The Student Loan Bubble That Many Don’t Want to See by Steve Rhode

This excellent essay by Steve Rhode originally appeared on Mr. Rhode's web site, Get Out of Debt Guy.  Rhode's web site contains a variety of good advice and information about all manner of consumer debt problems, including student loans.  You can learn more about Steve here.

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Steve Rhode

I can’t help but see the incredible irony in the mortgage collapse that many said would never happen, and the student loan bubble.

The collapse created by the student loan bubble is different but just as catastrophic. As the average debt per student loan borrower continues to climb and federal and private student loan debt grows, the consequences of not dealing with this bubble will be as traumatic as the mortgage failure recession.

The worst thing about these big economic bubbles is the data stares us in the face but most don’t see it.

Unlike the subprime mortgage failure that caused the foreclosure rate to explode and massive job loss, the bursting of the student loan bubble will cause more systemic issues.

When this bubble bursts, and it will, it won’t lead to an immediate collapse but a collapse of the United States to excel in a future world economy. A collapse in the student loan market will place real eduction out of reach of many and put a drag on the overall economy as fewer and fewer people will be able to pay for tuition that outpaces inflation.

Without easy access to student loans and a shrinking student base, schools will have to cut costs to bring tuition back inside available lending. Many schools, public and private, will fail. Public schools will fail as long as states continue to cut state funding for education.

It seems the thing we value least, at times, is education and opportunity for all. States cut funding for public colleges, teacher salaries remain flat, and education lotteries are a misnomer. They don’t really benefit education.

Like the crazy mortgage asset backed securities (ABS) or collateralized debt obligations (CDO) the private student loan industry had been packaging up student loans into trusts an student loan asset backed securities (SLABS).

Like CDOs that Wall Street rating agencies rated, ABS products have ratings as well. Moody’s Investors Service recently downgraded a bunch of these products.

“Moody’s placed 266 tranches in 141 transactions ($44.9 billion) on review for downgrade, 89 tranches in 59 transactions ($3.1 billion) on review for upgrade and 45 tranches in 34 transactions ($2.8 billion) on review with direction uncertain. Moody’s also confirmed the ratings on three tranches ($1.5 billion).

In addition, 101 tranches ($30.7 billion) previously placed on review for downgrade will remain on review for downgrade and four tranches ($1.4 billion) previously placed on review for upgrade will remain on review for upgrade.”

Moody’s goes on to say, ” For most tranches, Moody’s projects cash inflows to be less than sufficient to repay the notes by their final maturity.”

Moody’s also says that the quality of these securities will continue to decline if there is “growing borrower usage of deferment, forbearance and IBR.” – Source

But other people are seeing the same things and making the same connections as well when it comes to the issues created by federal loans.

Jack Du said, “Unlike private lenders, the federal government doesn’t check credit records for student loan borrowers. This leads to many uncreditworthy borrowers qualifying for loans and then being saddled with debt indefinitely with little hope of paying it back. This harkens back to the sub-prime housing loans that drove up the housing bubble. Investors should be wary of how much longer these aggressive student loan lending strategies can be sustained.” – Source

Du also observed, “student loan asset-backed securities seem to be a valuable asset to the economy. However, whether this industry can sustain itself will come down to whether enough borrowers can eventually pay their debt obligations and that is looking like a slim prospect.”

For a college student himself, he’s pretty smart.

So the situation we have is easy to access federal student loans are becoming lifelong debt and lead people to problematic income driven repayment programs.

The private student loan industry is a mess with fractionalized SLABS and the hooks into co-signers they most often won’t release.

It’s a bubble and a mess, all at the same time.

All the Bankruptcy Attorneys I Contact Say It’s Not Possible to Discharge Student Loans

Dear Steve,

I am a librarian with two masters degrees living in the Charlotte, NC area. I owe over $120K in student loans, both federal and private, as well as a large amount of unsecured debt thanks to living off credit trying to make student loan payments. I have had to default on my student loan payments in order to pay my other bills and rent. I have already done IBR, however, my federal loan payments are still almost as much as my rent and they will not work with me at all on the private loan amounts, which eat up almost as much as the federal student loans. I have contacted Damon Day for help and received no response.

How do I find a legitimate bankruptcy attorney that is willing to at least attempt to get my student loans discharged in bankruptcy? I am planning to declare bankruptcy, as I see it as the best solution for my financial struggle, however, the attorneys I have been contacting for consultations will not even consider attempting to include my student loans in the bankruptcy case.

Darcey

Answer:

Dear Darcey,

So to give everyone a different point of view on this type of question I’ve answered a lot I asked my friend Professor Richard Fossey to provide his point of view to assist you.

Here is what he wanted to share with you.

“Darcey, my name is Richard Fossey. I am a professor who has followed the student loan bankruptcy process for many years. A few bankruptcy courts have ruled more compassionately in favor of student loan debtors in recent years, but trying to discharge your loans in bankruptcy is still a heavy lift.

The courts seem to be influenced by a number of factors: age and health, children, good faith in making loan payments, etc. As you may have already found out, it is difficult for a student debtor to find a bankruptcy attorney. Debtors generally don’t have the money to hire an attorney, and often the bankruptcy attorneys know nothing about student loans. Many believe that it is impossible to discharge student loans in bankruptcy. You may have already been told that.

Some people have filed adversary proceedings in bankruptcy court to discharge their student loans, acting as their own attorney. One law review article concluded that people filing without attorneys had a success rate comparable to the debtors who were represented by lawyers.

One question only you can answer: what do you have to lose? If you are insolvent and eligible to discharge your other debts in bankruptcy, you might decide–what the heck–and file an adversary proceeding in an effort to get your student loans discharged.
If you do that, you need to know that you will filing a lawsuit without an attorney and will be opposed by skilled lawyers. It sounds like you have both federal loans and private loans. If that is the case, then an attorney for the Department of Education or a loan guaranty company will represent the federal government and another lawyer will represent the private lenders.

The standard for discharging a student loan in bankruptcy is undue hardship, and most courts follow the so-called Brunner test. You will need to show 1) that you cannot pay your student loans and maintain a minimal standard of living, 2) that additional circumstances make it unlikely you will ever be able to pay your student loans, and 3) your have dealt with your student loans in good faith.

Good faith generally means that you made loan payments when you could or that you negotiated with your creditors in good faith, but the Ninth Circuit Bankruptcy Appellate Panel ruled that one debtor met the good faith test even though she had never made a single voluntary loan payment because she had lived frugally and had tried to maximize her income.
If you file an adversary complaint without a lawyer you need to have the mental stamina to see it through. Some people’s litigation over student loans have stretched out for years. Also, you should get all your evidence and paperwork together before you file your adversary proceeding and you should have a good argument in place as to why you meet the Brunner test. You also need to be prepared for discovery requests from the creditors’ lawyers.

I am not a practicing lawyer and can’t give you legal advice. And a person’s decision to try to discharge student loans in bankruptcy is a person decision that involves the assessment of a lot of unique factors.

But I do think the public sentiment about the student loan crisis is changing and there are some indications that the bankruptcy courts are beginning to see that many people simply cannot pay off their loans. I would be happy to talk with you about this by phone. I wish you the best of luck. Richard Fossey”

So Darcey, there you go. Finding the right attorney is a tough job for people. They will run into far more “can’t be done” than “I can do it.” There is no other solution than to keep calling bankruptcy attorneys who are licensed in your state and ask if they have had experience in discharging student loans through an Adversary Proceeding.

Here are a couple of articles that will help inform you in the process:

How to Find a Great Bankruptcy Attorney

Federal Student Loans Discharged in Bankruptcy. A Look at the Surprising 2012 Data and Cases.

How to Really Discharge Your Student Loans in Bankruptcy. Many Can. But Never Try.

If you find a local bankruptcy attorney who is willing to tackle this, you can always ask them to contact me or Professor Fossey for help.

Alternatively, you might want to strongly consider setting up a consultation with my friend and debt coach, Damon Day. Damon and I discuss this topic very frequently and he can guide you through this process and has relationships with people who might be able to provide additional help.

Bottom line, for the right person who is willing to fight for relief there are options. People who are hoping most bankruptcy attorneys will tackle this, will be disappointed.

Note. This post was originally posted by Steve Rhode. The original post can be found at: https://getoutofdebt.org/100868/bankruptcy-attorneys-contact-say-not-possible-discharge-student-loans

Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994.