How to Fix the Broken Student Loan System

Seeking an Honorable Discharge

One of the fundamental problems is that since the law was amended in 2005, student debt cannot be discharged through bankruptcy.

That Bush-era modification of bankruptcy laws turned the basic precepts of debt upside down. With most loans, a borrower with a low credit score pays a higher interest rate to compensate the lender for the increased risk of default. But there is almost no risk of default when it comes to a student loan, because bankruptcy very rarely results in the discharge of the debt. So, lenders can throw lots of money at degree-seekers, whether or not they are suited for their educational pursuits (and whether or not those pursuits will yield the return that justifies the expenditure), and the bank-friendly 2005 bankruptcy law guarantees they'll get paid anyway. (If you're thinking, "That's not a credit market. That's legalized theft," you'd be right.) Petri's proposal serves to further deepen that rut.

The Company Store

Colleges and universities charge higher and higher tuition each year because there is an endless flow of federal loans and federally insured private loans protected by bankruptcy laws that are so lender-favorable they'd make a Feudal baron blush. With these ironclad guarantees that loans will be repaid, institutions keep the money spigots open, which in turn gives schools zero incentive to cut costs while creating optimal conditions for tuitions to increase exponentially.

I agree with the Obama administration, it's time to start treating student loans like any other type of debt and allow them to be erased by bankruptcy. That said, the administration's recommendations, which came by way of the Education Department and the Consumer Financial Protection Bureau this July, only apply to 15 percent of the total outstanding debt -- about $150 million in private student loan debt held by private lenders like SLM Corp.'s Sallie Mae and Wells Fargo. Why shouldn't the other 85 percent be treated the same way?

Freeing the Market to be a Free Market

If the federal government and private lenders choose to make student loans, they should also accept the risks inherent in lending. Maybe that means creating academic benchmarks that qualify would-be college students for vocation-specific educational loans. That's for them to determine. For sure it means stripping the immunity currently enjoyed by these institutions from borrower bankruptcies. The result of this simple change will re-introduce free market fundamentals, which will cause an adjustment to the cost of credit. Some students will pay higher interest rates on the money they borrow -- but they will also be more careful about what sort of credits they use it for. They will also be pickier about where they spend that money. These factors should exert downward pressure on tuition.

Colleges have adopted a corporate model of competition, building condo-like dormitories and outrageous student centers, installing state-of-the-art technology and Nobel Prize-winning labs at schools where no Nobel-level faculty can be lured, even with teetering mountains of cash and prizes used to lure the next best thing. It's the academic version of an arms race, and it will continue making college an engine for financial ruin for millions of young Americans until we, as a nation, start insisting on a reality principle -- that there should be some relationship between expenditure and the return on investment for students.

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