By Melissa B. Jacoby
Momentum appears to be growing in Congress for changing federal law to allow individuals to borrow money for education without undue risk to their financial futures. Specifically, Sen. Dick Durbin (D-IL) and Rep. Steve Cohen (D-TN) have offered standalone legislation, S. 3219, and H.R. 5043, respectively, that would restore the common-sense treatment of private student loans in personal bankruptcy. Sen. Al Franken (D-MN) has submitted an amendment to the Senate financial regulatory overhaul bill that would do the same, although it is unclear whether it will be considered.
To see the issue, imagine that Chris owes $10,000 to Bank One and $10,000 to Bank Two. Both banks conducted the same credit checks and charged the same interest rate. Now imagine that Chris suffers severe financial hardship and files for bankruptcy. If Chris is an honest debtor with few assets, he will emerge from bankruptcy with no legal liability to Bank One, but, under current bankruptcy law, likely will continue to owe $10,000 to Bank Two. Why the different treatment? Chris used the Bank One loan for medical care, food, and other basic necessities, but used the Bank Two loan for trade school tuition.
In the 1970s, for-profit consumer lenders publicly criticized the establishment of such a distinction. Their representatives noted, “If the social utility of what is exchanged for the debt is to be determinative of dischargeability then the question can be raised of whether it is proper to discharge medical bills, food bills, etc. This proposed [legislation] simply suggests that if sufficient political pressure can be generated, a special interest group can obtain special treatment under the bankruptcy law.”
Singing a different tune today, however, the Consumer Bankers Association now endorses treating student loans differently from debts incurred for food or medical bills. Why the shift? In 2005, Congress expanded the nondischargeability of private student loans, allowing for-profit lenders to become beneficiaries of the law they opposed decades earlier.