The Fresh Start Act is a big deal

A bipartisan proposal introduces student relief and clawbacks

Two prominent senators – Dick Durbin (D-IL) and John Cornyn (R-TX) – last week introduced a bankruptcy reform bill that if enacted and implemented will likely have a significant impact on students and a more limited one on the higher education industry.  The Fresh Start through Bankruptcy Act of 2021 permits discharge of federal student loans in bankruptcy and makes certain weaker-performing colleges partially liable for these discharged loans.  There are technical processes to be worked out and numbers to be negotiated but this relatively short amendment of existing bankruptcy law shows signs of a consensus shift – unpublicized but substantive – on Capitol Hill about how to alleviate the pain inflicted on student borrowers:

  • The two sponsors are senior figures with a history of involvement in higher education regulation, one from each side of the aisle.
  • The bill has already elicited a statement of support from a leading professional organization, before it was even posted on the congressional website. The speed of the support reflects behind-the-scenes negotiations and consensus-building prior to its introduction.  That behind-the-scenes action did not prevent Durbin and Cornyn from including provisions holding colleges accountable – not through toothless accreditation review but through actual cash – for their students’ future financial health.

What does the legislation do?

Student debt discharge

Students would be allowed to discharge federal loans in bankruptcy beginning 10 years after the loans first become due.  This will have the biggest impact and will likely dominate media headlines as the legislation moves forward. A commission on bankruptcy reform had recommended this wait period be 7 years in their 2019 report,  a return to the length in place prior to the 1998 act which made student loans entirely non-dischargeable.  We can infer that this 10-year period was subject to negotiation behind the scenes, with the counterarguments against a shorter period likely emphasizing equity concerns, moral hazard and federal deficits.

Discharging student loans still wouldn’t be a walk in the park: A 10-year wait before bankruptcy eligibility means that many of the borrowers seeking this relief will be in their early 30s. To obtain the relief, they will suffer a big credit history mark just when many would be building a career and thinking about buying a home.  Most entering college students would never aspire to a condition where, 10 years after graduating, they were broke, probably couldn’t buy a house and might have difficulties passing an employment check.  But it takes an untenable situation – where people both can’t pay their loans and can’t get out from under them – into a merely very unpleasant one.

Clawbacks for colleges reliant on federal loans with poor repayment outcomes

Student debt discharge would trigger a clawback: colleges would now be on the hook if students can’t repay their debt. But the bill’s technical language ensures this will apply to relatively few schools, those with weak student outcomes, and the amounts clawed back would come to a fraction of the discharged debt.

Nevertheless, the clawback represents a material risk, and colleges will now have skin in the game and will suffer if too many graduates encounter financial problems. Colleges at risk for clawback would be those with both a) over a third of their students borrowing federal loans and b) those with “cohort default rates” above 15%. The kicker is that the liability would in practice disproportionately apply to community colleges.

  • Higher reliance on federal student loans: This threshold — more than a third of their students borrow from the federal program — is the more rigorous of the two clawback thresholds, and includes many more students and colleges. Our initial estimate is that 74% of colleges educating 65% of students (full-time equivalent basis) would be liable because of it.
    • Community colleges and regional schools rely more heavily on federal loans than many well-endowed private universities and large public universities, such as the University of Arizona or Auburn.
    • Highly selective schools would generally not be subject to clawback. For example, 21% of Princeton’s entering 2019 class took out federal loans, below the threshold.
    • To look at just the California system, every Cal State campus has over a third of its student body taking out student loans but the more selective UC campuses don’t.
      • This distinction is seen in other state public systems.  For example, the main Rutgers campus in New Brunswick would not be liable for clawback under this first metric but smaller Rutgers-Camden would.
    • Interestingly, for-profit Grand Canyon would not be liable under it.
  • Cohort default rate:  Schools would also be liable for clawbacks if their students have difficulty repaying the loans, as measured by the Department of Education’s annual release of cohort default ratesFresh Start’s standards are loose enough that most colleges will not be subject to clawback.
    • Colleges with a 3-year cohort default rate of over 15% (in each year) are liable, vs the 2017 cohort default average across higher education of 9.7%. This would apply to about 17% of entering students. This group of colleges would be assessed 20% of the discharged debt.
      • A preliminary screening exercise indicates many community colleges, including those in Philadelphia, Portland (Oregon) and the state-wide Ivy Tech system in Indiana, would trip the lower bound and be liable for clawbacks.
      • A small set of 4-years would trip it, including New Mexico State, the Savannah State and Vincennes.
      • Several for-profits not surprisingly tripped this test, including American Public (APUS), Post and Colorado Tech.
        • Western Governors is not remotely close to tripping it.
      • A very few colleges with poor repayment rates would be assessed 50% of any student debt discharges (our initial estimate is this would apply to <1% of entering students).
      • Community colleges are of course open enrollment. It’s hard to see how they can respond to the incentive of clawbacks.
  • Consequences: Colleges may become somewhat mindful of the cohort default rate, a metric which had been back-of-mind. Because the cohort default metric is based on future results, certain colleges will as a precaution become more risk averse about student borrowings and admissions. But the largest group of institutions subject to the risk of clawback are open enrollment, so what is it exactly that they can do? Unclear.
    • An example of a school that would potentially change its behavior is Delaware State, which had a 3-year cohort default average of 13% (2017 data), so it was within shouting distance of needing to pay back money. It is also reasonably selective (53% admissions rate in 2019), so has some room to modify its enrollment process. Delaware State will need to begin paying closer attention to the amounts students borrow and the ultimate employment prospects of its applicants, if the legislation passes in current form.

Political odds

You have to like Fresh Start’s chances of becoming law.  Biden would almost be forced to sign it if it passed both chambers.  On the college side, certain underperforming for-profits will face a material financial risk and community colleges may just have to shrug and accept a weakened financial position. The industry will be more focussed on the cohort default, a metric which had previously been ignored, but only institutions like Delaware State, with application processes but mediocre default rates, would really key on it and how its graduates are faring.

We’ve focussed on the bill’s impact on the business of higher ed but ultimately the most important beneficiaries will be students struggling with repayment.  See this thread for their horror stories. (It’s so long it will take time for the page to load.)  They are in the seventh circle of financial hell now; if enacted, the bill will allow them to climb the rungs and make into a better, but still painful, circle.


Read this post and others at our CTAS Higher Ed Business blog on Substack.