Now Here’s a Bad Idea–Allowing Discharge of Student Loans in Bankruptcy

Yeah, I get the idea–if people don’t have to pay their debts now it is like we are giving a big random stimulus because people can buy new stuff and don’t have to pay for old stuff.  So they have more money.  And this is a wonderfully political gambit to give a windfall to middle-class families and over-educated and over-aggrieved OWS majors.  And higher ed would be cheaper if you couldn’t borrow money to finance it.

But that would be the effect–you wouldn’t be able to borrow money to go to college any more.  As my old friend Marcus Cole ably explained to the Senate a few weeks back when this issue was proposed.  The problem, of course, is that the moral hazard and adverse selection problems here are extreme: when most people graduate from college they are massively insolvent.  They have huge debts and very few assets (a used car perhaps).  But they have a huge future potential income stream.  Bankruptcy would allow them to shed the debts, keep their meager assets, and then protect all of that future revenue stream.  In the face of those incentives it is hard to imagine that the student loan market could exist at all, really, or would do so only at such high cost and other terms (collateral, co-signers, etc.) that it would defeat the purpose, which is to allow people to borrow now to make an investment in their human capital (just like any other capital investment).

Higher ed is too expensive and there is too much student debt (I’ve actually been concerned about student loan debt for years, back when I would tell everyone who was concerned about student credit cards that they were looking in the wrong place).  But the indirect approach of allowing discharge of student loans, and thereby unraveling the student loan market, isn’t a very productive way of thinking of it.

I don’t have a strong opinion on whether the current rules for discharge of student loans in bankruptcy are too stringent or not.  But they at least try to aim at the right question of trying to distinguish legitimate hardship from opportunism.