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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He also has an MBA from the University of South Florida. ...

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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Jun 5, 2012

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In the wake of the student loan crisis sweeping the nation, young borrowers are pleading for some sort of relief. Programs have been pitched and advice has been given, but little has been done to actually spare our college educated from starting their young lives off with, for some, debt the size of a mortgage.

And beneath the sound of students’ cries is a quieter, but equally passionate voice from bankruptcy advocates urging lawmakers to reform our bankruptcy law so that student loans can be discharged if a debt-ridden student files for a Chapter 7 discharge.

However, much like the Student Loan Forgiveness Act of 2012, more formally known as HR4170, the support for cancellation of college-related debt through bankruptcy suffers from short-sightedness and personal appeal. Before making such a declaration as, “We should forgive all student loan debt,” would-be proponents should consider the implications of such action from a utilitarian standpoint.

Don’t mistake this request as a promotion for utilitarian philosophy; the utilitarian standpoint isn’t necessarily correct. But it’s important nonetheless to consider such a view, particularly regarding decisions that would affect our nation—all 311 million people of it—as a whole.

The Immensity of our Student Loan Problem

People from all walks of life, whether they be laymen or experts, are looking at this growing student debt bomb and wondering how exactly we’re going to fix this national problem.

The quandary is this: our young, able-bodied members of the work force are entering their adult lives with debts the size of small (sometimes large) mortgages. The average graduate now carries student loan debt of $25,000, which are often on terms that extend these payments out by 10 to 20 years—sometimes resulting in interest payments that more than double the principal.

Take the story of 36-year-old Nick Keith into consideration, who, eight years after graduating from culinary school, is carrying $142,000 of student loan debt on his shoulders.

Keith, who has recently gained notoriety for appearing on the short, independent project, “Default: The Student Loan Documentary,” grew enticed by advertisements for various culinary schools.

“The culinary academy commercials were on the Food Network every 15 minutes,” he told Your Money in an interview, and added that the sales pitch said a culinary degree only required 12 months of study with a three month externship.

Those selling points prompted the young and hopeful television viewer to take out $46,000 in student loans, with an additional $14,000 private student loan to fund his room and board.

The school boasted a “48 percent to 100 percent” success rate for graduates looking for work, but Keith found that he was lied to. He and other students claimed that the culinary institute’s employment calculation included jobs that didn’t require a culinary degree or education at all. In other words, the institution’s calculations included graduates who were employed in fast food restaurants, customer service jobs, and retail suppliers. The success rate had nothing to do with succeeding as a chef.

Due to this misrepresentation the California Culinary Academy agreed to pay back over $40 million to thousands of students who joined in on a class action lawsuit this past September.

Keith, however, is still responsible for a student loan balance that has swelled into a massive $142,000 burden that continues to grow at a 17 percent interest rate.

“My life has become a daily swim in a tar pit with very little hope of ever getting out,” Keith told Your Money in an interview.

Why Isn’t There Hope?

The problem our students face today is that student loans are nearly impossible to have discharged. While mortgages, failed businesses, and even gambling debts can be discharged through our bankruptcy laws, student loans have a protective coat that allows them to pass freely through any bankruptcy filings and come out unscathed.

While such protections are great for Sallie Mae and other private lenders who manage student loans, they’re detrimental to debt-ridden students.

The only way for a student to find relief from their college financing through bankruptcy is by proving to a judge that the monthly payments derived from their borrowing is subjecting them to an “undue hardship.”

The problem, however, is that undue hardship is often interpreted very differently by students and judges. Consequently, very few undue hardship filings succeed.

But some experts believe that student borrowers are beginning to file for bankruptcy and simply shun their student loans despite judges’ rulings.

“We are starting to see the first big wave,” said Christina Henry, a bankruptcy attorney at Seattle Debt Law, to KVUE News.

A Discharge Doesn’t Erase Debt

And while the wounded economy continues to struggle, and while students continue to cry out for help, the government and our lawmakers aren’t budging.

Why?

One small fact that’s either ignored or unknown by many is that a discharge of debt—what many bankruptcy filers are seeking—is not the same as a forgiveness or erasure of debt.

A discharge, according to Charles Glanzer, a Chicago-based bankruptcy lawyer, “forbids all action to collect the debt from the discharged debtor.”

Since bankruptcy debt isn’t forgiven, it still exists in some form. Since it still exists, it just gets moved to someone else. In the event a borrower has a co-signer, discharged debt shifts entirely from the person who received a discharge to the co-signer. For the countless parents who have co-signed their children’s student loans, a change in bankruptcy law could present for them a horrible situation. For those without co-signers though, the debt burden will fall onto the shoulders of their lenders.

Consequently, lenders who take on discharged debt are forced to write that debt off as a loss.

The Utilitarian Standpoint

With that in mind, try to envision what would happen to our nation’s economic (and educational) structure if our bankruptcy laws were changed. Imagine what would happen as our largest sources of student loans begin taking on the trillions of dollars of outstanding college-related debt.

Sure the individual would be free of a debt burden they once agreed to take on in the past, but the entire system would be forced to weather a write-off of proportions never before seen.

From a utilitarian standpoint, such a change would be utterly destructive to the institutions currently established.

While some sort of change is obviously needed, could there be some sort of middle ground wherein both the individual and the masses can benefit?