If Student Debt Relief Spurs Rational Lending, Can For-Profit Universities Survive?

Multiple bills have been introduced by Congress recently to address the student debt crisis, which has been consuming headlines for several years. One bill receiving significant attention, H.R. 449, proposes to reverse a 2005 law that prevents debtors from discharging private student loans in bankruptcy cases.[1] In seeming support of the bill, the President recently requested that federal agencies explore this possibility as well. The goal of H.R. 449 is to provide many in need with the intended benefits of bankruptcy: a fresh start. But the relief will likely come to the detriment of many for-profit universities.

Students at For-Profit Universities Hold Substantially Higher Private Debt and Default Rates, but Substantially Less Hope for a Brighter Future Without Relief
Student debt is a major issue facing our country. The causes, consequences and solutions are in debate, but there can be little discussion as to whether an issue exists. At the end of 2014, education-related loans amounted to $1.6 trillion,[2] up 60 percent since the outstanding student loans in the U.S. passed the $1 trillion threshold for the first time in 2011.[3] Additionally, student borrowing has risen more than six times as fast as average hourly earnings, and almost half of student borrowers do not graduate with a degree – only debt.[4]

The average return on investment for a college graduate may not shock the conscious; the undergraduate class of 2014 graduated with an average student loan debt of $33,000 and an expected median salary of $46,900.[5] However, the return on investment for students that attend for-profit universities is simply appalling. Almost 100 percent of students at for-profit schools take on educational debt averaging $40,000, half with private loans.[6] Upon graduation, the average student salary is close to the average salary of those with a high school diploma.[7] However, only 34 percent of students attending a for-profit institution graduate in six years and 74 percent default or become delinquent on their loans.[8]

The current situation has created a host of issues with private student loans. One such issue has been highlighted in the wake of the closure of Corinthian Colleges, Inc., one of the nation’s largest for-profit career school chains. After a year of slowly collapsing under the eye of the U.S. Department of Education following allegations of systematically deceiving students with false gradation and job placement rates, Corinthian Colleges, Inc. filed for chapter 11 and shut down its remaining 30 locations on May 4, 2015. As a result of the closure, some students will be allowed to have their federal government loans forgiven, but unfortunately for others, private lenders will not offer such forgiveness, even in bankruptcy.[9] Unfortunately, if the Department of Education enforces its new 2014 guidelines for maintaining accreditation, which contributed in part to Corinthian’s closure, an estimated 840,000 students that currently attend for-profit institutions may face a similar fate.

These facts, along with a host of others, should support the relief being sought in Congress to allow private student loans to be discharged in bankruptcy.

Consequences of Reform: Private Lending Could Tighten if Consumers Can Discharge These Loans in Bankruptcy
On its face, reversing a policy that is only 10 years old would not appear to have a significant impact on the higher education market, particularly since private student loans only make up 12-14 percent of total outstanding student debt. However, given the factors stated above, private lenders should be clawing back their lending to these institutions, given the high default rates and the fact that such loans may soon be dischargeable in bankruptcy. Further, as highlighted above, significant changes have occurred in the past 10 years that must be considered. First, private loans have tripled since 2005.[10] Second, the for-profit education market has continued to grow rapidly. Additionally, approximately 30 percent of the budget for the average for-profit college is now supported by private loans – much higher than a public university.[11]

Since 2005, the law has given private institutions little incentive to partake in rational lending when it comes to student loans. As such, no lender has had an incentive to vet schools that their borrowers would attend, because the lender had the opportunity to collect on their loan forever. At least in theory, rational lenders would not write loans to students that want to attend universities that are unlikely to produce graduates, or produce graduates with a 50 percent debt-to-income ratio, or graduates who are unlikely to repay their loans. Without the protections currently drafted in the laws, rational lenders would not lend to students of many for-profit institutions. H.R. 449 should drive more rational lending. And if these students do not have access to private loans, for-profit universities that have inflexible operating budgets and have financed their growth with debt may be newly at risk for default. Admittedly, a change could cause low-income students to face greater challenges in obtaining access to college. But for so many low-income students, access to college has come with a significant burden and no greater opportunities in life.

Changing the Code so that private loans could be discharged in bankruptcy would offer relief for many individual debtors, though reform in the Code is unlikely to substantially address the student debt crisis. Nonetheless, if rational private lending halts the endless supply of tuition dollars some for-profit institutions have been dependent on, these institutions may soon be faced with their own debt crises.