Should the Right Support Making Student Loans Dischargeable in Bankruptcy?

Here's a riddle that many Americans are familiar with: how are a house mortgage, credit card debt, and a car loan different from student loans?  For the latter, the federal government has gone the extra mile to protect lenders by making them non-dischargeable in bankruptcy.  This means that student loans, unlike almost every other kind of loan available, cannot be escaped through bankruptcy.  With student loan debt approaching nearly $1 trillion nationally, a growing portion of Americans are facing a growing burden of inescapable indebtedness.  This burden of debt is especially borne by the young, the group which has perhaps been hit the hardest by the economic slowdown.

It wasn't always this way.  According to the non-partisan Congressional Research Service, until 1976, all student loans could be discharged in bankruptcy.  Up until 1998, student loans could be discharged after a waiting period (of initially five and later seven years after repayment was scheduled to begin).  In 1998, Congress made federal student loans nondischargeable in bankruptcy, and, in 2005, it similarly extended nodischargeability to private student loans.  (Extreme hardship can still result in the discharge of some student loans, but this condition is rather difficult to establish.)  Since 2000, student loan debt has exploded, and private student loans have grown at an accelerated rate.  Somehow, people still went to college and were able to get loans prior to 2005.  Clearly, certain lenders found it in their own interest to provide loans even when there was a chance of bankruptcy.

Some have tried to frame the issue of nondischargeability of student loans in terms of guaranteeing access to education.  According to these arguments, the fact that such loans are not dischargeable allows students greater access to higher education: since lenders know that students cannot escape their debt, they will be encouraged to lend money out more easily (increasing the amount of money lent out and lowering perhaps the interest rates on these loans in some cases).

Such arguments would seem to ignore some of the hard lessons of the past decade, when gratuitous credit for both private individuals and corporations helped lead to an unsustainable bubble in real estate and securities.  Moreover, at least people can declare bankruptcy and escape their mortgages (and certain favored companies can get government subsidies so that they can avoid bankruptcy).  This is not the case for student loans.  Furthermore, the argument that educational access is improved by creating an eternal tie between borrower and debt could be applied to other areas as well.  By such reasoning, perhaps the nondischargeability of car loans would help Americans get better cars or the nondischargeability of credit card debts could improve the material comforts of Americans by giving them access to more credit.

There's another approach to bankruptcy, however.  Borrowers' potential for bankruptcy represents a kind of risk for lenders---a risk that encourages lenders to be efficient about whom they lend money to.  And this efficiency may lead to results in the interests of both borrowers and lenders.  Due to this risk, the lender needs to determine how likely the borrower will be to pay him back, and the lender's evaluation of this risk can lead to him not lending too much money to the borrower, thereby preventing the borrower from getting over his head in debt.

Consider the case of student loans.  If these loans were dischargeable in bankruptcy, lenders (especially private ones) would have to be more prudent about how much money they lend out to particular individuals.  Currently, lenders have relatively little compunction about lending out $75,000 to a student as they know that this student's odds of escaping this debt are relatively small: it might not be paid back on time, but the lender will maintain a perpetual claim on the borrower.  If there were a greater risk of bankruptcy, however, lenders might be more targeted in the amounts they lend.

Ironically, this targeting might make education more---not less---affordable.  There is a limit to what students and their families can currently pay, and, by limiting the ability of some to borrow against their future, regulators might suggest to colleges and universities that the spigot of ever-more money might be turned off.  This economic pressure might encourage universities to be more efficient with their own spending, thereby slowing the rate of tuition growth.  Increased lending standards might encourage students to be more prudent with their own money.  Higher standards might raise hard questions.  A student might ask herself whether she should go to a low-ranked private university for four years or instead spend her first two years at a much more affordable community college before transferring to another university.  The end result for the student's employment prospects might be the same, but the debt accumulated along the way might be very different under those two scenarios.

Moreover, there is a matter of fundamental principle here.  Bankruptcy has a proud tradition in free market economies.  The ability to start anew is both good for the human spirit and economically beneficial: this ability encourages taking risks and gives a sense of hope in the face of adversity. It's true that a college degree cannot be repossessed like a car with delinquent payments can be, but there has been little evidence that, prior to 2005, there was massive abuse on the part of student loan borrowers.  Conservative politics is not just about the crude application of abstract principles; it also involves attention to local realities.  Yet it seems that there was considerable access to credit for student loans prior to their being made non-dischargeable in bankruptcy.

Republicans might have a particular interest in restoring market norms to student loans: by normalizing student loans, Republicans could at once stand for free market principles and demonstrate their empathy for younger voters.  If conservatives are serious about spreading free market ideas (rather than merely using the rhetoric of the market to hammer the opponents of the moment), a right-led movement to make student loans dischargeable in bankruptcy could be one more point of evidence for America's youth that free market ideas can work for a wide variety of people.

News stories abound with examples of graduates who have borrowed colossal amounts of money and who have little potential of paying it back, at least in the short- and medium-term.  These students are shackled to this debt.  It's true that these graduates chose to borrow this money, but it is also true that the federal government has chosen to give protections to lending companies for a certain kind of loan.  It is not clear whether these special protections for certain lenders are in the best interests of the nation and its citizens, nor is it clear why the loans taken on by some of America's youngest should be the hardest to discharge.  Making student loans dischargeable in bankruptcy is not loan forgiveness: in filing for bankruptcy, an individual would pay a considerable price for the dissolution of this debt.  But the ability to pay this price is one we offer to borrowers of countless other loans.

The mechanics of how to put in place such dischargeability are complicated.  Would old student loans be made retroactively dischargeable in bankruptcy?  Would there be a waiting period before someone could discharge his or her loans?  Would both federal and private loans be made dischargeable?  But these complications should not deter conservatives from taking seriously the free market case for student loan dischargeability.

In 2008, Congress decided it was in the national interest to rescue multinational banks from the prospect of bankruptcy, passing TARP.  If corporate bailouts are good enough for billionaires, perhaps opening up the door to student loan bankruptcy (far from a bailout) might be permitted average Americans.

CBO: Promise and Peril

The recently released Congressional Budget Office report on the budget for the next ten years has what might at first seem like good news for the US fiscal order.  It estimates that, by 2015, the national deficit would fall to under 2% of the GDP, often hovering around 1% until 2022 (when the CBO projections stop).  If one subtracts net interest payments on the national debt (which the CBO estimates would increase considerably after 2014), the US federal government would often be running surpluses that would, by 2018, reach around 1% of the federal budget.

The current federal deficit runs at around 8.7% of GDP, so a decline to 1% of GDP would be a big improvement.  Moreover, the size of the federal debt relative to the national economy would begin to decline around 2013, so the United States would, in many respects, be on a firmer fiscal footing.  By 2022, the debt held by the public would be only 62% of the national GDP (compared to the projected 75.1% of GDP in 2013).  That 62% figure would be higher than that of any year during the 1952-2009 period, but the trend is heading in a good direction.

However, there's some bad news: that CBO projection depends upon a number of assumptions, including improved economic growth, no "doc fixes" for Medicare, a decrease in defense spending, and the expiration of the Bush tax-cuts.

On growth, the CBO has little hope for the next few years: it projects that real GDP will grow 2% in 2012 and a mere 1.1% in 2013.  It does hope for a considerable increase in growth in the years after 2013, however.  It assumes that real GDP will grow an annual average of 4.1% in the 2014-2017 period, settling down to a 2.5% average rate of increase between 2018 and 2022.  Those growth numbers are possible, but they assume a much stronger economy than the US has had since 2000.  If the economy does not reach this rate, the deficits would likely be even worse.  And if the economy turns around faster and maintains a stronger rate of growth after 2017, we could see the deficit shrink even more due to increased tax revenue and less spending on various income-stabilization measures.

The CBO baseline projection assumes that defense spending will fall from 4.7% of US GDP in 2012 to 3% of the GDP in 2022.  Since World War II, defense spending has never been less than 3% of the GDP.  It also assumes that nondefense discretionary spending will fall from 4.3% of GDP to 2.6% of GDP.  Under this standard, discretionary spending would fall to the smallest proportion of the national economy seen in decades.  Will that happen?  If not, add some more to the deficit.

If payment rates for Medicare do not fall at the rate they are currently scheduled, the CBO estimates that over $300 billion would be added to the federal debt over the next ten years.

The CBO baseline assumes that revenues will climb considerably after 2012; they would jump from 16.3% of GDP in 2012 to 18.4% of GDP in 2013 to 20% of GDP in 2014.  They would stay above 20% of GDP until 2022.  Part of this increased revenue would come from an improved economy, but part of it would also come from higher taxes.  The CBO projection assumes that the Bush/Obama tax-cuts will expire at the end of 2012 and that the Alternative Minimum Tax will not be indexed to inflation after 2011.  Under this scenario, personal income taxes would climb from 7.4% of GDP in 2012 to 11.5% of GDP in 2022, a historic high.

Based on these projections, extending the Bush tax-cuts would add $2.8 trillion to the national debt over the next decade.  Keeping those tax-cuts and indexing the AMT to inflation would add $4.5 trillion to the debt over the next decade.  Those numbers do not include the increased interest payments such an increased debt would also cause.

If CBO assumptions about increased revenue due to tax increases and certain spending cuts are not met, the seemingly rosy scenario of a declining debt burden relative to GDP does not take place.  Under an alternative scenario in which these non-economic assumptions are not realized, deficit spending remains an average of over 5% of the national GDP and the debt burden would increase; publicly held debt would rise to over 90% of GDP by 2022.  The CBO suggests that decreased tax revenues due to tax-cuts would be primarily responsible for this increase: the deficit caused by extending current tax policy alone would equal almost 3% of US GDP during many years.

It's possible that extending current tax policies could lead to new growth unanticipated by the CBO, though it should be noted that Bush's and Obama's tax policies have led to slower growth that the CBO projects during the 2014-2017 period and slower growth than was seen during the Clinton and Reagan presidencies.

The CBO has some interesting information about entitlement spending.  Social Security spending is currently 4.8% of the GDP, and it is estimated to climb to 5.5% of GDP by 2022; it will stay around 5% of GDP until 2019.  Medicare is estimated to climb from 3.7% of GDP to 4.2% of GDP over the next decade, while Medicaid will climb from 1.8% to 2.5% of GDP.  So Medicaid is estimated to be the fastest growing entitlement over the next ten years.

The assumptions made here by the CBO suggest a radically different federal government than we're used to, one that taxes more and one that spends more on various mandatory domestic programs and less on defense and discretionary programs.

Increased growth with an improved employment picture may be one way of keeping some discretionary and military spending while also not having a much heavier tax burden.  Growth seen during the Reagan or Clinton (or Carter or Nixon or Johnson) years could spur enough increased revenue (combined with some tax reform) to allow the government to continue to meet its obligations and not indulge in radical deficit spending.  Some entitlement reform (especially regarding medical spending) might help bend the curve of government expenditures down.  The CBO assumes that domestic discretionary spending will decrease as a percentage of GDP, and a rigorous approach to cutting waste and appropriately focusing federal energies would help ensure that necessary and advantageous discretionary spending will be kept.

This CBO report suggests that the US fiscal situation is not necessarily at DEFCON 1, but it also implies that the stagnation of the past few years is untenable for the nation's long-term fiscal future.  Growth and reform will be necessary components of fiscal sanity.  As they gear up for the 2012 campaign, Republicans would be wise to attend to these crucial details.

(Crossposted at the Huffington Post)

S&P: Dysfunctional Politics and their Price

S&P has now downgraded the US government from AAA to AA+, a historic downgrade. The effects of this downgrade will no doubt echo throughout the US and global economy.

Zero Hedge posts the full text of the S&P statement. Contrary to what you might read in some quarters of the media, the statement regarding the downgrade does not merely focus on the inadequacy of the recent debt deal to reduce the long-term debt. Instead, it offers a broader critique of the structure of American fiscal politics.

The statement hammers away at what it views as political gridlock. The battle over the debt-ceiling has exacted a considerable toll, in S&P's eyes:

We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade....

The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year's wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability

Many wanted a "battle" over the debt-ceiling and hoped for more "battles" in the future; S&P suggests that this might not be a good idea for the long-term fiscal situation of the United States.

Though the report does vaguely ask for reforms to various entitlements, it mentions Republican intransigence on raising taxes multiple times. Unlike earlier reports, this new one, with its projections for an accelerating amount of federal debt, assumes the extension of all Bush tax cuts "because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act." This report emphasizes tax hikes at the end, as well:

As our upside scenario highlights, if the recommendations of the Congressional Joint Select Committee on Deficit Reduction--independently or coupled with other initiatives, such as the lapsing of the 2001 and 2003 tax cuts for high earners---lead to fiscal consolidation measures beyond the minimum mandated, and we believe they are likely to slow the deterioration of the government's debt dynamics the long-term rating could stabilize at 'AA+'.

The report notes that other sovereign nations will have greater debts as a percentage of GDP for years into the future, but it still insists on downgrading the US:

When comparing the U.S. to sovereigns with 'AAA' long-term ratings that we view as relevant peers--Canada, France, Germany, and the U.K.--we also observe, based on our base case scenarios for each, that the trajectory of the U.S.'s net public debt is diverging from the others. Including the U.S., we estimate that these five sovereigns will have net general government debt to GDP ratios this year ranging from 34% (Canada) to 80% (the U.K.), with the U.S. debt burden at 74%. By 2015, we project that their net public debt to GDP ratios will range between 30% (lowest, Canada) and 83% (highest, France), with the U.S. debt burden at 79%. However, in contrast with the U.S., we project that the net public debt burdens of these other sovereigns will begin to decline, either before or by 2015.

So part of this analysis is based on long-term trends, an analytic assumption that may or may not be warranted.

Part of S&P's justification for the downgrade is premised on the fact that the economy is much weaker than was earlier thought. Ironically perhaps for some, this report may further damage the national economy by leading to an increase in various interest rates and heightening a sense of uncertainty in the nation's finances.

S&P makes the following recommendations for the United States: increase revenue, improve the economy, and ensure that government can fulfill its routine fiscal responsibilities. Those aren't exactly bad points. High-wire political knife-fights may make for riveting blogging and TV, but they do not always reflect the utmost of fiscal prudence. Perhaps the US government should not dance to the tune of (far from infallible) ratings agencies, but S&P does have a worthy point in this: in order for our government to work in the long term, it must have some kind of governable consensus. We must also have an economics anchored in reality and not in ideology, and a fiscal politics of compromise and empiricism instead of flamboyance and wrath.

Jacobins in the GOP?

One might note within many ostensibly conservative discussions about the debt ceiling a strain that comes far more from Leon Trotsky than from Edmund Burke. One of the principal tenets of Burkean conservatism is the importance of avoiding Armageddon: crises are best held at arms' length, and revolution should be the measure of last resort.

Not raising the debt ceiling now could very likely be Armageddon: it would immediately force the government to spend no more than it took in in taxes. In 2010, tax revenue covered not even 60% of federal spending, so over 40% of the federal budget would have to be cut NOW to make up for it. Unemployment benefits---ended. Air Force jets---grounded. You need heart surgery, grandma? Maybe next year.

Not raising the debt ceiling would not necessarily lead to defaulting on the debt: the US could still make its interest payments. However, some prominent Republicans are now suggesting that even defaulting on the debt wouldn't be that bad. Since the election of George Washington, the federal government has never defaulted. Is it really worth throwing that legacy away to make a political point? Defaulting on the debt would very likely lead to higher interest rates and make the debts of private individuals as well as those of many governments even more onerous. An outright default could wreak havoc on the domestic and global financial systems.

Such an outcome could be a sure way to reduce the Republican party to the party of the 30% and make it radioactive for years to come.

And that political price would be by far the least problematic result of that scenario for allies of traditional liberty and conservatism. Deficit spending may perhaps be an important reason why we have not seen turmoil in the streets a la Greece, Egypt, and the waning days of the Roman republic. In terms of employment, this is the worst economy since the Great Depression. The social safety net is being strained in extraordinary ways, and the sudden cuts required by not raising the debt ceiling could be the equivalent of cutting it away. With those cuts to institutions that people have built their lives around (such as Social Security), a huge cross-section of this nation could erupt in rage.

Mob outrage is almost the polar opposite of classical American conservatism, and, if we did come to such public turmoil, there is no guarantee that the result would be a more economically free society.

One realizes that much of the debate over the debt ceiling is an exercise in partisan cynicism. Every Democrat opposed raising the debt ceiling in 2006, while almost every Republican (including the leading opponents of raising the debt ceiling) supported the raise in 2006. Meanwhile, almost every single House Republican has de facto pledged to raise the debt ceiling by voting for the Ryan budget, which gives us trillions of dollars in more debt over the next few years. House and Senate Republicans overwhelmingly backed nearly a trillion dollars in tax cuts and stimulus spending at the end of 2010. The premise of those tax cuts and stimulus spending was that they would push the economy along, even though those measures will, in the short term at least, add to the debt. By their votes, Congressional Republicans have declared that this nation can handle more debt.

The whole debate over raising the debt ceiling is also, in part, a game of chicken: Republicans want to force more spending concessions and potential entitlement "reforms" from Democrats. But something of the complexity of entitlement reform is perhaps the last thing that should be rushed; Republicans should not want entitlement reform to replicate Obamacare (and other measures), when Congress is voting on unread and uncomprehended bills.

Ironically for authentic opponents of debt, not raising the debt ceiling and defaulting on the debt could make the federal debt that much worse. One of the driving forces for federal debt over the past few years has been the poor economy: the economic slow-down, with its resulting decrease in tax revenue and encouragement of government spending on unemployment benefits and so forth, is probably the single biggest contributing factor to our current deficit. The poor economy is an immediate dagger aimed at the fiscal heart of this nation.

In order to keep from hitting the debt ceiling, Republican leaders may find it wise to offer their support for a relatively small increase of the debt ceiling (say a few hundred billion or even a trillion dollars). Classical conservatism teaches that, sometimes, if you can succeed in delaying a crisis enough, your prudence can ensure that there will be no crisis at all. Sometimes that strategy fails (witness the Civil War), but it can often succeed. And even if delay fails, sometimes that delay allows you time to gather your forces to help you cope with the eventual crisis; at least the Civil War didn't happen until the union was strong enough to weather such a war. Many of the trappings of the current federal government are sustainable, especially with modest long-term reforms. The long-term fiscal situation of the nation may be somewhat scary, but it can be improved. Kicking the can down the road isn't always a bad thing, not if it gives you time to solve the problem. From a classical conservative perspective, inciting a crisis now in order to avoid a potential crisis in the future may be a bad trade.

(Crossposted at FrumForum)

The Need to Increase the Debt Ceiling

Washington is currently absorbed in the Kabuki theater of raising the debt ceiling. As Derek Thompson at the Atlantic notes, for many Washington players, this debate over raising the ceiling is a mere game. Nearly everyone---Republicans and Democrats---believes that the debt ceiling must be raised. Every once and a while, the minority party shows its fiscal "prudence" in voting against raising the ceiling, while the majority party has to lumber forward and vote "for the future." The very same Democrats (such as Barack Obama) who now say that raising the ceiling is imperative were, but a few years ago, voting against raising the ceiling; Republicans now talking about the craziness of raising the debt ceiling were very happy indeed to vote for a raised ceiling when they were a Congressional majority under Bush.

Congressional Republicans' whole argument against raising the debt ceiling is about political positioning. Republicans are trying to extract more fiscal concessions from Obama in terms of budget cuts and are using the debt ceiling as a way of getting those.

While threats to not raise the debt ceiling might be effective talking points or bargaining tools, I think we should be far less impressed by their fiscal substance. Moreover, we should not confuse voting for raising the debt ceiling with conservatives "selling out": any Republican who votes in favor of raising the debt ceiling should not be viewed as an apostate from fiscal conservatism because of that vote.

There are many reasons why this is the case. Perhaps foremost among them is the fact that not raising the debt ceiling would be exceedingly traumatic for our economy and our nation's fiscal health. Not raising the debt ceiling would force the federal government to spend only as much as it takes in from taxes, and, right now, over 40% of the federal budget is deficit spending. Veronique de Rugy and Jason Fichtner offer the following numbers:

The most recent Office of Management and Budget data shows federal revenues will reach $2.17 trillion this fiscal year. Interest payments on the nation’s debt are estimated to be $205 billion this year, or about 10 percent of revenues. Taking that payment off the top, as Mr. Toomey’s plan would, leaves $1.9 trillion for Congress to spend. That’s enough to pay for Social Security ($741 billion), Medicare ($488 billion), and Medicaid ($276 billion), with $395 billion left for other programs.

That remaining $395 billion is not enough to fund fully the Department of Defense, let alone other government programs such as unemployment benefits, highway projects, education programs, and so forth. That massive drop in federal spending would very likely push the economy into a deeper recession, which would further eat into tax receipts and bring us no closer to fiscal health. While it's true that Congress has delayed raising the debt ceiling a few times in the past (in 1985, 1995, and 2002), deficit spending is now such a huge portion of the federal budget that those past examples may not be that instructive.

Meanwhile, every budget plan under serious consideration at the moment demands more deficit spending. Even the Ryan budget, which so many self-anointed fiscal hawks have embraced, requires trillions more in deficit spending. House Republican lined up almost uniformly behind the Ryan budget, and so they have already become de facto supporters of more debt for the federal government.

At a certain point, it becomes an honorable realism to acknowledge history. Every presidential administration since the end of World War II has added to the federal debt in terms of the sheer number of dollars. Budget plans that Republicans have embraced demand much, much more deficit spending at the moment, even if they will (supposedly) lead to less deficit spending in the future.

Even figures held in great esteem by fiscal hawks such as Pat Toomey are ultimately willing to raise the debt ceiling. The opening line in Senator Toomey's recent op-ed makes this plain:

As we have been approaching the $14.3 trillion statutory limit to federal borrowing, I and many of my colleagues have insisted on real spending reforms now as part of any agreement to allow still more government borrowing...

This statement takes for granted that there could be an agreement to allow more government borrowing.

Fiscal conservatives are hoping to trade their votes for raising the deficit ceiling for further budget cuts. That is a reasonable expectation.

What would be unreasonable would be for any supporter of the Ryan budget to tar those who ultimately vote for raising the debt ceiling as traitors to the cause of fiscal solvency. If conservatives hope turn our nation's fiscal situation around, they would do well to recognize the difference between a negotiating tactic and policy substance.