However, the vast majority, more than 90%, of student debt is government loans, where the government lends money directly to students without accounting for the borrower's credit worthiness or the value of the degree. Allowing bankruptcy relief in that case could create a moral hazard, where someone might borrow from the government to obtain an expensive degree, then declare insolvency and stick taxpayers with the bill.
How big of a risk is that, though? There's a high correlation between debt repayment and earnings. For anyone who is able to repay their loans, it's better to do so than declare bankruptcy because bankruptcy poses large costs in terms of credit rating, getting a job or securing a mortgage. For others, economist Beth Akers argues there are ways to mitigate the moral hazard, perhaps by requiring several years of payments before the borrower could discharge the loan. Another option is sharing the costs with universities, making them pay back some of the tuition to the government if a student declares bankruptcy.
There will surely be some abuse. But there is already abuse. The government lending someone hundreds of thousands of dollars, at below-market interest rates, for a masters in folklore studies also costs tax-payers and has no sign of ending. Allowing bankruptcy relief would increase the level of scrutiny given when extending credit to students, helping break the debt cycle by forcing more discretion in who gets how much funding for what type of degree—and perhaps motivating students to pursue higher-value degrees to obtain that credit.
Allison Schrager is a Bloomberg Opinion columnist. She is a senior fellow at the Manhattan Institute and author of An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk.