Discharging student debt in bankruptcy would be a good idea, provided that colleges were on the hook for losses. | Eastern North Carolina Now

    Publisher's note: The John William Pope Center for Education Policy provides a treasure trove of information suggesting the better path forward in regards to North Carolina's number one issue - public education. Public education, at all levels, requires a significant amount of funding from our state government, and all one hundred North Carolina counties, so it is essential that leaders effecting education policy get it right, and know that concerned entities, like the John William Pope Center, will be minding their progress to do so. We welcome the John William Pope Center for Education Policy to our growing readership, and expect our readers to learn all they can to do their part in this wise endeavor to better educate our People.

    The author of this post is George Leef.

    Ever since the obstreperous Occupy Wall Street protests of 2011, Americans have been getting an earful about the alleged crisis of student loan debt. Sensing a chance to appear both compassionate and pro-education, many lawmakers want to do something to ease the plight of indebted students.

    Senator Elizabeth Warren, for example, is pushing her populist plan of allowing students to refinance their loans at absurdly low interest rates. President Obama recently expanded the touchy-feely repayment system so that students would never have to pay more than ten percent of their discretionary income for 20 years before the rest of the loan is forgiven.

    And that is only ten years if the individual goes to work in a "public service" job. For more on Uncle Sam's foolish generosity with our money, see this piece I wrote in May.

    What about good old bankruptcy? Unlike other kinds of debts, the law does not permit students to wipe out their college debts by declaring bankruptcy. Should the law be changed?

    In this recent Weekly Standard article, Ike Brannon made the case in favor of allowing students to erase their debts via bankruptcy.

    At first hearing, that sounds like yet another way of sticking the suffering taxpayers with more pointless costs. But we should hear Brannon out.

    If individuals can escape from heavy credit card, medical bills, and other debts through bankruptcy, what should be different about student loans, Brannon asks.

    There is, however, one gigantic difference. Private lenders can say "no" to borrowers and suffer the consequences when they fail to say "no" when they should have. Student loans, however, are now overwhelmingly in federal hands and almost anyone who wants a loan can get one. It thus seems that allowing bankruptcy would merely encourage more careless borrowing and force taxpayers cover the costs for clueless students who borrowed a lot for a fluff degree.

    Brannon has a good reply, however. "If we are concerned that allowing students to escape debt via bankruptcy might open up the college loan market to the same moral hazard problems that befell the mortgage market and will leave the government on the hook, we could make the institutions of higher learning assume their loan payments after a bankruptcy."

    Now we're talking.

    As things currently stand, colleges and universities have absolutely nothing to lose when they enroll students who have borrowed for the tuition but have minimal academic ability and interest. The schools pad their bottom lines (and never listen to anyone who tells you that non-profit entities aren't interested in revenue maximization) and try to keep students happy with a weak curriculum and inflated grades. They bear no risk at all.

    Suppose that we implemented Brannon's idea and said to colleges and universities: If you enroll students who later go bankrupt, you take over the payments. The consequences would be dramatic.

    Instead of trying to recruit any warm body who can use government loans to cover the tuition, schools would have to think about each student's academic ability and future prospects. Those who can scarcely read and show no evidence of interest in learning anything of value would be risky to admit. Instead of obsessing over students' "diversity" or sports prowess or legacy status, admission committees would have to think about the likelihood that an applicant would later declare bankruptcy and stick the school with a large bill.

    That would change the incentives, both for colleges and for students.

    Colleges would have stronger incentives to admit only students who show some promise. They'd also have stronger incentives to ensure that those they do admit can't just coast along without learning anything. They would have good reason to put an end to what Professor Murray Sperber calls "the faculty/student non-aggression pact."

    Students would have an incentive to show that they are worth taking a risk on, not just that they'd like to give college a try. As I argued in "A Tale of Two Bubbles" last October, the trouble in both the housing and higher education markets is rooted in the way government policy changed people's incentives—away from having to strive for something they want and into a sense of entitlement.

    That need to strive would be revived if college administrators could say, "Sorry, but you don't seem to be a serious enough student."

    My guess is that even if student loan debts could be discharged in bankruptcy, few people would try to do so. Bankruptcy is not a right and the process is somewhat daunting. Students fresh out of college aren't likely to petition for bankruptcy, particularly since the law calls for a showing that the person cannot pay his debts and has no prospect of being able to. Merely having piled up considerable debts in college is not sufficient grounds.

    Still, if college loan debts could be discharged, that would have some impact on college officials—a salutary impact.

    The federal government should not have gotten into the business of college lending in the first place. There is no constitutional warrant for it and even if there were, politicians make for lousy loan officers. It would be best if the federal government scrapped its college lending, but perhaps the first step in that direction is to ensure that colleges have some "skin in the game" when they take federal student aid money.

    Does any politician have the nerve to advance this idea?