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How to Save the Victims of the Student Loan Crisis

The $1.1 trillion emergency — and why large-scale civil disobedience is the only way to fix it.

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There is only one way out of the student loan crisis — civil disobedience on a massive scale. Two reforms could bring a fair settlement to banks and borrowers alike. However, while fair, these reforms would cost the banks billions in receivables, which means they will use their considerable political influence to block them. That's why civil disobedience is the only way to succeed.

This is an emergency. In addition to the deepening distress experienced by millions of former students, the Federal Reserve, the Treasury Department, and several other governmental agencies have all warned that the $1.1 trillion in unsecured educational debt, much of which will never be repaid, creates a significant danger to the entire economy similar to that generated by housing debt in 2008.

This crisis is too big to sweep under the rug. Currently, close to ten million broke and under-employed former students are trapped in a debtors' prison without walls. Unable to maintain monthly payments, their loans have fallen into default, they are barred from obtaining ordinary consumer credit and prohibited from discharging their debts through bankruptcy. Tens of millions more struggle with excessive interest rates that limit their economic activity and add to their debt (some now owe two or even three times what they originally borrowed).

Civil disobedience would not be necessary if government was capable of functioning as a neutral arbitrator between the borrowers and the banks. Unfortunately, it cannot do that. From the beginning, government tilted the playing field to give unfair advantage to the banks, then, for decades, passed laws biased in their favor.

The Higher Education Act of 1965 established the federal student loan program, but this legislation allowed banks to fund the loans and collect the interest payments made, while the government pledged to back up the banks if the loans were not repaid. The banks got guaranteed profits while the students benefited from interest rates slightly below market. It seemed like a win-win arrangement. It wasn't.

The government should have lent the money directly from the Treasury. If the banks were unwilling to extend credit to young students, the government should have done so itself, subsidizing the risk to make the loans affordable, and simultaneously insuring that any profit came back to taxpayers.

Instead, with little notice, the federal government actually violated one of the most fundamental principles of a free-market economy. By creating a risk-free business for the banks, government compromised its essential impartiality.

Once started, government entanglement with the banks deepened. Decades later, when the cost of college dramatically rose, eventually at twelve times the overall rate of inflation, federal loan amounts had to increase in tandem. Because of the high interest rates, bank profits soared, but so did bankruptcies. To protect those profits, government intervened in the free market again, repealing in 1998 the ability to discharge federally-backed student loans through bankruptcy.

But college tuition kept increasing, eventually at too fast a pace for the federal student loan program to keep up. Because the federal loans were too little and too few, many students were forced to seek high-interest private loans from banks. These loans did not come with a federal guarantee, but in 2005, at the urging of the banks, the government repealed the ability to discharge these private loans in bankruptcy, as well.

Government had a financial interest in the federally backed loans, but it had none in these private bank loans. Its action was a straightforward gift to the banks and another egregious violation of the role of government in a free society. Ironically, it was conservatives, usually enthusiastic cheerleaders for the free market, who lead the effort to ensure that the risk-free business set up for the banks remained profitable.