Private Student Loan Bankruptcy Fairness Act

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:

Wow.

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!

Bonus Link: Student Loans Piling up

Bob Lawless, “Student Loans Now Greater Than Credit Card Debt“.

One analyst calculates $605.6 billion in federal loans and $167.7 billion in private loans (total $830 billion according to the article, but that figure’s off by $56 billion so consumer debt is still higher) compared to $824 billion in revolving consumer debt.  The good news is that Americans are paying off their consumer debt, but they’re “retooling” for an economy that won’t need their training because no one thought to create the jobs in the first place.  Lawless opines:

All of these facts suggest more questions than answers for me. Should we be concerned as a policy matter about rising levels of student debt, or is this just an indication of a populace investing in human capital during a financial downturn? Are growing levels of student loan debt sustainable? If not, what are the implications for universities (and, gasp, law schools)? (more…)

Remain in Links

Three Memorial Day morsels fresh from the grill:

(1)  Rochelle Olson, “Job Market Leaves New Lawyers far from Easy Street

The Minneapolis Star Tribune notes the underemployment plights of a handful of recent law grads.  One is even fluent in multiple foreign languages, which I thought was a shoe-in qualification.  Only temp work is available for them at best.

Related to my previous post: towards the end, University of Minnesota Law School dean, David Wippmann, blames tuition increases on the state for reducing public funding of higher education.  He obviously doesn’t see a legal education bubble because he should be asking why law school is so expensive relative to its outcomes to begin with.  I also disagree with State Supreme Court Justice Anderson’s characterization of the State’s educational priorities: no one is starving the beast and then blaming it for failing; rather, people are failing to see the beast gorging itself unsustainably.  On the contrary, Minnesotans should be happy their tax dollars aren’t being funneled into an asset bubble.

Minnesota is a special case I’ll return to later.

(more…)