Why students should be able to kill their college debt
This week, the Obama administration made a bold move in the ongoing saga over the country's $1.2 trillion student debt crisis.
Back in April, Corinthian Colleges Inc., one of the biggest names in the for-profit college industry, collapsed after a long investigation into bogus advertising of job prospects and illegal debt-collection tactics. That left a few thousands students in the lurch, and thus eligible to have their debt forgiven. But this week's announcement expanded the offering to 350,000 former Corinthian students, if they can prove malfeasance on the part of the college when it recruited them. That could dispose of as much as $3.5 billion in student debt — the biggest such forgiveness in U.S. history.
And the specific mechanics of the plan go even further, offering debt forgiveness to any student from any for-profit and nonprofit institution who can demonstrate harm.
Unfortunately, we need to go further still. For one thing, the plan's details are pretty labyrinthine. But the deeper problem is this: It's basically impossible to get rid of student debt by filing for bankruptcy.
Technically, you can do it. But the federal government has introduced so many hurdles and hoops and delays that student debt is effectively un-killable. If the activists looking to do something about student debt want a big fish to fry, rewriting the bankruptcy code so it treats that debt like all other debt is as worthwhile a goal as any.
There's a buried assumption in the White House's plan that the debt that deserves forgiveness is the debt that was incurred thanks to criminal deceit. The unspoken corollary of that, of course, is that debt that's legally above-board should always be paid off.
Here's the thing, though: Debt is always a gamble, on the part of the the person or entity loaning the money as well as the person or entity borrowing it. Whenever you loan, you're placing a bet that some chunk of the economy — be that chunk a big corporation, a small start-up firm, a family, or even an individual — will economically perform in such a way that it can pay you the interest and the principal. And no one is entitled to having all their economic bets pay off. This is why investments in debt like bonds and mortgages and so forth are rated for their risk: We just take it as a given that some of this debt will fall through.
Framing it that way probably tastes bad to most Americans. We tend to moralize debt — an obligation that must be paid off as a matter of honor. But it takes two to tango, and creditors are also taking a risk when they loan. They're as responsible as anyone for making sure the risks they take aren't stupid, and for paying a price when they are.
The moralization of debt essentially introduces a cultural thumb on the scale in favor of creditors over debtors. And that should worry us in moral terms, since debtors tend to be much less powerful and wealthy than the people they owe money to.
The funny thing is, while America's moral norms may be unforgiving about debt, our actual bankruptcy law is far more humane. As Megan McArdle has pointed out, our approach to bankruptcy is considerably more generous than the way it generally functions in Europe, and this comes with a lot of aggregate economic benefits. "Less onerous bankruptcy procedures boost rates of entrepreneurship," McArdle wrote. "Reduce the cost of failure, and people become more willing to take risks. America's business environment is much more dynamic than that of Europe or Japan, for many reasons — and our generosity to capitalism's losers is one of them."
Obviously, for the markets to function, you want to incentivize against creditors indulging in debt that's too burdensome and extractive, and you want to incentivize against debtors getting out from under their obligations too easily. That's tricky, since debt contracts are inescapably a legal construct, which means how we structure those incentives often boils down to political choices. But it looks like America has done a better job threading the needle between those two countervailing needs than other western countries.
Now, you could argue that, because the government subsidizes student debt, it should be treated differently by the bankruptcy code. But it's not clear why the second point should follow from the first. The subsidization doesn't change the fundamental give-and-take between creditors and debtors. Having the government perpetually extract debt service from people is no better than having private actors do it.
Furthermore, all markets are just information processors. And the purpose of any market is to allocate scarcity. If what we want to do is make something (like education) less scarce, and thus make it more affordable, subsidizing the debt necessary to purchase it is a really terrible, inefficient, roundabout way of going about it. It introduces all sorts of weird complications and possible short circuits into the mix. (See: the housing crisis.) If we think higher education is an intrinsic good or even a universal right — and that debate is its own can of worms — the economically quick and clean way to make it less scarce is to just subsidize it directly. Reverse the long fall in public funding for colleges and universities, so more of their operating costs are born by the government and the price tag of a college education comes down.
In fact, the government's contribution to the student debt industry is now so bloated and inefficient that an equivalent sum could more or less make some form of higher education free for every person in the country.
But if we're not willing to call a spade a spade, then bringing bankruptcy's treatment of student debt more in line with how it treats other forms of debt is a good interim goal.
Intentionally or not, Americans have developed a bankruptcy code that treats most debt in an unusually sane way — both in economic and moral terms. We should take our own advice, and treat student debt the same way.