Should Colleges Have an Easier Time Declaring Bankruptcy?

A provocative op-ed appeared in The Hill the other day. In it, the author—a former counsel to the U.S. Department of Education—proposes lowering the barriers to bankruptcy for colleges and universities.

Given that more than half of all higher-education institutions in the U.S. are experiencing varying degrees of financial distress, the notion of insolvency is more than an academic hypothetical.

Yet from a practical standpoint, a bankruptcy filing has little appeal for schools for a pretty big reason: Any higher-education institution that chooses to take that action will immediately lose access to the various federal loan programs and grants on which its core revenue model depends.

That a school is loath to declare insolvency may also lead to other problems as it works to resolve its difficulties.

Troubled enterprises often pursue three turnaround methods: an operational restructure in which strategies are employed to increase revenues and decrease expenses; asset restructures where surplus possessions are sold for the cash needed to pay down debts; and financial restructures in which existing obligations are renegotiated for more favorable repayment terms.

The final method becomes much harder to accomplish when a fiscally challenged company takes the bankruptcy option off the table. That’s because bankruptcy is the last thing a lender wants to have happen: The process is slow, the costs are high and the outcome is uncertain. So when a creditor knows that bankruptcy is a nonstarter for its debtor, the negotiating power shifts to the creditor’s side of the table, which is a good part of the reason why the op-ed’s author advocates for changing the rules.

When you think about it, though, the scenario I just described isn’t all that different for student borrowers.

Bankruptcy for them is a virtual impossibility, albeit for other reasons (education-related debt cannot be discharged except in extreme circumstances). So it’s fair to ask why the schools should be favored over those who, some would argue, have been harmed by the business practices they employ.

In fact, by choosing the interests of students over that of the schools they attend, the very trajectory of higher education costs and, consequently, that of the macro economy would be influenced for the better. Here’s why.

Assuming colleges are able to have continued access to federal funding, those that choose bankruptcy can look forward to having their financial and other contractual obligations restructured, if not fully discharged. Thereafter, it’ll be up to institutional leadership and the boards that are charged with their oversight to determine how to make the best use of this fresh start within a competitive world that remains, for the most part, unchanged.

By contrast, granting student borrowers the ability to discharge their education-related debts accomplishes three important things.

First, the mere threat of declaring bankruptcy for what are essentially unsecured loans should motivate otherwise obdurate lenders, investors and loan servicers to offer more substantive solutions to financially distressed borrowers—something that’s not happening now.

Second, a statutory right to bankruptcy will cause education-related loans to become significantly less attractive to all lenders—government and private alike. In turn, institutional revenues would be negatively affected (because the majority of college students borrow to fund their education), which would leave the schools with no alternative but to do what they should have done long ago: rein in costs.

Once payments for the loans already on the books are made more affordable, as well as for the cost of higher education going forward, then college graduates may no longer be compelled to move back home, forego major purchases and delay important life events such as marriage or starting a family—all of which benefits our national economy.

A streamlined path through bankruptcy for the schools? Sure. But not before we attend to those who need that more.

This story is an Op-Ed contribution to Credit.com and does not necessarily represent the views of the company or its affiliates.