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WHY CAN’T STUDENTS ACT LIKE DETROIT?: Salon touches on a pet peeve of mine, namely the nondischargeability of student loan debt. Author Tim Donovan of The Suffolk Resolves has some interesting history I wasn’t too familiar with:
First, in 1976, Congress instituted a fairly reasonable reform to bankruptcy laws: To prevent unscrupulous students from amassing a number of expensive post-graduate degrees (only to immediately declare bankruptcy and simply wait out the seven years without credit), a five-year delay on bankruptcy protection was implemented for student loan debt. In 1990, that waiting period was extended to seven years. Hypothetically, by forcing students to delay dischargement, they would be given the necessary time to build equity, earn a good credit score, and acquire some wealth, which would in turn provide a key disincentive to the “moral hazard” that immediate bankruptcy might present to younger, less stable graduates.
And yet, for the banks, this wasn’t enough: In 1998, the law was changed again, this time ensuring that federally backed student loans would be made completely and permanently nondischargeable through bankruptcy. But for the banks, even this wasn’t enough: In this system, private loans could still be discharged — albeit after a seven-year waiting period and the self-inflicted destruction of one’s credit and assets. Still, the banks continued the push to deregulate: In 2005, the law was changed a final time, shielding private student debt from bankruptcy just like their federally backed kin.
Since the article mentioned the phrase “moral hazard”, let’s print Wikipedia’s definition so that everybody’s clear on what we’re talking about:
In economic theory, a moral hazard is a situation where a party will have a tendency to take risks because the costs that could incur will not be felt by the party taking the risk. In other words, it is a tendency to be more willing to take a risk, knowing that the potential costs or burdens of taking such risk will be borne, in whole or in part, by others.
I understand the moral hazard issue, and it’s certainly reasonable and just to treat student debt differently because of it. You want to have a delay on bankruptcy protection to prevent youngsters with nothing to lose from charging off their student loans? I’m fine with that.
But there is a countervailing moral hazard at play here: student lenders, since they are shielded from the threat of bankruptcy, will have a tendency to take risks–that is, make loans that they really shouldn’t be making–because they won’t incur the costs. Somebody else will.
It’s the same sort of moral hazard that helped bring about the credit crisis of 2008: people acting foolishly with money because they think somebody else is picking up the tab.
I’m all in favor of financial responsibility, paying back your loans, truth, justice, the American way, all that stuff. I’ve certainly paid back my share of student loans. But financial responsibility is a two-way street, and lenders have a duty not to make silly loans, even if somebody else is going to pay for it. On student loans, the balance has swung too far in favor of the lenders, and order needs to be restored.
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