New Push on Bankruptcy Protections

Obama administration backs a legislative effort to make it easier for private student loans to be discharged in bankruptcy, a change long sought by consumer and student advocates.

October 2, 2015
 

The Obama administration is calling on Congress to make it easier for some student loan borrowers to erase their debt through bankruptcy, as part of a package of proposals aimed at helping Americans who are struggling with loan payments.

In a report released Thursday by the U.S. Department of Education, administration officials outlined a range of recommendations for improving the nation’s student loan system, most of which require congressional action.

Perhaps the most significant proposal -- and likely to be among the more contentious -- is for Congress to ease the process for private student loan borrowers seeking to have their loans wiped out through bankruptcy. The administration is proposing that Congress roll back a 2005 law, enacted at the behest of private lenders, which set a high bar for when bankruptcy filers can discharge their private student loan debt.

Consumer advocates and some congressional Democrats have long sought such a change, but this is the first time the Obama administration has backed a revision to the rules governing how student loans are handled in bankruptcy proceedings.

"All other types of consumer debt are dischargeable in bankruptcy and we think private student loans are a glaring exception," Under Secretary of Education Ted Mitchell said in an interview, explaining the administration’s new position.

"We feel strongly that while there are protections built into the [federal] direct loan program that are important for borrowers, there aren't parallel protections for borrowers in the private student loan market," Mitchell said. "We think it's important to do what we can to create those protections, and we think starting with a bankruptcy provision is the way to go.”

The administration’s proposal would not ease bankruptcy discharges across the board on private student loans. Instead it would extend the enhanced borrower protections only to private student loans that don’t offer flexible repayment plans like those granted to federal loan borrowers.

Meanwhile, the standard for discharging student loans made by the Education Department should not be lowered, the administration said in the report.

“There are strong grounds for maintaining different standards for federal student loans,” the report says. “Federal loans are not underwritten, have generous terms and protections, and the payments can be limited based on income.”

Private student loans, by contrast, tend to lack some of those protections and can leave “borrowers in financial distress with few options,” officials wrote.

Beyond changes to bankruptcy, the administration also proposed adding other consumer protections to private student loans, such as banning private lenders from automatically declaring a loan in default when a co-signer dies.

Penalties for For-Profit Executives, Tax Code Changes

The Education Department report, which President Obama ordered earlier this year as part of what he called the Student Aid Bill of Rights, also recommends an expansion of the department’s powers to hold college executives personally liable for fraud committed at the institutions they run.

Administration officials said they wanted “new statutory requirements that hold colleges and their executives -- not taxpayers -- responsible for fraudulent acts.”

That proposal is aimed at addressing the “need to hold executives accountable, directly and personally, for malfeasance,” Mitchell said. “We are able to fine schools, we're able to sanction institutions, but we don't have tools to sanction individuals.”

A group of Senate Democrats earlier this week introduced similar legislation.

The report also recommends that Congress allow students who were defrauded by their college and successfully prove their case to the Education Department under its new debt relief process should have their Pell Grant eligibility restored.

In addition, Congress should eliminate taxes on the amount of student loan debt forgiven under the federal income-based repayment programs, the report says.

Enrollment in such plans, which typically forgive unpaid balances after a borrower makes payments for 20 or 25 years, has surged in recent years as the administration has expanded and heavily promoted them. But when the government begins canceling student loan debt under those programs, which could start as early as 2017, borrowers will have to consider the amount of loan forgiveness as taxable income.

Changes to Federal Loan Servicing?

The report also outlines some general principles for how the Education Department should improve its system for hiring companies to collect federal student loans. The department’s oversight of federal student loan servicers has been a frequent target of criticism from consumer, labor and student groups as well as some congressional Democrats and other federal agencies.

The recommendations arrive amid a flurry of activity in recent weeks surrounding federal loan servicing. The Government Accountability Office said in a study released last week that the Education Department’s loan servicers had done too little to help borrowers sign up for income-based repayment plans. And earlier this week, the Consumer Financial Protection Bureau said it is exploring new regulations to crack down on what it sees as abuses in the student loan servicing industry.

“There’s a rapidly growing consensus to correct the serious deficiencies in the student loan servicing industry,” said Rohit Chopra, the former student loan ombudsman at the Consumer Financial Protection Bureau who now serves as a senior fellow at the Center for American Progress. “The industry is at a critical inflection point: either quickly clean up its practices or face a very uncertain road ahead.”

For its part, the Education Department has said it wants to conduct an overhaul of the existing contracts it has with its loan servicers, which was originally slated for later this year.

Mitchell said Thursday that the department is “still working out the specifics” of redoing the contracts, which he said the department expects to put out for bid early next year.

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