An obscure ruling in a U.S. bankruptcy court last week should totally revolutionize the way we finance higher education in America. It probably won’t. But that’s only because of the strange, shortsighted way we separate student debt from all other debt.
The case concerned Lesley Campbell, a graduate of the Pace University School of Law in 2009, who took out a $15,000 “bar study loan” with Citibank so she could pay living expenses while preparing for the state bar exam and taking a test-prep course.
These bar study loans are ubiquitous: Financial institutions like Discover, Sallie Mae, PNC Bank and Wells Fargo offer them. It’s one of the few areas of the student loan business where private lenders still dominate, after the federal government eliminated banker middlemen on undergraduate and graduate-school loans.
Campbell failed the bar exam, and while she found a secretarial job making $49,000 a year, it was not nearly enough to finance a student debt burden that had ballooned to $300,000. So in 2014, she filed for bankruptcy.
Most of that student debt is not dischargeable in bankruptcy, thanks to Congressional changes precipitated by a false narrative that students routinely scammed the government by using bankruptcy to shed their loans. Only borrowers demonstrating “undue hardship,” a nearly impossible standard practically requiring proof of an inability to feed or clothe oneself, can extinguish their debt. According to The Wall Street Journal, less than 1,000 people in bankruptcy each year even try to get their student loans discharged.
However, U.S. Bankruptcy Court Judge Carla Craig made a distinction in the case between Campbell’s other student debt and the bar study loan, which after years of payments now totaled $11,000. In the opinion, Craig ruled that the bar loan did not constitute an “educational benefit” under the law, meaning it could be discharged.
Even though Citibank required that Campbell was a law student to qualify for the loan, that “does not turn an arm’s-length consumer credit transaction into a ‘benefit’” that would make it eligible for the exemption, Craig wrote. In other words, the bar study loan shared the same characteristics as an ordinary consumer loan, regardless of whether she used it to allow her to study for a test.
The nominal reason Congress made student loans non-dischargeable was to ensure the solvency of federal loan programs. “These considerations are simply not relevant when the loan at issue is a consumer loan extended by a for-profit actor,” Craig concluded. As a result, Campbell is allowed to extinguish the $11,000 balance on the Citibank bar study loan as part of her bankruptcy plan.
The ruling is “seismic,” according to Campbell’s lawyer, William Brewer. “It flips the script for thousands of people who our client believes have fallen victim to predatory loan practices and been told they cannot discharge these loans.”
This is technically true in the case of bar study loans. However, that reflects a small portion of overall student debt, most of which is federally provided to pay for tuition and fees and living expenses, and would presumably fall under the “educational benefit” standard.
The question we should be asking, though, is why that standard should truly exist. The bar study loan case posits that the lending institution knew the risks when it gave the borrower the money and cannot have the loan protected just because it was related to education. But that logic applies across the board. Why should an entrepreneur whose business idea washes out or a gambler who racks up debts on his credit card playing blackjack have the ability to start over through the bankruptcy process, while a young person making a fateful decision at the age of 18 to fund their education through debt can’t?
This is especially true when the school doesn’t uphold its end of the bargain and deliver a meaningful educational experience. I’ve written often about the travails of students of predatory for-profit Corinthian Colleges, who obtained worthless degrees and still have to jump through hoops to get their debt eliminated. But to say that certain classes of people don’t deserve bankruptcy protections because of the way they use the loan is to deny the purpose of bankruptcy at all.
Bankruptcy laws prevent a single bad choice from destroying someone’s financial life forever. They allow an orderly process to pay back creditors what is available so the individual can regain some semblance of a productive life. The idea of bankruptcy as a scam perpetrated by people wanting to shirk their obligations just isn’t true. Nobody wants to go into bankruptcy because it’s a terribly difficult process, not to mention a humiliating one. But it puts people on a better path. And we shouldn’t randomly deny that to students, especially in a time of mountainous student debt burdens.
There’s credible evidence that high student debt is stunting the growth of the economy. Locking people into repaying tens of thousands of dollars with no opportunity for a fresh start hurts all of us if the economy materially suffers.
The White House has begun to come around on this. In a fact sheet in March, the Obama administration directed the cabinet to devise recommendations for “possible changes to the treatment of loans in bankruptcy proceedings,” a reversal of decades of hardline stances. Bankruptcy lawyers cheered the news.
Judge Craig’s ruling shows that the legal system is taking a more compassionate look at student debt. It’s possible that they will find that other loans that did not deliver an “educational benefit” are similarly eligible for discharge in bankruptcy, including even federal loans for shady for-profit colleges. But the bankruptcy statute shielding student debt should change for all borrowers. It’s wrong to force students at the beginning of their college tenure to gamble on a lifetime of debt peonage.