Should student debt be dischargeable in bankruptcy?

I’m not an economist who studies education or bankruptcy, and I’m not 100% confident I spelled dischargeable correctly. I am, however, above average at highlighting the difficulty of a question when dissuading a grad student from attempting an impossible thesis question, so let’s dig into this one, which sounds pretty hard to me.

First of all, it is very difficult to discharge student debt during Chapter 7 or 13 bankruptcy, but I think you still can do it if you convince a judge that continued attempts at repayment would create undue hardship i.e. put you in a state of poverty in the wake of previous good faith efforts.

That said, maybe you shouldn’t have to face literal starvation to discharge student loans. That’s a reasonable idea, but what would the broader consequences be? This is tricky question to untangle because there are both welfare consequences and knock-on effects where we are put down different forking paths of politics and policy.

If debt is dischargable, then lenders will expect lower rates of repayment. This increase in lender risk and decrease in return on capital would likely have immediate consequences in the form of:

  1. Higher interest rates
  2. Lower rates of loan approval
  3. Greater dependence on loan collateral
  4. Greater lender interest in what the loaned funds will be applied towards.

Before we tackle those, we also have to consider the different policy environment paths lenders may have to anticipate:

  1. The government stops subsidizing loans. This would lower tuition, but also lower access for low income students.
  2. A loan forgiveness program. Great for people with outstanding debt, but changes how expectations are formed forever going forward.
  3. The government launches a massive “free college” program that covers tuition at state colleges and universities. This would have all kinds of consequences potentially.

But where this really leaves us is with a billion dollar question: will dischargeable students loans lead to lower costs of higher education? I am confident that the answer is a definitive, unassailable maybe.

Higher interest rates is a pretty straightforward prediction, but the consequences are less clear. Higher interest rates could lead to less college matriculation, greater barriers for lower income individuals, and higher expected rates of bankruptcy, in part because decisions are being made by young people who don’t know the future, their future, or, really, anything. Related to this, lenders will become more discerning regarding who they lend to, giving more money on more favorable terms to matriculants from wealthier backgrounds, in no small part because wealthy parents are filled to the brim with collateral, making for excellent co-signers and providers of high school graduation gifts nicer than any car I ever hope to drive.

That is all boring and moderately obvious. It’s 4) that I’m most curious about. If you get into medical school, there is no shortage of institutions eager to dump several hundred thousand dollars in the foyer of your home. Part of the reason for this is the expected future income of physicians and their high graduation rates from medical school thanks to rigorous admission screening. But what is underappreciated is the 100% rate at which medical school students study medicine.

Not so with undergraduate education. You might study electrical engineering with a minor in computer science. You also might study something a senior tells you is the easiest major at your school. You might major in something that sounds fun or interesting. You might study Miscelleneous Studies, where Miscelleneous is a subject that is likely interesting and possibly extremely important, but within which you can choose classes that facilitate your avoiding learning anything useful or applicable in the labor market.

Herein lies the problem. Lenders treat loans for consumption very differently than loans for investment. Nursing and statistics degrees are investments. Art History classes (for most people) are consumption. What’s going to happen to higher education when the lender tells you you can have $200K at 3% to study any STEM field or $75K at 6% to study anything in the humanities? Will the demand for humanities degrees drop? Will the supply of humanities education recede? Are humanities and STEM education complements or substitutes?1

Let me phrase it a different way? Are wealthy fine arts majors cross-subsidizing STEM majors pursuing the first college degrees in their family? Or are they driving up the price of tuition because heavily subsidized credit is facilitating pre-career retirement lifestyles for 4 years?

All of this leaves me with the suspicion that dischargeable student loans will lower tuition for some while raising it for others. This heterogeneity would likely shift the electoral popularity of free tuition programs while also shifting the nature of those program. Maybe “free college” turns into a means-tested program. Maybe “free college” becomes “free STEM college”. Maybe both.

We could speculate what this means for loan forgiveness or subsidies, but this post is too long already and, as should be already clear, we’re not going to solve anything today. My elegant and succinct point is this:

When you massively subsidize a [knowledge, signal] bundled good for so long that it transforms into a [knowledge, signal, 4-year luxury cruise with your peers] bundle, and to accommodate that subsidy you protect your poorly constructed macro-investment in human capital by exempting it from bankruptcy proceedings, and as a result of this weird landscape a bizarre higher education industry emerges that is both one of the greatest achievements in US history but also a trap that 19-year-olds fall into because, really, is there any trap we don’t fall into when we’re 19, and from which thousands of people never financially recover, but if you just fix one part of it no one knows what will happen, and if you try to fix all of it at once in the back of your mind you’re afraid it could turn into the US healthcare industry part deux, well then what you have is a real and important problem that I don’t know how we will solve but I remain confident that other people will be very confident that they know how to solve it and they will get extremely cross with me for not sharing their confidence.2

So maybe don’t try to solve that in your dissertation.3 Might be safer to just definitively estimate the natural rate of interest that underlines all monetary transactions. That’ll be easier.

1The answer is “Yes”.

2 This is, to be extremely clear, not me picking on Ms. Reisenwitz’s tweet which was good and interesting and left me thinking about student loans for two days when I should have been working on the research topics I have actual expertise in.

3 Of course, if you do find a natural experiment where huge chunks of student debt were accidentally made dischargeable in a state for 2 years because of a legislative SNAFU, you should write that dissertation and put me in the acknowledgements.