Give strained student loan borrowers their fresh start

President Biden intends on executive action to cancel $10,000 in federal student loans for each borrower. Yet liberals want more with $50,000 in relief. Critics argue that debt forgiveness could mean $1 trillion to assist high earners more than those at the bottom. The liberals and the critics are both right. Low earners and the jobless need more than $10,000 in relief, while many who would benefit from a blanket debt cancellation make enough to more easily repay their student loans.

But what if Biden could forgive $100,000 in student loans for those who truly need it with the same price as the policy to forgive $10,000? Biden could be this bold and still satisfy his critics with the smart mechanism of bankruptcy. Rather than forgive $10,000 or $50,000, executive action to allow borrowers to have student loan debt forgiven through bankruptcy means the borrowers who truly need it could find relief.

Bankruptcy offers a fresh start by reducing debt obligations. But it comes at a cost. Filers pay a hefty fee and often hire a lawyer at an average cost of $2,000 to $4,000. Their credit ratings take a hit, which raises the cost and lowers the availability of credit in the future. Potential filers also face internal and external stigma. Most people do not file for bankruptcy even with such benefits. Indeed, the coronavirus has caused unprecedented unemployment, yet only 520,000 people filed for bankruptcy last year. Instead of filing for bankruptcy, those in financial distress are relying on measures such as eviction moratoria and loan forbearance.

Federal student loans are not typically forgiven in bankruptcy. Unless the government takes action, filers must demonstrate undue hardship to have the student loans reduced in bankruptcy. The Education Department and its private loan servicers contest most efforts to reduce student loans in bankruptcy. Having to prove to a bankruptcy judge that they would “not be able to maintain the minimal standard of living” with no student loan relief, only 40 percent of student loan borrowers with no means manage to get their debt reduced or discharged with bankruptcy.

The Education Department, with authority to forgive student loans for borrowers in and out of financial distress, rejects most efforts to reduce student loans by bankruptcy filers. But Biden plans to give blanket relief for all federal borrowers. Most of the benefits of that will be enjoyed by Americans in the top third with income distribution, many if not most of whom are stable in the economy. Liberals want $50,000 in student debt relief, a policy whose benefits will be even more skewed to high earners. Why are we showering forgiveness so widely when we are so stingy with forgiveness for bankruptcy filers in financial distress?

Debt cancellation for people in bankruptcy is the solution. It would tailor executive action to those truly in need. The many hurdles to bankruptcy mean that only those in financial distress could file and benefit from the loan forgiveness. If a tenth of all student loan borrowers tried bankruptcy, which marks a high estimate, then debt cancellation can be focused on borrowers who need it most. Because we are not giving windfalls to the wealthy, we can assist those in hardship at the same cost.

Giving strapped student borrowers a reason to file for bankruptcy offers other benefits. Unlike temporary forbearance rules, bankruptcy provides a permanent solution, removing a crushing debt burden from people whose livelihoods have been wrecked across many sectors of the economy in the pandemic. Moreover, the prospect of this federal student debt relief could help, rather than hurt, other creditors. If student debt was eliminated with bankruptcy, other creditors stand a better chance of partial repayment. By targeting student loan forgiveness to those in distress, the administration can heal the economy and assist borrowers most in need.

Yair Listokin is the Shibley Professor at Yale Law School and the author of the new book “Law and Macroeconomics: Legal Remedies to Recession.”