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July 6, 2020

Debt relief is now harder for students of for-profit colleges

[Cross-posted from The Hill]

By John Patrick Hunt

For-profit colleges are accused of deceiving students across the nation and leaving them with a legacy of student debt. Predatory schools allegedly targeted veterans for their GI benefits and also set their sights on lower-income communities and communities of color.

Now, new, controversial rules will make it more difficult for deceived student borrowers to get relief from their loans. The rules went into effect July 1, after President Trump — ignoring veterans and consumer groups — vetoed a resolution that would have stopped them.

More than 300,000 student borrowers have applied to the Department of Education for loan relief. based on school misconduct. The collapse of large chains of for-profit schools such as Corinthian CollegesITT, and the Art Institutes have highlighted allegations of false job placement statistics, misleading accreditation claims, deceptive claims about financial aid, and costs of attendance, and more.

After years of wrangling, in late 2018 a court ordered into effect rules the Obama administration had drafted to help deceived borrowers. But by that time, the department, now led by Secretary Betsy DeVos, was far along in drafting new rules. 

The DeVos rules make it harder for borrowers to get relief in many ways. One critical change is that the department can no longer handle similar claims in batches, for example providing relief to everyone who entered a program after the school lied about employment statistics. Now each individual borrower is on their own.

Moreover, those individual borrowers now must prove that the school made misrepresentation with the knowledge that it was false or with reckless disregard for the truth. An individual borrower usually will not be able to prove a school’s state of mind — the rules do not say how borrowers can get evidence on the point — so opponents of the new rules have aptly described them as imposing a “near-impossible” standard of proof. 

Although a pending lawsuit challenges the rules, its prospects are uncertain. With the Education Department abdicating its responsibility to protect student borrowers from fraud and deception, it is time to think about consumer bankruptcy as another avenue for relief. 

Despite a perception that it is impossible to escape student loans in bankruptcy, studies have found that 40-60 percent of borrowers who actually seek to do so enjoy at least some success. The main obstacle for the other 40-60 percent is the requirement, unique to student loans, that the borrower show “undue hardship” to get a discharge.

In evaluating undue hardship, courts typically look to factors such as the debtor’s age, health, and family responsibilities, as well as the repayment efforts the debtor has already made. By contrast, courts almost never consider whether the borrower was tricked into taking out the loan in the first place.

It is not entirely clear why this is so. Perhaps it is because courts developed their tests for undue hardship before enrollment at for-profit schools took off. For-profits reportedly have accounted for over 98 percent of higher education fraud complaints.

It is now time for a change. Bankruptcy courts should start to consider whether the school deceived the borrower into enrolling. Dictionaries tell us that the word “undue” means unjustifiably great. As between two borrowers, each of whom will suffer equally in trying to repay student loans, the one who was deceived has a stronger claim that hardship is “undue.”

The federal government makes most student loans, and it might be argued that the government is not responsible for schools’ misconduct. But since 1976, private consumer lenders have been responsible for sellers’ deception if the seller refers the buyer to the lender. Schools do more than “refer” students to federal student loans; they run the entire process of originating the loans under the department’s supervision.

Chapter 7 bankruptcy can affect credit scores, cause social stigma, and require the sale of the debtor’s property. It will not be an attractive option for all victimized borrowers.

However, many deceived borrowers must be in such financial distress that bankruptcy makes sense. Courts can apply bankruptcy law to offer a greater chance of relief than the DeVos rules do. And most importantly, bankruptcy courts can provide relief even if the political process in Washington, D.C is stalled.

Student loans are a source of rising anger and frustration, and loans arising from fraud are among the most infuriating. Bankruptcy courts must step in to help where the education department has failed.

July 15, 2019

Student loan borrowers are defaulting yearly -- how can we fix it?

[Cross-posted from The Hill]

Over a million borrowers defaulted on student loans last year. Many of those carrying this debt file for bankruptcy. In fact, an estimated one-third of bankruptcies involve student loans. But what many people might not know is that in bankruptcy, student loan debt is rarely forgiven. One researcher found that of over 230,000 student-loan borrowers who filed bankruptcy in 2007, under 450 — less than 0.2 percent — even tried to discharge their education loans. 

Presidential candidate Beto O’Rourke just proposed a large-scale debt-forgiveness program to help address the problem. Fellow candidates Sens. Elizabeth Warren (D-Mass.) and Bernie Sanders (I-Vt.) already offer such programs. But such relief will come, if at all, after the presidential election. In the meantime, bankruptcy should be a more readily available option for truly overwhelmed borrowers.

Congress is considering bills proposed by Warren and Sen. Richard Durbin (D-Ill.) and by Reps. John Katko (R-N.Y.) and Jerrold Nadler (D-N.Y.) that would make it easier for borrowers to escape, or discharge, student loans in bankruptcy. Recently, the House Judiciary Committee held hearings on student loan bankruptcy.

The bills would eliminate a requirement that applies to student loans and not to any other type of debt: To get a discharge, the student-loan borrower must undertake the daunting task of suing the creditor within the bankruptcy and proving that repayment would cause the borrower “undue hardship.” 

By severely restricting bankruptcy relief, the undue-hardship requirement undercuts the basic purposes of the student loan programs: equal access to higher education, benefiting society through educating the population, and helping students.

Excessive debt can undermine access to education. Research has shown that high undergraduate borrowing is associated with lower graduation rates and with not pursuing further education

Bankruptcy can help tear down this barrier. It is a fundamental premise of American bankruptcy law that bankruptcy discharge is a powerful remedy for discouragement caused by unmanageable debt, and that notion applies fully to education debt. 

The undue-hardship requirement also can interfere with education’s benefits to society. In a recent Florida case, the debtor worked at a Salvation Army shelter as a counselor to battered and abused women. According to the record, she was “at the top of her profession” and “unlikely to find other work in her field that would pay more.” 

The court refused to grant relief, no matter how low her standard of living. According to the court, a debtor cannot claim undue hardship if she “choose[s]” to work only in the field in which she was trained. The court effectively told the debtor to abandon her successful, if lower-paying, career to try to make more money to pay loans. It interfered not just with her own career choice, but with society’s ability to benefit from her education.

Finally, the undue-hardship requirement transforms an intended benefit into a high-stakes gamble. Congress intended borrowers to repay out of increased earnings, not to suffer because of failed educational investments

Of course, student loans can help borrowers by making education possible. But loans can also harm students. Researchers have found links between education debt and lower income, net worth, and probability of owning a house or car, as well as self-reported mental health, life satisfaction, and well-being

The harms can outweigh the benefits. For example, one bankrupt debtor borrowed over $50,000 for an information management master’s degree, could not find a job in the field, and worked as a telemarketer. The gamble did not pay off for him. 

Congress should enact legislation, such as that under consideration, to alleviate or eliminate the “undue hardship” requirement that obstructs bankruptcy relief for overwhelmed student borrowers. But even if Congress does not act, other actors should step in to limit the harm caused by the undue-hardship requirement.

The Department of Education makes the rules governing student loans issued under federal programs — the large majority of student loans outstanding. The department is considering changing those rules. It should, as others have suggested, adopt a policy of agreeing to discharge under certain defined circumstances that indicate severe hardship and inability to pay, such as when the debtor is disabled and has an income under 150 percent of the poverty level. By sparing such struggling borrowers the hassle of litigating a case in bankruptcy court and by providing clear rules, such a decision could help thousands each year. 

The courts have broad latitude to interpret “undue hardship.” They should move toward granting discharge more consistently and freely. For example, they should stop insisting that debtors abandon callings at which they have achieved success so that they can repay debts. Further, courts should allow discharge when the borrower cannot repay the loans within a reasonable time, such as 10 years, while maintaining a lifestyle well above the poverty level.

Thus, there are several ways to mitigate the undue-hardship requirement’s interference with achieving the student-loan programs’ goals. With over a million borrowers defaulting each year, the need for action — one way or another — is urgent.

 

July 15, 2019

Student loan borrowers are defaulting yearly -- how can we fix it?

[Cross-posted from The Hill]

Over a million borrowers defaulted on student loans last year. Many of those carrying this debt file for bankruptcy. In fact, an estimated one-third of bankruptcies involve student loans. But what many people might not know is that in bankruptcy, student loan debt is rarely forgiven. One researcher found that of over 230,000 student-loan borrowers who filed bankruptcy in 2007, under 450 — less than 0.2 percent — even tried to discharge their education loans. 

Presidential candidate Beto O’Rourke just proposed a large-scale debt-forgiveness program to help address the problem. Fellow candidates Sens. Elizabeth Warren (D-Mass.) and Bernie Sanders (I-Vt.) already offer such programs. But such relief will come, if at all, after the presidential election. In the meantime, bankruptcy should be a more readily available option for truly overwhelmed borrowers.

Congress is considering bills proposed by Warren and Sen. Richard Durbin (D-Ill.) and by Reps. John Katko (R-N.Y.) and Jerrold Nadler (D-N.Y.) that would make it easier for borrowers to escape, or discharge, student loans in bankruptcy. Recently, the House Judiciary Committee held hearings on student loan bankruptcy.

The bills would eliminate a requirement that applies to student loans and not to any other type of debt: To get a discharge, the student-loan borrower must undertake the daunting task of suing the creditor within the bankruptcy and proving that repayment would cause the borrower “undue hardship.” 

By severely restricting bankruptcy relief, the undue-hardship requirement undercuts the basic purposes of the student loan programs: equal access to higher education, benefiting society through educating the population, and helping students.

Excessive debt can undermine access to education. Research has shown that high undergraduate borrowing is associated with lower graduation rates and with not pursuing further education

Bankruptcy can help tear down this barrier. It is a fundamental premise of American bankruptcy law that bankruptcy discharge is a powerful remedy for discouragement caused by unmanageable debt, and that notion applies fully to education debt. 

The undue-hardship requirement also can interfere with education’s benefits to society. In a recent Florida case, the debtor worked at a Salvation Army shelter as a counselor to battered and abused women. According to the record, she was “at the top of her profession” and “unlikely to find other work in her field that would pay more.” 

The court refused to grant relief, no matter how low her standard of living. According to the court, a debtor cannot claim undue hardship if she “choose[s]” to work only in the field in which she was trained. The court effectively told the debtor to abandon her successful, if lower-paying, career to try to make more money to pay loans. It interfered not just with her own career choice, but with society’s ability to benefit from her education.

Finally, the undue-hardship requirement transforms an intended benefit into a high-stakes gamble. Congress intended borrowers to repay out of increased earnings, not to suffer because of failed educational investments

Of course, student loans can help borrowers by making education possible. But loans can also harm students. Researchers have found links between education debt and lower income, net worth, and probability of owning a house or car, as well as self-reported mental health, life satisfaction, and well-being

The harms can outweigh the benefits. For example, one bankrupt debtor borrowed over $50,000 for an information management master’s degree, could not find a job in the field, and worked as a telemarketer. The gamble did not pay off for him. 

Congress should enact legislation, such as that under consideration, to alleviate or eliminate the “undue hardship” requirement that obstructs bankruptcy relief for overwhelmed student borrowers. But even if Congress does not act, other actors should step in to limit the harm caused by the undue-hardship requirement.

The Department of Education makes the rules governing student loans issued under federal programs — the large majority of student loans outstanding. The department is considering changing those rules. It should, as others have suggested, adopt a policy of agreeing to discharge under certain defined circumstances that indicate severe hardship and inability to pay, such as when the debtor is disabled and has an income under 150 percent of the poverty level. By sparing such struggling borrowers the hassle of litigating a case in bankruptcy court and by providing clear rules, such a decision could help thousands each year. 

The courts have broad latitude to interpret “undue hardship.” They should move toward granting discharge more consistently and freely. For example, they should stop insisting that debtors abandon callings at which they have achieved success so that they can repay debts. Further, courts should allow discharge when the borrower cannot repay the loans within a reasonable time, such as 10 years, while maintaining a lifestyle well above the poverty level.

Thus, there are several ways to mitigate the undue-hardship requirement’s interference with achieving the student-loan programs’ goals. With over a million borrowers defaulting each year, the need for action — one way or another — is urgent.

April 28, 2010

Fixing the Rating Agencies

Credit rating agencies are back in the public eye as the Senate Permanent Subcommittee on Investigations releases another trove of embarrassing agency e-mails and the financial reform bill nears enactment.  In this context, a proposal by two professors at NYU's Stern School of Management, Lawrence White and Matthew Richardson, to improve credit rating agency performance by having the SEC decide which agencies will rate each instrument has attracted favorable attention from commentators such as Paul Krugman.  Although the proposal is refreshing in its boldness and offers a potentially useful way to address one of the many problems besetting the agencies, it should not be understood as a complete solution.  The complementary issue of rating-agency accountability for poor quality should also be addressed.

By now, the background story is familiar: Rating agencies - Moody's, Standard & Poor's, and similar firms whose business it is to assess the likelihood that debt obligations will be paid as agreed - gave their stamp of approval to innovative financial products that were in fact incomprehensible and/or based on the premise of an unending real-estate boom.  Panic set in when everyone realized that the ratings were wrong or unsupported.  The details and even the basic correctness of this narrative are disputed, but the major rating agencies have all more or less conceded that there was a problem of some kind:  their ratings on novel financial products didn't do  as well as they could have.

What exactly are the problems with the rating agency market?  There are several candidates:

(1) Lack of competition.   The SEC says that the three largest agencies have over 97% of the market, as measured by number of ratings outstanding.

(2) Absence of transparency.  Market participants complain that it is hard for users to know what the agencies do and how well their ratings perform.

 (3) Financial regulators' reliance on credit ratings in their rules.  If the rules say that regulated firms like banks and insurance companies have to own financial instruments with credit ratings, then there will be a demand for credit ratings, even if the agencies have no idea what they are doing. 

(4) The "issuer pays" business model.  The firms selling the financial products usually are the ones who pay for the ratings.  "Issuer pays" poses an obvious conflict of interest, as rating agencies have an incentive to please their customers, who are the people selling the products, not those buying them.

 (5) Absence of accountability.  There is no clear way to hold rating agencies liable for poor performance unless it rises to the level of fraud.

Congress' and the SEC's actions to date have focused mainly on the first two issues, competition and transparency:  Legislation passed in 2006 and rules adopted since then have focused on trying to get more rating agencies into the market and on increasing disclosure about what the agencies are doing, what data they're using, and how they're performing.  There has been fitful action on the third issue.  Starting in 2008, the SEC and other regulators have considered reducing their use of credit ratings in their rules, but they have not eliminated their reliance on credit ratings and do not seem to be on track to do so, although deliberations are ongoing.  The problem here is that financial regulators need a measure of credit risk, and it is not clear what would take the place of credit rating agencies, an issue I took up in this article last year. 

The White and Richardson proposal focuses on the fourth issue.  The idea is to remove issuers' ability to shop for high ratings from agreeable rating agencies by using the SEC to assign the agency that will rate each debt instrument.  Under the proposal, the issuers still pay for the rating, but they pay the agency that the SEC selects to do the rating.  The SEC will make its selection based on its assessment of which agency  is likely to do the best job, thus eliminating the conflict of interest that arises from the issuer-pays business model.  This is an innovative idea, and its boldness is refreshing given the limited scope of the reforms that have even been considered to date.  White and Richardson would fundamentally restructure the rating market - indeed, they apparently would eliminate the rating "market" and substitute SEC assignment. 

Of course, those who think that government can't do anything right will oppose this idea, arguing that the regulators are corruptible, capturable, and/or unskilled at evaluating the performance of rating agencies.   Those who think the SEC in particular is the wrong choice - pointing perhaps to the Madoff affair, to the SEC's oversight of the Wall Street investment banks leading up to the financial crisis, or to allegations that the SEC has been biased toward the large incumbent rating agencies - will oppose the choice of this particular regulator.  Those who think that government approval of rating agencies led to excessive reliance on them will observe that the proposal could exacerbate that problem.  I'll note all three sets of objections and set them to the side for the moment.   

I have two different concerns about this proposal.  First, it seems overbroad to prohibit agencies from expressing their opinions unless authorized to do so by the SEC.  If the SEC selects Moody's to rate a bond, should S&P really be barred from opening its mouth about that bond?  Even setting to one side the agencies' more extravagant First Amendment claims, this seems problematic.  The overbreadth concern could be addressed without changing the essence of the proposal by saying either that the SEC-selected agency is the only one whose ratings "count" for regulatory purposes or that only the SEC-selected can be paid by an issuer, leaving other agencies free to express their opinions in other contexts.

Second, the White and Richardson proposal doesn't address what I see as a central problem:  When confronted with a large and growing market for a set of novel products, agencies that are paid by the rating (or otherwise based on the volume of their business) have a financial incentive to issue ratings on those products even if they don't know what they are doing.  After all, the more ratings, the more revenue - even if the technical complexity or novelty of the product means that the agency can't do a good job.  Indeed, White & Richardson acknowledge this issue, stating that "it's surprising that rating agencies would even attempt to rate" certain types of novel products because of the technical difficulty of doing so.  But under their proposal, agencies apparently still are paid by the rating even though they are selected by the SEC:  The more ratings, the more revenue.  That enticement to poor quality still exists even though the issuer-pays problem may be eliminated.

This problem can be addressed by taking on the fifth issue, rating agency accountability.  Eventually, poor-quality ratings will be discovered and if the agencies know they will have to give up their profits from the poor-quality ratings in that event, that reduces their incentive to issue ratings when they don't know what they are doing.  An article I wrote two years ago addressing this point can be found here

The Dodd bill takes steps in the direction of accountability by clarifying that a rating agency can commit fraud by failing to conduct a reasonable investigation of facts upon which it relies and by empowering the SEC to decertify rating agencies that consistently produce poor-quality ratings.  Neither of these provisions really addresses agencies' temptation to issue ratings when they don't know what they're doing.  Decertification is a weak remedy, as credit rating agencies can operate without being certified, and the requirement to conduct a factual investigation doesn't go to the fundamental question, which is whether the agency knows what to do with the facts that it has. 

The Dodd bill does provide for further study of agencies' incentives to produce high-quality ratings, so even if neither the White and Richardson proposal nor a stronger rating-agency accountability provision makes it into the financial reform bill that seems likely to be passed soon, there is some chance that the complementary issues of issuer-pays and accountability will be addressed.