When people get in over their heads with debt, they can decide to take a major hit to their credit score and sort things out in bankruptcy. Lenders bake the cost of that risk into their loans, and two centuries of excruciatingly detailed legal precedent details which creditors gets priority and what debts can be erased. That’s an option for almost every type of common personal debt … except for student loans.
As we wrote last week, the Consumer Financial Protection Bureau and the U.S. Department of Education came out with a new report (PDF) taking aim at the $150 billion private student loan industry, saying it paralleled the reckless lending that characterized the subprime housing bubble. The report’s most controversial suggestion was that Congress reconsider the 2005 law that excluded student loans from bankruptcy. Congress had intended the law to promote more lending and lower interest rates, but the report says it didn’t find strong evidence that those things actually happened.
Since the report, Moody’s looked at what changes to the law would mean for the lenders and found that while it would hurt them, it wouldn’t be too painful. Put another way, the changes might not help students as much as you’d think. Surely many defaults wouldn’t show up on the books of private lenders because the government would cover the losses for loans created before Congress killed the federal loan-guarantee program in 2010. But Moody’s says other factors will limit the impact, particularly in the future. It says only students who didn’t have parents co-sign their loans would likely file for bankruptcy because it would be very rare for both kids and their parents to take the huge credit hit just to discharge the loans. And these days, almost all new private student loans have co-signers, limiting the potential pool. The report also downplays the risk that’s often the boogeyman of these debates—that lots of students will take out lots of loans, then immediately file for bankruptcy after graduation. Moody’s points to the CFPB report that didn’t find any instances of that type of “abuse” in the past, when the loans could be discharged.
The last reason the proposed change wouldn’t help that many students is that the CFPB was talking only about changing the law for private loans. Government student loans make up 85 percent of the market, and those won’t be touched. Proposed laws to let student discharge private loans have gone nowhere during the past few sessions of Congress, so you can imagine the response to an effort adding federal loans. As Moody’s writes: “For fiscal reasons, the federal government may be reluctant to extend such protections” to its own portfolio. With $848 billion in student loans outstanding on the government’s books, that’s a real understatement.