Student Loans Debacle-Part II: Failure to Forgive – The Ticking Time-Bomb

The recent push for student loan forgiveness has been met with increasing opposition. The rationales for not providing a generally applicable path for student loan forgiveness or cancellation have included arguments based upon imagined unfairness to those previously able to pay off their loans, which seems to be both short-sighted, as well as a “red herring” argument. It does not address the question of whether those who are not able to pay should be trapped for life under such debt load. A better argument against general loan forgiveness is, of course, the considerable burden that would be placed upon the federal treasury (taxpayers), which, pursuant to the benevolent policy of helping worthy, but needy, students pursue educational opportunities, guaranteed re-payment as an inducement to lenders to lend money without the usual safeguards or qualifying criteria. The problem with that argument is that the taxpayers are already obligated to repay these ever-increasing loans on into an indeterminate future.

In my practice, I am regularly confronted with those having little in the way of resources yet saddled with massive student loans. The individual circumstances and causes are myriad and variable; yet all possess the near identical characteristic that they came out of college with course work or degrees that did not elevate their earning prospects or upward mobility. Then, they were required to make immediate payment on their student loan debt, but at the time when wage or salary was at the new-hire range, or they were yet unemployed. This often morphed into a choice between a significant monthly payment for the student loan or affording necessary housing, food, and transportation costs. Some did begin repayments immediately but were later confronted with budget-stressing life events, such as divorce, job-loss, economic downturns, or even the happy arrival of children. The ease of delay mechanisms for student loan repayment made the choice of delaying repayment very attractive, if not necessary.

At all times, whether during repayment or deferral of repayment, interest on the original student loan continues to accrue. It is annually capitalized into the original loan balance, with the obvious result that the student loan balance grows. In as short a time as 5 to 8 years, without significant repayment efforts, the original balance may completely double. To lenders, having a federal guarantee for a bad loan that increases in value over time, is the gift that keeps on giving.

At the present time, there are millions of student loan borrowers who have little prospect of full loan repayment, who now pay little or nothing on their loans. They will likely continue in this state as they age, grow old, and die. At the time of death or disability of the student loan borrower, the lender will be entitled to payment of the entire sum, accumulated over decades, consisting of the original principle, decades of interest compounded upon interest, and all adding to an amount that may be 10 times what was originally borrowed. This is the true ticking time-bomb. Far better to effectively confront the matter now rather than allow that debt-bomb reality to fester.

The several income-based repayment programs now in existence may ultimately prove illusory. The executive orders creating debt cancellations at a future time were not then opposed by lenders for all the previously mentioned advantages of letting the debts grow. Also, even small repayments by borrowers to lenders avoids the costs of default and creates a present cash flow permitting more loans. Obviously, small payments are better than none. Further, the matter of cancellation is put off for a significant time, i.e., 20-25 years. However, borrowers who qualify under such programs have not arrived at the 20 or 25 year thresholds for debt cancellation to kick in. Only then will the vulnerabilities of the program be fully examined and possibly challenged. One question is whether a private lender’s fully vested, substantive right, bestowed upon lenders by contract, can be retroactively vitiated by any law or executive order. Another issue, previously mentioned, is that the delay of repayment for 20-25 years upon interest-bearing loans will become an incredible stress upon the federal treasury at that future time. The political process may well react to cancel the cancellation.

Other Approaches

There are two, more positive approaches to making student loan forgiveness/cancellation a generally applicable tool for the needy. Each, if applied with common sense, would ease the current stress upon borrowers, and avoid the cumulative time-bomb waiting down the line. Further, if adopted, such processes would spread out, even minimize, the impact upon the federal treasury.

The first would be a general allowance for bankruptcy discharge of student loan debts. Properly applied, this approach would do a great deal toward alleviating the burdens upon the truly needy and upon the federal treasury. Obvious to all, the present bankruptcy process for student loan discharge has been deliberately turned into a nearly insurmountable, burdensome process. The Department of Education and lender banks directly engaged high-brow, downtown law firms, paying them the highest attorney hourly rates, to apply the full litigation process in opposition to any attempts at student loan discharge in bankruptcy. This includes significant discovery processes and motion practice upon less sophisticated debtors.

The path to bankruptcy discharge has been deliberately contrived into the most expensive, time-consuming process imaginable. It is truly unworkable as a fair, general solution for ordinary debtors. Replacing this with an assumed discharge in Chapters 7 or 13 would always allow creditor review of the worthiness of discharge, or opposition to discharge, in individual cases.

I still remember the claims of “gaming the system” utilized in the 1990s to drastically circumscribe, and practically eliminate, the possibilities of bankruptcy discharge of student loan debt. We were regaled with reports of just-graduating medical students, earning a small portion during internship/residency of the significant earnings to be realized later on, who filed for, and obtained, a bankruptcy discharge of all their student loan debts during those low pay years. These, although not at all typical, were held up as taking unfair advantage of the bankruptcy process to the detriment of taxpayers. Thus, the bankruptcy portal was radically narrowed, not only for medical students, but for all student loan borrowers.

It is perhaps useful to recall that the sudden attention to student loan bankruptcy discharge was not accidental. There had been a gradual, but profound, ballooning of tuition and residence charges by the universities since the early 70’s, with concomitant increases in the need for larger educational loans. The earlier bankruptcy discharge of a few thousand dollars might have had a small impact on the general well-being of the student loan program. However, with later drastically increased tuition, room & board amounts, routinized bankruptcy discharges of one-hundred thousand dollars or more, could significantly stress the entire program, as well as complicate congressional fiscal planning.

Yet the responsible policing of bankruptcy cases can prevent systematic abuses of the bankruptcy processes. Attorneys, trustees, and judges are all aware of the differences between a single mother of three and a just-graduating physician, attorney, engineer, architect, accountant, or other professional. Further, unlike previously, the Office of the United State Trustee has been brought into the bankruptcy process, armed with a statutory mandate to guard against bankruptcy abuses. A multi-tiered approach easily allows more scrutiny of professionals seeking discharges, as well as moving the ordinary debtors toward a discharge without complication.

Another method of dealing with student loan debt would be for the federal guarantors of student loans to be supportive of negotiated settlements. It is in the long-term self-interest of the Treasury to do so. Lenders and servicers, at present, will hardly ever meaningfully negotiate the resolution of a student loan. Under the current regime, any lender of a federally guaranteed student loan will lose that guarantee if they settle with the borrower for a lesser sum. Whatever they settle for will be all they will get. Also, there exists the disincentive that the ongoing accumulation of interest creates the vision of a larger, future payday for the lender. These considerations, unlike other kinds of indebtedness, render settlement most unlikely for anything less than nearly the full loan amount.

However, debtors who are normally unable to pay, may come into a lesser lump sum; or over time, they may develop credit worthiness to borrow a lesser sum. If the guarantor agency could support the settlement by honoring the guarantee as to the remaining unpaid balance, the accumulation of interest would cease, and the amount of guaranteed money ultimately paid would be far less than letting the debt run. The file would be closed, the guarantee would be capped, and all at a significant discount!

Finally, rather than either of the above approaches, repayment of student loans could be positively incentivized, such that significant repayments would come into the student loan coffers and the entire matter of lingering, interest-bearing guarantees would be curtailed. One significant encouragement would be to make student loan repayments directly deductible from income for tax purposes. Such repayments would impact the taxation for only a few years, while the debt for many would actually get repaid well before any 10-15 year repayment process.

Such an approach should also be without regard to income level. After all, those with more income likely owe larger student loan balances; and, as well, have a better ability to repay. Incentivize the repayment and the student loan reservoir gets refilled, while the future danger of ever-increasing guarantees is eliminated.

One further point: there are those who should be made to share the burden of debt cancellation or forgiveness. Certain universities may also have “gamed the system.” Where proven, they surely bear some proportionate responsibility for the increases in the numbers of those who owe but have no serious means of repayment.

Consider the following: In the usual situation, admission to a college or university is limited to those prepared to engage the more rigorous educational challenges presented. Thus, ordinary admission requires graduation in the upper half of one’s high school class (a higher level for some universities), and certain minimum scores on the standardized college admission tests -ACT or SAT. While individual special circumstances may also garner a special circumstance admission, these gatekeeper factors reasonably control admissions. In this way, aptitudes and present level academic abilities are evaluated, with the goal of admitting those presently able to have success in specialized training programs. Thus, one must be able to perform calculus level math (at a minimum) for admission into the colleges of engineering or business. Demonstrated present skill levels are prerequisites for admission into most university colleges or programs, at the time of application.

A university may easily increase its income by admitting large numbers of students who do not possess ordinary admissions criteria, but who do qualify for financial aid and student loans. Thus, a university may set up a process whereby those in the lower half of their high school class, with poorer ACT or SAT scores, are admitted to the university in larger numbers, but not into the main level colleges. While such students may be formally admitted, they may be shunted into remedial course work or programs that would include lesser level courses for math, English, and the sciences. These students are given a chance, and if they do well, then admission to one of the colleges may occur. But in many cases, such students cannot progress. All the while, the university receives significant sums, their budgets may be doubled, and they are incentivized to increase tuition and housing costs.

Where it can be shown that a university has so acted, then they are directly responsible for specific loan burdens upon those who were not uplifted by their “opportunity.” As beneficiaries of such student loans and incentivizers, universities should also be forced to help repay the loan where the benefits have proven illusory to the student. It is only fair that their “gaming of the system” requires some share in the alleviation of guaranteed repayment.

In conclusion, there are no easy or painless ways out. Taxpayers are already on the hook for repayment. The only questions are when and how much.

Attorney

R. Michael Smith graduated Summa Cum Laude from the University of Cincinnati in 1982. He then attended The Ohio State University College of Law, where, after serving on the Law Journal and winning the Judge Joseph Harter Award for Trial Advocacy, he graduated in 1985. Mike then served as a law clerk/administrative aid to Ohio Supreme Court Justice Robert E. Holmes. Afterward, he served as Referee (magistrate) and Editor for the Court at the Ohio Court of Claims. Later, he also earned a Master of Divinity degree from The Southern Baptist Theological Seminary. Upon entering private practice in 1994, Mike’s practice included appeals, trials, general business and criminal representation and bankruptcy. He has tried cases, argued cases before the Court of Appeals, and drafted appeals for other attorneys. In addition to admission to the Courts of Ohio, he is also admitted to practice in: Federal District Court, Southern District of Ohio; Federal Bankruptcy Court, Southern District of Ohio; and United States Supreme Court

Related Articles

February 10, 2019
Jan M. Sensenich graduated from Windham College in Putney, Vermont in 1978 and Vermont Law School in 1983. He served as Core Faculty Member and Director of the Woodbury College Legal Clinic from 1983 to 1987and from 1990 to 1992. Jan was an Associate with Jerome I. Meyers, P.C. from 1987 to 1990 when he opened his own practice concentrating...
Copy of Hildebrand-2016
A reverse mortgage, having fallen due as a result of the death of the borrower, is not protected from modification by the borrower’s heirs by virtue of § 1322(c)(2). (Halfenger) In re Sandoval, 2022 WL 982182 (Bankr. E.D. Wis. March 31, 2022) Case Summary Juan Sandoval filed Chapter 13 and proposed a plan which dealt with his principal asset, a...
Members
May 3, 2020
By Cathy Moran, Esq. (Redwood City, CA) After the pandemic, when the economy lurches back into motion, bankruptcy lawyers will confront a clutch of troubled Chapter 13 cases. In the face of disruption, distress, and the unknown, we'll be called on to guide clients forward, in one direction or another. Let's review the questions we'll need to answer in order...
Members
Copy of Hildebrand-2016
October 30, 2022
In order for a debtor to succeed in setting aside a dismissal in a motion filed under Rule 9024, F.R.B.P., the debtor must prove specific grounds as outlined in Federal Rule of Civil Procedure 60(b). (Oxholm) In re Gardner, 2022 WL 654410 (Bankr. E.D. Mich. May 24, 2022) Case Summary Carl and Taisha Gardner filed Chapter 13 in September of...
Members
April 18, 2021
By Herbert L. Beskin, Chapter 13 Standing Trustee for the Western District of Virginia (Charlottesville) If you’re looking for a well-written and clear appellate opinion about a much-litigated topic, with a bit of ancient mythology thrown in for good measure, this HUD’s for you. The case is Wood v. U.S. Dept. of Housing & Urban Development (In re Larry and...
Members
AAA_4864
January 30, 2022
(Used with expressed permission from the MI Bankruptcy Journal and the Steven W. Rhodes Consumer Bankruptcy Conference) I. Introduction Although the Bankruptcy Code has been around for decades, bankruptcy courts continue to be faced with significant disputes regarding the interpretation of its provisions. An emerging issue that has gained traction in recent years involves the compensation of a chapter 13...
Members
January 19, 2020
By David Cox,1 Cox Law Group, PLLC (Lynchburg, VA) Click here for Part 1 of 3 Click here for Part 2 of 3 C. Challenges unique to older debtors. Mobility/hearing attendance requirements. Attendance at 341 hearing. Section 343 Examination of the debtor clearly indicates that the debtor shall appear and . . . It looks like you are not signed...
Members
October 11, 2020
By Cathy Moran, Esq. (Redwood City, CA) Once again, I sat in a 341 meeting where the trustee’s representative purported to deliver vital information to the assembled debtors. She had a captive audience of anxious listeners. She had ostensible power of life and death over their financial future. They needed to know what she had to say. But as communication,...
Members
August 18, 2019
By Lawrence R. Ahern, III, Brown & Ahern (Nashville, TN) PART I Overview Introduction Four bankruptcy-related bills have been passed by both the House and the Senate this term. The legislation was sent to the President for signature on August 13, 2019.1 The bills were not controversial and had bipartisan support. The legislation affects both business and consumer cases. One...
Members
Academy Circle Logo Final
August 7, 2022
William F. Jaworski, Jr. - Bill - was appointed Chapter 13 Standing Trustee for the District of Delaware on April 1, 2022. Jaworski has very large shoes to fill as he is taking over for Michael Joseph upon his well-deserved retirement. Jaworski was born and raised in Buffalo, New York. As a hometown boy, he didn’t venture too far away...
Members