is. Thankfully it’s precise for the other two series.

(2) It occurred to me late yesterday that pre-2005 law students may have had access to Parent PLUS loans, from which Grad PLUS loans were conceived. Indeed, since 1993, the limit on those was cost of attendance minus other aid, so there was a federally guaranteed option available to cover what Staffords could not. I also forgot to consider Perkins Loans, which are a whole ‘nother issue I know little about.

To rephrase the question I was asking, “If the student loan system were unchanged since 2005, would people still be able to finance law school today or would lenders be telling them ‘No.’?” The optimist in me says the former is correct: I don’t think parents would co-sign such huge unlimited loans, and I think private lenders wouldn’t cut loans that would be discharged shortly after graduation (unless they could sell it to some other chump MBS-style). As a result, tuition would have dropped. The key word I used deliberately was “conservatively” because the cynic in me suspects that law schools would’ve engaged in other shenanigans like pushing more people into cheaper part-time programs to squeeze more out of them and things like that. A lot to think about.

How Grad PLUS Loans Saved Law Schools

[Information in this post is supplemented here.]

Georgetown University Law Center professor Philip Schrag’s review of Failing Law Schools is not at all the gyokusai attack on the critics of legal education that Lawrence Mitchell’s op-ed was. I even suspended my contrarian urges long enough to agree with parts of it. You can read Brian Tamanaha’s response, along with LawProf’s. Theirs cover most of the issues, but there are a few remaining that I feel the need to go into.

I’m going to break this process into more than one post. Today’s is a quick counterfactual history of legal education without IBR, Grad PLUS Loans, and nondischargeable private student loans. The world as it was in 2004.

Why do this? Because Schrag believes IBR renders law school cost issues irrelevant (and if you think subsidizing it is unsound, well, we subsidize a lot of things). The bigger problem for Schrag is how we license lawyers, which I think Tamanaha acknowledged on pp. 176-77 of his book.

So what would’ve happened if the student lending laws went unchanged since 2004?

(1)  No Grad PLUS Loans means most private law school students would’ve had to rely on private loans.

(2)  Tuition increases and eroding values of Stafford Loan limits would’ve also necessitated private loans.

(3)  Dischargeable private loans means noticeable waves of law school debtors would’ve defaulted and/or filed bankruptcy due to their student loans.

(4)  Lenders would be more suspicious of legal education, leading to even more forceful demands for transparency on employment outcomes and higher interest rates.

(5)  Certainly middle-range to low-end private law schools’ tuition hikes and expansions (including branch campuses) would have been curtailed.

In our universe, the real breakpoint period is in the 1990s, when private law school tuition began to permanently exceed Stafford Loan limits after their 1994 increase.

(Source: ABA, FinAid.org)

By 2004, there was a $10,000 gap (in 2011 dollars) between the annual Stafford limit and median private law school tuition. Seven years later, that gap grew to about $19,000 per year, despite a small boost to the annual loan limits in 2007.

Furthermore, in 1999, 28 private law schools’ tuitions were below the annual limit, by 2010, that number had dropped to two: the two private law schools in Puerto Rico. Even Brigham Young’s tuition can no longer be covered by Stafford Loans alone, but 42 public law schools’ tuitions still can.

God only knows how these people paid for their living expenses (I lived on savings). Also, to answer your question: Yes, I’m psychotic enough that I ordered back-copies of the Official Guide going back to the 20^th century. What’s really surprising is that I’ve managed to find such an interesting use for them so quickly.

What’s strikes me is how rapidly the law school unaffordability problem grew. In six years, nine law schools that required significant supplemental financing grew to 70 by 2005, and as a result, I’m not sure I believe the counterfactual history myself. Maybe law school tuition would’ve kept going up everywhere no matter what? Would private lenders have realized that their loans wouldn’t be repaid? Would they have cared? How many law school debtors would’ve filed bankruptcy if they could have? I regularly criticize arguments from incredulity, so maybe things could’ve really turned out better, just not for law schools.

This is why I’m not persuaded by Schrag’s argument. Conservatively, I think if we went back to the 2004 system, private lenders’ reluctance would cut away needless waste on law schools without any loss to students, taxpayers, the profession, or the economy.