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.

Stafford Loan Limits and Law School Tuition

I wish I could say Hurricane Sandy has kept me from blogging, but in truth, work has been the culprit.

In my last article for the Am Law Daily, I wrote something like:

[L]aw school tuition increases regardless of changes to loan availability (Grad PLUS Loans displacing private loans, 2006; elimination of Subsidized Stafford Loans, 2012), loan borrowing limits (annual and aggregate), new repayment options (IBR, 2009) and even bankruptcy protections (1990, 1998 for federal loans; 2005 for private loans).

I thought it was a good zinger, but I’m returning to it because the decision to take Grad PLUS Loans came up in a conversation I had with some recent law school grads last weekend (I don’t think any of them took them), and I don’t think I’ve ever looked through all the changes to the Stafford Loan program over the years. It’s an important historical exercise because “increasing the loan limits” was the ABA’s mantra for dealing with over-indebted, under-incomed law school graduates, as this line from former ABA president Carolyn Lamm in “Law School Education Debt Has a Manageable Solution” attests:

Now is the time for modest changes in current federal student loan programs to increase the amount that law students may borrow, and to bring existing private loans into the federal student loan system.

This was published in November 2009, well after the advent of Grad PLUS loans and mere months after IBR went into effect, but it embraces a pre-2006 thinking: What the government won’t give you in Subsidized and Unsubsidized Staffords, you must get from your parents via a PLUS loan or private lenders. Thanks to the diligence of FinAid.org, here’re the Stafford Loan limits (both Sub’d and Unsub’d) charted over time against median law school tuition.

Why median and not mean tuition? I was hoping that medians would weaken the effects public law schools that have gone off the state dole have on mean public law school tuition. Instead, it appears the ABA’s median non-resident public law school tuition is just plain wrong for 2009 and 2010. Both years appear to be using Wisconsin’s non-resident tuition, but Wisconsin was the 16^th and 17^th highest in those two years, certainly not, you know, number 40 as one would expect with a median. The correct numbers should be $30,519 (Missouri-Columbia) and $32,882 (Northern Kentucky), before adjusting for inflation, of course. So, it’s just another lesson in distrusting the numbers the ABA puts into its publications.

Since the mid-1990s, the likelihood that private law school students would have to go beyond Staffords has steadily increased due to both tuition inflation and regular inflation melting away the annual Stafford limits. You can see why the ABA was so keen on increasing the limits, not that it would’ve made legal education any cheaper, which the ABA is not serious about. What’s really surprising, I guess, is that private lenders would be so eager to make these loans back when they were readily dischargeable in a Chapter 7 bankruptcy. Maybe it was because things were so much better in the late 90s that lenders didn’t care, but as the Lamm quote above implies, don’t expect anyone at the ABA to endorse Congressional efforts to repeal that odious section of the BAPCPA.

For those interested here are the aggregate debt limits against three years of median law school tuition. I don’t think it’s ever been a problem, but some part-time students may’ve run into them.

I’m not going to look into changes in interest rates today, but the point, though, is similar to why I bother listing all those tuition numbers going back nearly a decade: The deal changes for each incoming class with the asymmetry very much in law schools’ favor, and Grad PLUS Loans plus IBR aside, in strict dollar terms prior classes usually got a better deal.

Quick Links on Student Loan Bankruptcy Reform

There are two.

(1) Reuters, “Obama to announce help on housing, student loans,” in The Raw Story

Don’t bother clicking on the link. All it says is, “In Denver on Wednesday, he will announce a student loan initiative.” If I know my B. H. Obama, I predict the proposal will be underwhelming.

(2) Karina Frayter, “Bankruptcy Law Change Could Help Consumers Recover: Experts,” in CNBC

Looks like people are considering this as an option.

Dean Baker, co-director of the Center for Economic and Policy Research, agrees and says: “People can overplay the importance of debt relief, but it would certainly help if people could get out from under their burdens.”

Go Dean Baker.

But Joshua Shapiro, chief economist at MFR, doesn’t like the idea.

“In the longer-term it would diminish the availability of credit, as lenders balk at extending credit to borrowers who have easy means of shirking their debts,” says Shapiro.

Julia Coronado, chief economist for North America at BNP Paribas, agrees and says it punishes those who were prudent. “They may also be having hard times because of the tough job market but would not receive any assistance as they never took on debt they couldn’t afford.”

These two miss the point. (1) Extremely few people file bankruptcy capriciously. People are honest and want to pay their debts so long as they have the income to do so. (2) Bankruptcy isn’t a free lunch. It appears on your credit report, and you can’t file for again seven years after discharge. “Those who were prudent” do not lose out. They get the benefit of an economy in which people have more disposable income, which means jobs for them, raises, etc.

Some economists go even further and call for a “Debt Jubilee” to forgive excess mortgage, student loans and credit card debt for some borrowers.

Prominent economist Stephen Roach, who is also a non-executive chairman at Morgan Stanley Asia, is one of them.

“The American consumer is going nowhere,” Roach said in an August appearance on CNBC. “If we don’t address that, all the public policy aimed at the fiscal and monetary stimuli are going to be pushing on a string.”

I think this is the first economist of any stripe I know of who’s advocated debt forgiveness.

“Making existing contract invalid is not conducive to a healthy economy,” says [JPMorgan Chase chief US economist Michael] Feroli.

The right to contract is worthless without fair enforcement. The enforcer is going to be the government, and it’s going to want concessions from the parties, like protecting citizens from predatory lenders and allowing them to become debt-slaves. This means that lenders will have to take on the risk that people won’t repay their loans. If that’s a problem, charge a higher interest rate or lend to someone else. This is why “credit” is related to “credibility.” Those who have money will lend it to the most trustworthy people, and stripping bankruptcy protections makes all debtors equally trustworthy. Not how the system is supposed to work, unless you’re a communist, or a kleptocrat.

NYT Supports Private Student Loan Bankruptcy Reform, Protects Financialized Dept. of ED

After trashing for-profit universities, the New York Times editorial, “Relief for Student Debtors” adds this:

It had long been the case that federally backed student loans were protected during bankruptcy proceedings. That is reasonable, since those loans were backed by taxpayer dollars and flexibly structured so that borrowers could receive deferment in tough times and resume payments when their finances improved. The country has a compelling interest in making it as difficult as possible for student borrowers to elude payment for federal loans.

Sort of. Congress extended the “undue hardship” exception on federal student loans into perpetuity in 1998. Before then, the law required people to wait seven years before discharging federal student loans. Even then, the exception has always been a solution in search of a problem. Default rates in the late 1970s never reached 1% when it was first enacted. Contrary to the Times’ belief, the bankruptcy restrictions obscure the fact that the government has a far more compelling interest in (a) ensuring consumers have purchasing power (economic growth), and (b) using its money towards productive purposes, which is the inherent problem to government lending because it is by definition taking on a greater risk than the private sector is willing to. Otherwise, normal banks would be making the loans themselves.

As a result of this “crowding-out per se,” the government tries to protect its inherently high-risk investment by changing the bankruptcy code, but that makes borrowers debt zombies, which runs contrary to the purpose of increasing their productivity through education. So the government sways the opposite direction, creating hardship deferments and income-based repayment programs, but then it starts losing more money on the loans while universities live high on the hog until at some point, tuition increases so high that the Direct Lending Program could be replaced with a cheaper, more effective national university system. The New York Times Editorial Board does not understand the Hegelian ouroborous Congress spawned by financializing the Department of Education. I suspect it will take a few more years until it and other mainstream media do.

In other news…

I eschewed the news on Hurricane Irene and favored the National Hurricane Service’s reports.  The whole time the government predicted it’d be a severe tropical storm by the time it hit NYC, so I wasn’t terribly worried–mostly annoyed that Bloomberg shut down the subway system. On Sunday I strolled around and found a bar near my home that had this to say:

Now tropical cyclones talk to me through drinking establishments.

Quick Link: ABA House of Delegates Passes Annual Disappointing Student Debt Resolution

In 2010, the ABA House of Delegates passed Resolution 301, which according to the ABA’s report does the following:

This resolution addresses the [law school debt] problem by calling upon Congress, the Executive Branch and/or Commercial Lenders to convert private debt into federal loans, which offer more flexible repayment options; and identify federal funding to cover interest payments for graduates who defer loans because of economic hardship. It also calls for more flexible repayment terms for federal law student loans. [Emphasis LSTB].

In short, asking private lenders to take a haircut on loans that have a good chance of not getting paid back without any long-term relief for students.

This summer, the House of Delegates has risen to the challenge again with Resolution 111A. It proclaims:

RESOLVED, That the American Bar Association urges Congress to enact legislation that assists individuals who are experiencing financial hardship due to excessive levels of student loan debt but are not covered by the provisions of the student loan overhaul passed into law on March 30, 2010.

The law the ABA is referring to is the Health Care and Education Reconciliation Act of 2010, the health care reform. Aside from enraging Republicans, the law notably dismantles the FFEL system in which the government subsidized banks making student loans on its terms and instead transforms the Department of Education into a massive near-monopoly student loan lender (the Direct Lending program). Now the government lends out about $135-50 billion in new student loans every year, including Grad PLUS loans to law students that cover total attendance costs at whatever price law schools decide to raise tuition to any given year, and the ABA House of Delegates still can’t connect the dots between “excessive levels of student loan debt” and the legislature that enacts laws permitting its accumulation.

Like last year’s resolution, the ABA futilely seeks to change the terms of private student loans, and it does nothing for people who’ve taken out government loans that’re ineligible for IBR, e.g. Parent PLUS loans. The remainder of the resolution beseeches the same commercial banks that wrote the 2005 bankruptcy reform rendering private student loans nondischargeable in bankruptcy to voluntarily take another student loan haircut by offering their own income-based repayment programs. Banks do nothing voluntarily.

Like last year, the word “bankruptcy” does not appear in the resolution, and it couldn’t even bother to acknowledge to Private Student Loan Bankruptcy Fairness Act/Fairness for Struggling Students Act that’s stalled in Congress. The ABA simply lacks the courage to admit that universities capture student loan increases and raise tuition accordingly, an admission that would condemn the law schools’ practices worse than the transparency resolution accompanying 111A. Unsurprisingly, the ABA still haplessly champions universities’ goal of perpetual, unaccountable wealth transfer with only token support for student debtors and taxpayers.

Speed Link: Law Professor Wants Taxpayers to Shovel More Money to Universities

The folks from Kratola Films, producer of Default: The Student Loan Documentary sent me this surprisingly poorly thought out piece scholarship.

Jonathan Glater, “The Other Big Test: Why Congress Should Allow Students to Borrow More Through Federal Aid Programs,” the Journal of Legislation and Public Policy

Glater, a visiting law professor at the recently provisionally credited UC-Irvine School of Law, spares his readers with some concise writing, summarizing his assumption in one paragraph.

This article contends that, if we accept at face value the normative claim that widespread higher education benefits and protects democracy, and that the government’s efforts to promote access to higher education are appropriate, then we should also endorse more complete government intervention in credit markets, in order to preserve the public benefits flowing from the education of more students. (16-17; pdf 6-7)

I do not accept at face value the normative claim that widespread higher education benefits and protects democracy because higher education is not a sacrosanct institution immune from accountability. Nor do I accept at face value the normative claim that the government’s efforts to promote access to higher education are appropriate when higher education is transmitted the same way it was in the 1950s before the digital age and costs more nonetheless. In fact, scholars are not supposed to accept anything at face value unless they’re fundamental and irreducible like the real number system, nor should they be basing 63-page articles off such broad ideological assumptions such as:

Higher education generates unique returns. It produces a citizenry better able to make enlightened judgments and resist tyranny, and it develops wiser leaders. (13; pdf 3)

Certainly such a bold claim emerges from a careful review of empirical research into higher education’s outcomes? Nope, it’s just one source, that renowned expert on 21^st century higher education, Thomas Jefferson. Footnote 6: “See Thomas Jefferson, Preamble to a Bill for the More General Diffusion of Knowledge (1778), in 2 THE PAPERS OF THOMAS JEFFERSON, 526–27 (Julian P. Boyd ed., 1950).”

I agree (or want to) with the Jefferson/Glater assertion that education is a means to enlightened society and wizened leadership, but note that Glater’s argument cleverly sidesteps Richard Vedder’s concerns that tens of millions of Americans aren’t using their college degrees and that plenty of those who do have the aptitude to do what they’re doing without them. As far as Glater is concerned, we’re all better off because Vedder’s B.A.-holding bartender is an enlightened citizen.

However, our legislators don’t appear to demonstrate the wise leadership Glater sees. According to Michael Morella of U.S. News and World Report, the previous Congress, boasted 499 of 533 members with bachelor’s degrees or greater. Now, in fairness, I have a cautiously positive opinion of the 111^th Congress as it actually passed legislation aimed at the good of the country rather than at keeping feeding tubes in one brain dead individual, but it wasn’t exactly the 21^st century New Deal Congress the country needed.

As for the Senate of the 112^th Congress? It boasts 53 B.A.s, 8 B.S.s (including a bunch from military schools), 40 J.D.s/LL.Bs, 2 M.D.’s, 5 M.B.A.s and a smatter of others. These wise leaders, along with an Ivy League educated president with a law degree, are resisting tyranny by advocating deflationary policies during a depression.

Potshots aside, Glater is essentially arguing that the terms of private student loans are onerous, their lenders devious, so the government should expand its lending program to cover rising tuition. Just why are costs rising? Glater doesn’t say. He merely accepts as a given that cost increases over inflation are reasonable, but spends pages 66-68 disagreeing with the Center for College Affordability and Productivity’s (CCAP) Andrew Gillen that increased federal aid causes increased tuition. In the process, he misreads Gillen:

Gillen’s argument suggests that somehow, scarcity of credit has constrained tuition hikes by colleges and universities—a questionable assertion. Given how colleges’ prices cluster around each other, the only current, evident constraint on tuition appears to be a desire not to be too much of an outlier. (66; pdf 56)

No, CCAP argues that increases in credit influence tuition hikes because colleges capture federal aid. They know how much students can afford to pay when calculating total cost of attendance and raise their prices accordingly. It does not dispute that colleges factor in competitors’ tuition. CCAP’s problem—and mine—is that higher education does not compete to keep prices down as free markets are supposed to. Nothing Glater writes disputes this. Indeed, as a law professor he can see it firsthand: since fall 2009, legal education can be fully financed by Direct Loans and Grad PLUS loans with many graduates eligible for income-based repayment. Universities did not promptly raise prices to $100,000 per year to bleed their students and taxpayers dry, but they have continued raising tuition in line with their competitors as we’d expect. My favorite was Stanford’s justification for increasing its 2011-2012 tuition by 5.75%:

[Stanford Board of Trustees President Leslie] Hume explained that the school was “under-pricing” itself relative to its competitors. “There was a feeling that we were delivering a quality product equal to or better than our competitors, and yet our tuition costs less,” she said.

In normal markets, this would be good. Not here, apparently.

Beyond that, Glater does not argue for debt servitude; he favors income-based repayment as a backstop against poverty, and one of his objectives is to make it easier for people to go into public service.

Ultimately, Glater wants life to imitate art: Winston Universities, Potemkin institutions whose sole purpose is to suck on the teat of federal loan money and provide degrees (and four years reprieve from the “real world”) because everyone needs one. Whether they have high standards, controlled costs, students who are intellectually capable of Jeffersonian enlightenment, and connection to gainful employment doesn’t matter to him.

While he appears indifferent to the Private Student Loan Bankruptcy Fairness Act/Fairness for Struggling Students Act that would return bankruptcy protections to private student loans, Glater believes nondischargeability in federal loans in bankruptcy remains necessary:

There is a rationale for making it difficult for borrowers to cancel federal student loans through bankruptcy, too, because those loans are taxpayer subsidized. (61; pdf 51)

At first blush one wants to agree. It’s taxpayers’ money, so they need special protection. Wrong. If the government wants to play private sector lender, it plays by free market rules. There is no “special exception” whether it’s lending money to students or requisitioning ballpoint pens for the Office of the Comptroller of the Currency. This entitled attitude has consequences. Consider: Which is cheaper and more efficient for taxpayers?

(1)  Reducing or eliminating all federal loans (which lowers costs), treating student debt like all other debt, with fewer than 1% of student borrowers discharging their student debt in bankruptcy as they did before Congress enacted the first “special treatments” in the late 1970s?

vs.

(2)  Allowing colleges to capture unlimited federal aid and overcharge students relative to the labor market value of their degrees, forgoing four years of their output as workers, and then forgiving tens of billions in student loans on IBR plans after twenty-five years?

Glater characterizes his option (2) as a counterintuitive progressive policy prescription, but in practice it’s an irresponsible ploy by higher education to scam taxpayers and water down higher education.

FILM REVIEW: Default: The Student Loan Documentary

Krotala Films gave me the privilege of reviewing Default: The Student Loan Documentary. I didn’t expect blogging would lead me to film reviews. Indeed, that’s more my brother’s bailiwick. But like Marty McFly, when someone calls me chicken…

While I don’t have an eye for composition (Default had an attractive color scheme and looked great in Hi-Def), I can waddle through some of its arguments and points.

1.  I think it was Alan Collinge of Student Loan Justice who delineated the triumvirate of players: Lenders—Congress—Universities. He lays out how lenders influence Congress into passing student debtor-unfriendly legislation. I also liked how the history of student lending traced back to a fluke in the Great Society. I hadn’t realized that people were considering a tax credit rather than a lending program.

2.  The students’ stories were compelling, and chalkboarding their loans was an effective visual. I’m glad the students all discussed their part-time or full-time work. It helps counter the arguments from those criticizing students for laziness.

3.  Default claims the student debt problem has grown in the last 10 to 15 years, which I hadn’t heard before. I’d heard the problem originated in the late 1970s when bankruptcy protections were first removed from student debt.

4.  Sallie Mae benefits from defaults. I never understood why until now. SLM can print money by charging defaulting debtors whatever fees it wants, and debtors can’t negotiate them or discharge them in bankruptcy.

My greatest difficulty with the movie was wondering what I would’ve done with 27 minutes. It’s not a lot of time to present the problem, but I felt the film’s tone arced well throughout. The producers deserve credit for working with the time they had.

Some things I would’ve added:

1.  Apologists dismiss critics with the, “You borrow it; you live with it,” argument. That’s the largest obstacle to reform. I think asking one of the borrowers what she or he thought of it would’ve been interesting.

2.  As you can imagine, I wanted more on how universities have been increasing tuition due to free money from the government. A profile of how one university spent the money would’ve connected them better to the triumvirate Collinge outlined above. For example, the details and stories Mish Shedlock describes in this post make me want to set the nearest free-spending university on fire. Moreover, this explains the problem mentioned in the movie of Pell Grants’ decreasing value: it’s not that they don’t keep up with tuition or inflation; it’s that tuition is growing out of control.

3.  Towards the end, one borrower said that education leads to a just society. This is the great philosophical issue underpinning all higher ed discussions. It’s an Enlightenment-era sentiment: knowledge both liberates us from superstition and leads us to progress. I agree with this sentiment—or at least, I want to agree with it, for yours truly has two humanities degrees, a law degree, a social science degree, and was once a teacher himself. I appreciate the education I received. However, the great counterargument to the excesses of our higher education system isn’t coming from mildly statist social liberals like myself but from conservatives and libertarians such as Shedlock above, or for you academics: Charles Murray and perhaps Richard Vedder. These are individuals who adamantly claim that higher education isn’t for everyone, is wasting resources because many college graduates end up in jobs that don’t require college educations, and worse holds people to intellectual standards they can’t meet. When confronted with universities’ decadent spending, I’m finding myself agreeing with them, though I hope the emancipatory aspects of the humanities can be shifted into lower education or be sold a lot more cheaply. If the movie had another half hour, it could’ve related the student debt nightmare to spending and then on to this higher level of analysis. Those interested can watch a longer, more sterile discussion on Blogging Heads.

4.  I also would’ve added an economist to describe what would happen if student loan debt were forgiven. I’m not that person, but the idea isn’t as radical as the lawyer in the movie made it out to be. Bailouts rescue both the debtor and the creditor. For the federal government, this’ll rescue itself from an open wound hemorrhaging tax dollars. It would stimulate the economy, since the money would be spent productively rather than getting hosed up by loan corporations and collectors. Finally, it could be financed by the Federal Reserve printing the money, buying the necessary Treasury securities, and then rebating any subsequent interest back to the Treasury. This would leave no interest burden on future Americans.

5.  Finally, there are three efforts improving the student debt situation that may’ve been worth mentioning. One is the Private Student Loan Bankruptcy Fairness Act/Fairness for Struggling Students Act (that’s probably going to stall in the new Congress). The second is the Department of Education’s Gainful Employment rule change that will curb for-profit higher education, and the third is the non-profit advocacy company, All Education Matters run by Cryn Johannsen.

There was one point I disagreed with:

At one point someone said that we spend more on the elderly than on the young. Government spending on the elderly comes largely from Social Security, which they paid into when they were working. It’s their money, and they deserve the return because it was forced savings. We don’t need to impoverish the elderly to invest in the young.

I’m not going to give a thumb or star rating to Default. It’s message is more important than what more sophisticated reviewers can dissect that I cannot, but I hope Kratola can distribute it as widely as possible, especially to high school students who can best benefit from its warning.

Income Based Repayment Helps Law Students, Not the Tuition Bubble

Last week, I wrote:

[The “ABA Economic Recovery Resources” webpage] also contains Resolution 301, a futile (but thanks for trying) request to Congress asking it to convert private student loans to public loans, increased access to loan consolidation and income-based repayment plans, and amusingly, TARP funds.

And I quoted former President Carolyn Lamm’s “Law School Education Debt Has a Manageable Solution”:

Now is the time for modest changes in current federal student loan programs to increase the amount that law students may borrow, and to bring existing private loans into the federal student loan system. [My emphasis]

Reading up on the College Cost Reduction and Access Act of 2007 and its income-based repayment plans (IBR) that entered into force in July of 2009, gave me a better understanding of what the ABA and Lamm had in mind.

IBR lowers monthly student loan payments, capitalizing the interest until 25 years have passed when the loan is discharged.   It applies only to Stafford, Grad PLUS, or federal consolidation loans.

Bearing this in mind, I have three thoughts:

• Converting private student loans to federal loans would help recent grads discharge more of their debt via IBR later on, which is good.
• Assuming a law degree can be fully financed by combining Direct Loans with Grad PLUS loans (which are unlimited), current and future law students will not be crippled with debt (provided they don’t miss payments).

Does this change my opinion of the ABA’s goals?  Somewhat. True, when I wrote, “President Lamm: (i) didn’t care if private sector lawyers were underpaid for their degrees or were drowning in debt…” I didn’t consider whether IBR would aid them, and it would.  However, IBR has disadvantages, and those interested should also read Angel’s digest of Angry Future Expat’s thoughts on it.  I’ll summarize and add my own points:

1. IBR doesn’t cover all loans.  Your private student loans from undergrad with adjustable rates are unaffected.  This is one more reason to support the Fairness for Struggling Students/Student Loan Bankruptcy Fairness Act.
2. IBR doesn’t apply retroactively.  Older debtors must start the 25-years clock from scratch just as younger debtors do, meaning younger debtors get to save more money in the long run.  This isn’t necessarily unfair—it’s not a bailout—but middle-aged professionals, especially those who already have mortgages and children won’t receive the prospective savings of childless graduates.  The real question is how it affects post-retirement debtors.
3. Defaulted debtors are ineligible.  This is typical government mispaupery, especially towards older graduates who are already financially crippled by previous default.  Student debt is not evenly distributed among debtors, so if you’ve defaulted, you’ll discharge the loans with your last breath.
4. IBR is not the default repayment plan.  Obviously the government wants graduates to pay the full monthly payments rather than capitalize the interest only to watch it all evaporate after 25 years.
5. Affects on graduates’ credit ratings?  None, but if a lawyer isn’t making a lot of money in the private sector it’s plausible the capitalized interest could push the debt into seven figures.  Creditors may elect not to extend loans to graduates with that kind of debt over their heads.
6. Are dropouts eligible?  I doubt the federal government wants to appear to encourage it.
7. The effort required to document income sources annually to calibrate payments.  It also means graduates will have to save money in anticipation of salary shocks.  I imagine that someone who (accidently) omits an income source would be punished severely.
8. Forgiven loans are taxable income in the year they’re discharged, so until that’s modified prepare to take one pretty big hit one year.  Law grads who haven’t made a lot of money in the private sector may end up paying a six-figure chunk in income taxes, wiping out their savings in a student loan judgment day.  Bet your opinion on the Bush tax cuts expiring suddenly switched, huh?

That’s just IBR as it applies to graduates generally.  As far as the law school tuition bubble is concerned, there are specific problems.

1. IBR does not affect law schools’ cost structures.  Law schools’ primary economic interest is filling seats to pay their instructors’ salaries.  IBR shifts risk from students to the government, meaning taxpayers subsidize the tuition bubble, which is better than permanently impoverishing graduates.  If anything, less risk to students reduces disincentives against going to law school, e.g., “The price tag doesn’t matter because I’ll qualify for IBR.”  Higher education financing reform must shift the risk to the universities.  Presumably (without reform), 24 years from now, the Department of Education will be hit with a titanic shortfall caused by forgiven debt.
2. IBR does not improve a juris doctor’s market value.  This blog is premised on facts evidencing a decline in a law degree’s value due to excessive tuition and attorney oversupply.  As always, I’m open to those with better information than I proving me wrong on these facts.  However, as the value added of a law degree declines, decreasing debt does not help enough: graduates will still be paying debt on a degree that they either aren’t using or didn’t really need to secure their employment.
3. Finally, IBR doesn’t repay one for the opportunity cost of going to law school.  That might be nothing today, but then again I also don’t predict a recovery any time soon.

The good thing about blogging is you learn things, and now I don’t worry for current and future law students so much, unless they were ineligible for Graduate PLUS loans to begin with and went the private route.  I’m still incredulous the government intended to completely deregulate graduate/professional schools and allow them to set their tuitions with no regard to quality control, so I am curious whatever the “catch” is, whether it’s a hit to one’s credit score or the tax hit in the discharge year.  I can see why the ABA pushes for converting private loans to public ones, but it still needs to care about the market value of the degrees it accredits.

The Links by Numbers—Bankruptcy, ROI-Based Rankings, the Tuition Bubble, and the Uniform Bar Exam

Four late summer links:

(1) Leigh Anne Faugust, “Changes on the Horizon for Student Loans in Bankruptcy?” in Leesburg Bankruptcy (Law Office of Robert Weed)

A lot of investors saw student loans as a sure bet because the students would not be able to get relief under any but the most extreme circumstances.

Of interest is the graph at the top of her post:

Given that we know student debt is now at $850 billion and rising, I suspect this chart is the volume of loans issued per year and not total volume.

Although the Dept. of Education should’ve put more year markers along the X-axis, the upward bend begins roughly in the late 1990s—when Congress first inserted the undue hardship exception into the bankruptcy code for federal student loans.

The House bill is slowly moving through committee.  Too bad Congress doesn’t realize the moral hazard the undue hardship exception created still imperils all public student loans, which are the majority of those in the system.

(2) Debra Cassens Weiss, “Forbes Will Rank Law Schools Based on Job Results, Northwestern Reveals,” in the ABA Journal

Citing TaxProf Blog on Forbes’ college rankings, Forbes will look at law grads’ salaries one year and five years after graduation to generate a set of law school rankings based on return-on-investment.  Looking over its college rankings (and its “objective” methodology), I get the impression that Forbes is looking at salaries, and not at interest on debt, nor at whatever the discount rate is (very high these days).  In other words, Forbes’ definition of ROI is heavy on the R but light on the OI, unless we’re talking about a national military academy.[i] It also fails to test whether higher education between $150,000-$200,000 over at least four years plus interest is preferable to moving up the management chain at the local department store.

It’s now within the realm of possibility that a 17-year-old planning to go to a private college and then law school can expect to “responsibly” accumulate a quarter million dollars of non-dischargeable student debt.  And that’s just the principal!  Given that Herwig Schlunk calculated the break-even annual starting salary for most private law schools at well over $150,000 (excluding prior student debt), it’s hard for me to believe that Forbes’ rankings will tell us anything practical.  It certainly won’t be very helpful to rank law schools based on employment statistics during a period of mass unemployment.

Remember: Any higher education ranking must include the other option: Not going at all.

(3) Elie Mystal, “Citi Sells Student Loan Division: Can’t You Hear the Bubble Bursting?” in Above the Law

Contrasting to Faugust’s investors seeing student loans as a “sure bet” and Forbes’ novel definition of ROI:

Tuition is out of control.  Lenders lend without considering whether these kids will be able to pay the money back, and the American job market is in the tank.  Is this really the time you want to be in the business of originating student loans?

Apparently Citi has elected not to be in that business anymore.

(4) Martha Neil, “ABA Group Backs Uniform Bar Exam,” in ABA Journal

Yes, the UBE is a good idea.  Telecommunications and the ease of research mean state boundaries hinder legal professionals, and the costs of the testing complex are ultimately borne by clients.  If one of the commenters is right, that is, the UBE merely includes the Multistate Bar Exam, the Multistate Essay Exam, and the Multistate Performance Test, then the issue is the exam’s contents.  Bear in mind that the MBE tests generic common law where state laws often differ, especially criminal law.  Federal law beyond constitutional law doesn’t appear at all, especially bankruptcy.  Law schools are often criticized for their archaic curricula, but the easiest way for a law school to measure its performance is by teaching the local bar exam.  Of course, licensing authorities need only care about their definition of “competence,” and they have no incentive to worry about rising tuition, over-supply, or skill-sets.  The tuition bubble broadly exists because decision-making power has been diffused to multiple institutions with minimal cause to worry about the overall state of the profession.  Harmonizing these institutions would hopefully resolve the problems.

---

[i] Clearly the flaw in the methodology is that it studies salaries longitudinally, assuming current graduates will have the same earning potential of those thirty years ago.  The 30% of the score assigned to “Postgraduate Success” relies on three factors: alumni salaries on Payscale.com, alumni listings in Who’s Who in America, and amusingly “Alumni in Forbes/CCAP Corporate Officers List” (only 5% though).  Undoubtedly, late boomers and early gen-Xers, if they’re still employed, went to college when it was a no-brainer investment.  The longitudinal prospects of 2011 graduates and beyond are not good given that tuitions have risen faster than inflation.

A Quick Link–Student Debts and Walking Away from Law School

Here are five Labor Day goodies:

(1) Ryan D. Caldwell, “The Private Student Loan Discharge?” in Omaha Bankruptcy Attorney

Updates on legislation to discharge student loans in bankruptcy, The Fairness for Struggling Students Act (Senate) or 2010 Bankruptcy Fairness Act (House).

(2) Walter Russell Mead, “Back to School,” in The American Interest (Online)

An article on higher education’s value in the future labor market.

Most of your elders know very little about the world into which you are headed.

(3) Elie Mystal, “The Student Loan Racket: Now in One Easy to Understand Graphic,” in Above the Law

READ THIS!

(4) David Lat & Elie Mystal, “Cut Your Losses, or Finish Law School? An ATL Debate,” in Above the Law

A 2L wrote in to ATL about whether he (I’m guessing) should walk away from a top 8 law school and mediocre grades.  Mystal says yes, Lat says that the letter-writer’s high quality school and the hope of a student loan bailout is a good enough reason to stay.

Missing from the debate is what kind of summer work this 2L did, which is another indicator of future opportunities.  Aside from that, the law school’s rank is double-edged.  In times of plenty, it would be gold, but these days, top-tier law students are facing unemployment.  This is a problem for three reasons:

1. Top-tier schools are very expensive and require a damn good job to make the investment worthwhile.
2. A J.D.’s value deteriorates over time, even from a good school.  Employers find subsequent experience far more useful.
3. Similarly, the legal sector faces structural unemployment.  Cyclically unemployed people become structurally unemployed in the long run.  This is very bad for graduates from top-tier schools with top-tier debt.

Consequently, I side slightly with Mystal over Lat, mainly because a student loan bailout is nice, but it won’t help if the legal sector doesn’t recover.  Angel from But I Did Everything Right has more specific criteria worth considering.

(5) Josh Wright, “Attention Economists and Grad Students: Thought about Law School?” in Truth on the Market

George Mason is offering free law school rides plus stipends (!) to its econ graduate students.  These are favorable circumstances in which to go to law school.

Enjoy your long weekend!