The Unintended Consequence of Allowing Student Loan Bankruptcies

An article by Josh Mitchell in the weekend Wall Street Journal raises the specter that Congress may reverse itself and allow privately financed student loans to be discharged in bankruptcy. Debt discharge is a common bankruptcy exit strategy for companies in which they write off their existing loans and either extend equity in the new post-bankruptcy enterprise to the former creditor or in the case of junior creditors they sometimes are given nothing.

When Congress changed the Bankruptcy Code in 2005 to make student loans non dischargeable it had the effect of guaranteeing to lenders that their student loans would be repaid. What this did was to attract lenders to the student loan market since loans made there would be safe. Low interest rates offered to students reflected the safety of this loan category.

It's not often that the unintended consequences of governmental actions can be predicted before they actually occur. In this case however, Congress's recent discussions of lifting the non-dischargeability provision from student loans comes with a clear and certain set of unintended consequence. First, lenders requiring loan safety (does anybody remember the recently passed Dodd - Frank legislation) will leave this market segment because a significant fraction of student loans would need to be classified as risky. Second, companies continuing to lend to this market would raise interest rates to borrowers to compensate for future default risk.

I suspect this is another example of legislators coming up with legislation because their titles imply that that is what they do. The first rule of government ought to be do no harm.  That is what my book, Unintended Consequences: How to Improve of Government, our Businesses, and our Lives, is all about. This proposed legislation can and will do massive harm under the guise of being helpful.

Harlan Platt's blog can be found at harlanplatt.com

An article by Josh Mitchell in the weekend Wall Street Journal raises the specter that Congress may reverse itself and allow privately financed student loans to be discharged in bankruptcy. Debt discharge is a common bankruptcy exit strategy for companies in which they write off their existing loans and either extend equity in the new post-bankruptcy enterprise to the former creditor or in the case of junior creditors they sometimes are given nothing.

When Congress changed the Bankruptcy Code in 2005 to make student loans non dischargeable it had the effect of guaranteeing to lenders that their student loans would be repaid. What this did was to attract lenders to the student loan market since loans made there would be safe. Low interest rates offered to students reflected the safety of this loan category.

It's not often that the unintended consequences of governmental actions can be predicted before they actually occur. In this case however, Congress's recent discussions of lifting the non-dischargeability provision from student loans comes with a clear and certain set of unintended consequence. First, lenders requiring loan safety (does anybody remember the recently passed Dodd - Frank legislation) will leave this market segment because a significant fraction of student loans would need to be classified as risky. Second, companies continuing to lend to this market would raise interest rates to borrowers to compensate for future default risk.

I suspect this is another example of legislators coming up with legislation because their titles imply that that is what they do. The first rule of government ought to be do no harm.  That is what my book, Unintended Consequences: How to Improve of Government, our Businesses, and our Lives, is all about. This proposed legislation can and will do massive harm under the guise of being helpful.

Harlan Platt's blog can be found at harlanplatt.com

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