In the United States it is very hard to get rid of student loans. They cannot be discharged in bankruptcy except for under extenuating circumstances. I find that bizarre given how people are encouraged to go to school but this law discourages lower income individuals from making it to schools.
I've heard that this was a part of a bankruptcy law signed in the early 2000s, but I don't remember what it was called. What is the motivation behind this decision?
I don't think there's a clear and definitive reason. The Nondischargeability of Student Loans in Personal Bankruptcy Proceedings: The Search for a Theory by John A. E. Pottow of the University of Michigan Law School explores the very question you ask here. It provides 6 six reasons for making student loans nondischargeable. I'll try to summarize those reasons a bit by quoting some introductory paragraphs for all six reasons.
Section three of the linked paper focuses on your question:
III. POSSIBLE THEORIES FOR NONDISCHARGEABILITY
U.S. bankruptcy law treats student loans as nondischargeable debts. Why is that so? There are several plausible theories under which educational debt should be treated as nondischargeable.
The six reasons provided by the article are as follows (note that the article itself provides more details than the limited quotes here):
One long-standing reason for holding bankruptcy debts nondischargeable is fraud. Accordingly, one theory for subjecting student loans to a nondischargeability rule is an assumption that they are presumptively fraudulent.
Elaborating on what fraud means in this case:
To say that a loan is fraudulent is to say, or postulate as a rule of thumb, that students intend to take out huge sums of money with no intention whatsoever, from the ex ante perspective, of ever paying them back. While it may be a dramatic assumption, it is one that would provide a sound theoretical basis for a nondischargeability rule.
A more likely fraud-animated foundation for nondischargeability of student debt is what might be called "soft fraud", although that is an imperfect label. "Opportunism" also captures the concern, but that too is problematic because "opportunism" is a notoriously amorphous concept in bankruptcy.
To elaborate what soft fraud means in this case, the article provides the following example:
In any event, the opportunism concern of "soft" fraud is as follows: Perhaps without the malice aforethought of traditional fraud, Student takes out a six-figure loan to finance her undergraduate and graduate education. [...] Her first year out into the real world, however, hardens her. She realizes she faces the prospect of amortizing a multidecade loan, when she has few personal assets to her name other than well-highlighted law books. She has no appreciable savings (as a rational life cycle consumer, she had no inclination to accrue them yet), no home, and perhaps a beat-up car at best. But she has lots of difficult-to-monetize, let alone liquidate, human capital in the form of her J.D. degree.36 Recognizing that the price exchanged for the bankruptcy discharge is giving up all her non-exempt assets, she happily trades in the car for unfettered access to that high future income stream. There is a perverse temporal arbitrage of sorts. She gets to pick her debt relief at the point in time when her realizable assets and present income are at their lowest and her debt and future income are at their highest. Her impecunity is transient and arguably artificial.
This theory builds on the notion that the recipient of a private benefit (here, education) should have to bear its cost (here, the debt for tuition).
As the article explains through the example of future lawyers and who pays for them:
If tuition debt is publicly subsidized and then discharged, the benefit is realized privately but the cost is shifted back to the public. Indeed, some enthusiasts of "constructing"'" education as a private benefit go even further. Here, it is not even higher earning, but the chance for higher earning, that is the private benefit of education. The unsuccessful lawyer must bear that cost just as much as the successful one, lest the taxpayer fall into the role of guarantor of financial success (of lawyers!).
The article mentions that this is probably not the main reason, but that it is a "logically coherent rationale" nonetheless.
The argument is that students fall into a class of morally deficient debtors whom society wants to stigmatize and punish for non-economic reasons. Indeed, as mentioned, a paradigmatic nondischargeable debt is the intentional tortfeasor's.
A wholly different justification for treating student loans as nondischargeable in bankruptcy proceedings is couched in terms of "protecting" the solvency of the public student loan programme, which is perceived to be in a crisis.
As the article goes on to explain:
If bankruptcy law treats student loans leniently, then more students at the margin will be inclined to "take bankruptcy" and discharge their loans. And if more students discharge their federally insured loans in bankruptcy, then more federal dollars will be devoted to bailing out failed loans (and reimbursing guaranteed lenders) than might otherwise be devoted to making initial loans to new students. Here, bankruptcy policy becomes an indirect lever for education policy. If bankruptcy policy can be altered to make it harder to default on student loans (e.g., changing otherwise dischargeable debts to become nondischargeable), then incentives will change.
If an otherwise dischargeable unsecured debt is rendered nondischargeable by the law, then the bankruptcy-state scenario regarding that debt becomes worse for the debtor (it does not go away) and better for the lender (it does not go away). In a world of competitive, zero-profit lending markets, this increased payoff for the lender must be translated ex ante into an improved cost of capital for the borrower. Without addressing the empirical likelihood of this competition, it suffices to observe that making bankruptcy harsher for the debtor, at least from the standpoint of economic theory, makes borrowing more affordable for that debtor in particular and all borrowers generally (especially in a world where it is difficult or expensive to distinguish good from bad borrowers up front).
In other words, because the risk associated with these dischargeable loans is lower from the lender's perspective, the free market should lower the cost of borrowing for all debtors.
Also adding the recommended citation for the source of the quotes:
Pottow, John A. E. "The Nondischargeability of Student Loans in Personal Bankruptcy Proceedings: The Search for a Theory." Canadian Bus. L. J. 44, no. 2 (2007): 245-78.
While this answer doesn't specify which reasons actually came up when the law was debated, it does provide a number of arguments that defenders of nondischargeable student loans would give.
The limitations on the discharge of student loans was hardened in the 2005 Act but long predates it.
The basic notion is that the education that you receive in exchange for a student loan is not collateral that can be recovered by a creditor. You get to keep your education, no matter what.
Since this is a big investment and provides economic benefit to someone who has received it for a long period of time, it makes sense to amortize the loan over a long period of time, if it is paid in full.
But people have the lowest incomes of their lives shortly after they graduate from college in most cases, and usually have accumulated very few assets at that point in their life.
Since bankruptcy exchanges your current assets (excluding assets exempt from creditor's claims which most assets of recent college graduates are) and at most a small portion of three to five years of income for the sum total of all of your dischargeable debts, if you could discharge a student loan on the same basis of debts owed to other general creditors, almost everyone would find it to be economically rational to file for bankruptcy.
And, actually, in the case of people who earn a degree, and get any professional certifications in their chosen field, and are able to work in that field, the default rate on student loans is very low.
The problem is that the logic behind not allowing student loans to be discharged is flawed. It only makes sense if the education purchased with the student loan is something that generates an increase in future monthly income much greater than the student loan payment amount. When this logic fails, the inability to discharge student loans becomes an unfair hardship that defeats the purpose of bankruptcy of allowing someone a fresh start.
This could be because the student didn't graduate, or didn't successfully get licensed in a relevant profession, or didn't get a job, or was disabled and unable to work, for example.
Under pre-2005 law student loans could be discharged for hardship, but the legal threshold was tightened in 2005 out of a concern that too often someone who was able to pay was able to convince a judge that it was a hardship. From the perspective of finance industry lawyers, reducing the litigation of collecting student loans from bankrupts was a greater priority than relieving overwhelmed debtors which they had the power but not the obligation to do without bankruptcy. And, people with student loan hardship rarely have much in the way of lobbying might in Congress.
Why are US student loans nearly impossible to remove via bankruptcy?
History of Student Loans: Bankruptcy Discharge, March 18, 2021, identifies changes in bankruptcy law, that added more and more restrictions on the discharge of student loans through bankruptcy.
Further Legislative Changes Related to Bankruptcy Law and Student Loans
In 1978, the exception to bankruptcy discharge of student loans was moved from the Higher Education Act to the U.S. Bankruptcy Code at 11 USC 523(a)(8) with the passage of the Bankruptcy Reform Act. While the bill written in the House of Representatives had proposed reversing the 1976 reforms, the Senate version prevailed. An amendment the next year clarified that the five year limit applied to loans backed “… in whole or in part by a governmental unit or a nonprofit institution of higher education.”
In 1984, the Bankruptcy Amendments and Federal Judgeship Act of 1984 further tightened the rules on bankruptcy discharge by dropping “of higher education” from the wording of the legislation. This broadened the restrictions on discharge to include private loans backed by non-profit institutions as well as government loans.
The Crime Control Act of 1990 extended the period before which bankruptcy proceedings could commence to seven years after repayment began.
In 1991, the six-year statute of limitations on collection of defaulted loans, which had been established in 1985, was completely eliminated by the Higher Education Technical Amendments.
Tightening Restrictions
Further legislation was even less generous toward student debtors. By 1998, the seven-year period after which student loan debt could potentially be eliminated through bankruptcy proceedings was also eliminated with the passage of another set of Higher Education Amendments. Thus, the nebulously defined “undue hardship” was the only remaining provision under bankruptcy law which student loans could be discharged.
Seven years later, in 2005, all qualified education loans, including most private loans, were excepted from discharge with the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act. Private student loans no longer needed to be associated with a nonprofit institution to be excepted from bankruptcy discharge.
I've heard that this was a part of a bankruptcy law signed in the early 2000s, but I don't remember what it was called. What is the motivation behind this decision?
In summary, the 2005 law tightened discharge rules due to continuing claims of bankruptcy abuse and effective lobbying by the financial services industry.
Note that "student loans" were not the only target of the law. The primary effect of the law on student loans was the addition of exceptions from discharge for certain private loans. As noted above: Private student loans no longer needed to be associated with a nonprofit institution to be excepted from bankruptcy discharge." Generally, the law intended to make more uniform the courts' decisions regarding "ability to repay ... from future earnings."
The law is: S.256 - Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. A Wikipedia article is available.
The "motivation" as cited in House Judiciary committee report is given here.
H. Rept. 109-31 - Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
FACTORS SUPPORTING BANKRUPTCY REFORM
Representing the most comprehensive set of reforms in more than 25 years, S. 256’s consumer bankruptcy provisions respond to several factors. First, the recent escalation of consumer bankruptcy filings does not appear to be just a temporary event, but part of a generally consistent upward trend. In 1998, for example, bankruptcy filings exceeded one million for the first time in our nation’s history. Over the past decade, the number of bankruptcy filings has nearly doubled to more than 1.6 million cases filed in fiscal year 2004. As a result, there is a growing perception that bankruptcy relief may be too readily available and is sometimes used as a first resort, rather than a last resort. Despite the view of opponents of bankruptcy reform that abuse in the system is not widespread and that most bankruptcy filings result from causes beyond debtors' control, such as family illness, job loss or disruption, or divorce, the Committee concluded that reforms were nevertheless necessary.
Second, there are significant losses asserted to be associated with bankruptcy filings. As one witness explained during the Senate Judiciary Committee’s hearing on S. 256 earlier this year:
Like all other business expenses, when creditors are unable to collect debts because of bankruptcy, some of those losses are inevitably passed on to responsible Americans who live up to their financial obligations. Every phone bill, electric bill, mortgage, furniture purchase, medical bill, and car loan contains an implicit bankruptcy "tax" that the rest of us pay to subsidize those who do not pay their bills. Exactly how much of these bankruptcy losses is passed on from lenders to consumer borrowers is unclear, but economics tells us that at least some of it is. We all pay for bankruptcy abuse in higher down payments, higher interest rates, and higher costs for goods and services.
According to some analyses, the increase in consumer bankruptcy filings has adverse financial consequences for our nation’s economy. For instance, it was estimated that in 1997 alone more than $44 billion of debt was discharged by debtors who filed for bankruptcy relief, a figure when amortized on a yearly basis amounts to a loss of at least $110 million every day. These losses, according to one estimate, translate into a $400 annual "tax" on every household in our nation. In 2003, the Nilson Report (a credit industry newsletter) announced that issuers of proprietary and general purpose credit cards "lost $18.9 billion in 2002 from consumer bankruptcy filings," an increase of 15.1 percent over the prior year. The Credit Union National Association (CUNA) reported that credit unions, as of 2002, lost "nearly $3 billion from bankruptcies" since Congress began its consideration of bankruptcy reform legislation in 1998. CUNA estimates that over 40% of all credit union losses in 2004 will be bankruptcy-related, and those losses will total approximately $900 million.
A third factor motivating comprehensive reform is that the present bankruptcy system has loopholes and incentives that allow and — sometimes — even encourage opportunistic personal filings and abuse. A civil enforcement initiative undertaken in 2002 by the United States Trustee Program (a component of the Justice Department charged with administrative oversight of bankruptcy cases) has "consistently identified" such problems as "debtor misconduct and abuse, misconduct by attorneys and other professionals, problems associated with bankruptcy petition preparers, and instances where a debtor’s discharge should be challenged." According to the United States Trustee Program, "Abuse of the system is more widespread than many would have estimated." Such abuse ultimately hurts consumers as well as creditors.
A fourth factor relates to the fact that some bankruptcy debtors are able to repay a significant portion of their debts, according to several studies. Current law, however, has no clear mandate requiring these debtors to repay their debts. Accordingly, "[w]hile there is a universal agreement among the courts that an individual debtor’s ability to repay his or her debts from future earnings is, at the very least, a factor in determining whether substantial abuse would occur in a chapter 7 case, there are differences among the courts as to the extent to which they rely on a debtor’s ability to repay."
Because Joe Biden lobbied the passage of the BAPCPA bill in 2005 at the behest of his corporate benefactors from Delaware (which he was a congressman of at the time), thus stripping Bankruptcy Protection from millions of students just before the recession of 2007.
Delaware is a banking haven state, and banks benefitted from students' inability to get out of the debt.
Sources:
"How Biden Helped Strip Bankruptcy Protection From Millions Just Before a Recession" https://www.gq.com/story/joe-biden-bankruptcy-bill
"How Biden helped create the student debt problem he now promises to fix" https://www.theguardian.com/us-news/2019/dec/02/joe-biden-student-loan-debt-2005-act-2020
