Trying to Shed Student Debt

By JOSH MITCHELL

The growth of student debt is stirring debate about whether the government should step in to ease the burden by rewriting the bankruptcy laws—again.

In 2005, Congress prohibited student debt from being discharged through bankruptcy, except in rare cases, because of concerns that many young graduates—who often have no major assets such as a house or a car—would be tempted to walk away from loan obligations.

As the House of Representatives debates how to pay for preventing interest on college loans from doubling, FinAid.org publisher Mark Kantrowitz checks in on Mean Street to examine the showdown between the White House and Congress and the potential impact of higher interest rates on students. Photo: AP.

SmartMoney's AnnaMaria Andriotis looks at the battle over student loans and why banks have taken steps to make sure that a proposal in Congress to forgive some loans won't work. Plus, can private student loans undercut federal rates? Photo: Getty Images.

Some lawmakers now want to temper that position, pointing to concerns that a significant number of Americans could be buried under education loans for decades. Their efforts, however, would apply only to private loans—a fraction of the market.

In the past decade student debt has surged as tuition and enrollment climbed. At the same time, college graduates' earnings have declined. The average debt load of all new graduates rose 24%, adjusted for inflation, from 2000 through 2010, to $16,932, says the Progressive Policy Institute, a left-leaning think tank in Washington. Over the same period, the average earnings of full-time workers ages 25 to 34 with no more than a bachelor's degree fell by 15% to $53,539.

Terri Reynolds-Rogers, a 57-year-old health-program manager from Palmer, Alaska, declared bankruptcy in 2007, but still has $152,000 in student debt. She said she dropped out of medical school in 1999 to care for her two children after her husband died of brain cancer.

Ms. Reynolds-Rogers's lenders at one point garnished $950 a month from her wages when she fell behind in her payments. She works a second job as an adjunct instructor at the University of Alaska and expects to work well beyond retirement age. "It's enslaving," Ms. Reynolds-Rogers says of her student debt. "At a time I should be looking at the possibility of retirement sometime in the near future, I'm taking on another career if I'm lucky."

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Tracy Paulsen, a 34-year-old lawyer from Wenham, Mass., delayed payment on much of her $200,000 debt, while interest accrues. When she starts making payments in a year, she doesn't know how she will manage.

Stories like hers have prompted Sen. Dick Durbin (D., Ill.) to introduce legislation to make it easier for borrowers to shed debt issued by private lenders, and not backed by the government, through the bankruptcy process.

The federal government now provides the bulk of student loans.Federal loans accounted for more than 90% of all student borrowing in the 2010-2011 academic year, according to the College Board. Nonfederal loans—including those issued by states, banks and credit unions—accounted for 7%. The government expanded its lending after the financial crisis drove up student borrowing costs. However, making federal loans easier to discharge through bankruptcy would be politically thorny, given that taxpayers would pick up the tab if those debts were shed. The Obama administration argues that government lends at lower interest rates than private lenders and is often more lenient about allowing borrowers to delay or adjust payments when they run into financial trouble. However, since the government caps how much money each student can borrow per year, many students take out a combination of public and private loans to fund their education.

Consumer advocates and groups representing universities support the bill, saying that the threat of bankruptcy would spur private lenders to work out better terms with borrowers when they run into trouble. Bankruptcy lawyers are lobbying for the change, which would generate new business for them.

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But banking-industry groups, including the American Bankers Association and the Financial Services Roundtable, oppose the measure, saying it would tempt students to rack up big debt that they won't repay. "The bankruptcy system would be opened to abuse," the industry groups said in a letter to the Senate Judiciary Committee last month. Critics of the Durbin measure also say lenders would respond by charging higher interest rates on student loans to account for the increased risk of losses.

Sen. Charles Grassley of Iowa, the top Republican on the Senate Judiciary Committee, hasn't taken a position on the Durbin bill. "We don't want to do anything that would cause costs to increase for the majority of responsible borrowers who are paying off their loans," Mr. Grassley said in a statement. "Many of us are still looking at the specifics of the Durbin measure and whether it actually helps to address these major concerns."

The bankruptcy debate comes as student debt has emerged as a campaign issue, with both President Barack Obama and likely Republican presidential nominee Mitt Romney calling this week on Congress to extend a freeze in the 3.4% interest rate on one of the government's most popular student-loan programs. If lawmakers don't act, the rate will double to 6.8% for such loans made starting July 1. Administration officials estimate the change would affect roughly 7.4 million students who are projected to take out federally subsidized loans in the year beginning July 1.

The House on Friday passed a Republican plan to extend the freeze on interest rates, but the White House threatened to veto the bill because it would cover the $6 billion cost of the subsidy by eliminating a prevention and public-health fund created by Mr. Obama's 2010 health-care law. Senate Democrats plan to vote next month on legislation to hold rates steady but fund it by ending a tax provision benefiting some small-business owners.

Also on Friday, Mr. Obama promised to crack down on what he said are deceptive and aggressive tactics by some for-profit colleges that prey on soldiers returning from war with misleading information and high-pressure tactics.

In front of troops during a visit to Fort Stewart, Ga., Mr. Obama signed an executive order requiring new disclosures and stiffening rules for for-profit colleges.The White House said the moves will curb abuses by schools that harass vulnerable members of the service until they sign up for programs that they sometimes can't afford and may not deliver what they promise.

Senate Democratic aides said alternatives to Mr. Durbin's bankruptcy bill are being considered. A Durbin spokeswoman said the senator was looking for a way to attach the bill to a broader measure that would pass later this year.

Many college graduates are struggling keep up with their debt payments. About 27% percent of borrowers who have begun repaying their student loans are defined as delinquent, having at least one past-due student-loan account, according to the Federal Reserve Bank of New York.

As people defer or fall behind on their payments, the total amount they owe grows as interest accrues.

Tracy Paulsen, a 34-year-old lawyer from Wenham, Mass., said she recently moved in with her aunt, has put off marriage talk with her long-term boyfriend and depleted her individual retirement account—all so she can get a handle on more than $200,000 in student loans outstanding, most of which paid for law school. "It's a noose around my neck that I see no way out of," she said.

Ms. Paulsen has used an option to delay payment on much of her debt while the interest accrues, which has caused the total amount owed to balloon by tens of thousands of dollars. She has to start making payments within a year, and doesn't know how she will do it.

Write to Josh Mitchell at joshua.mitchell@dowjones.com

A version of this article appeared April 28, 2012, on page A3 in some U.S. editions of The Wall Street Journal, with the headline: Trying to Shed Student Debt.