The Big Problem With the Ongoing Law School Bailout

, The Am Law Daily

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Recently, U.S. senators Richard Durbin (D-Ill..), Jack Reed (D-R.I.) and Elizabeth Warren (D-Mass.) introduced the " Protect Student Borrowers Act of 2013." The bill would allow the U.S. secretary of Education to require that colleges and universities pay a penalty on federal student loans in default. The size of the penalty would increase in line with the school's default rate.

But waiting until a loan is in default is too late to create a more effective nexus between educators' incentives and their graduates' fate. Consider the statistics: Thousands of recent law graduates are already living with the consequences of a system that immunizes schools from financial accountability for their students' poor employment outcomes. Eighty-five percent of today's newest lawyers are carrying six-figure law school debt. Only about half of all those graduating from law school in 2012 found full-time long-term jobs requiring a J.D. The most recent U.S. Bureau of Labor Statistics employment report indicates that between December 2012 and December 2013, employment in the "all legal services" category actually declined by 1,000 people.

Demand Down; Supply Still Growing

As the profession was losing 1,000 jobs last year, law schools graduated a record number of new lawyers—46,000—and more large classes are in the pipeline. Sure, law school applications are down, but acceptance rates have gone way, way up to compensate, and recently revised BLS estimates suggest an ongoing lawyer glut for years to come. (For a more detailed analysis, take a look at Matt Leichter's recent Am Law Daily article.) In the midst of this disaster, law school tuition keeps increasing. It's all quite perverse.

Unfortunately, it's also a predictable consequence of structural incentives. Most university administrators (and the deans that run their law schools) run their institutions as businesses. Under the current system by which higher education is financed, that approach produces a myopic focus: maximizing short-term tuition revenues by filling classrooms.

Added encouragement comes from U.S. News rankings criteria that, for example, actually reward expenditures regardless of added value or the lack thereof. The vast majority of students borrow enormous sums to pay tuition. But—and here’s where educational institutions lack the constraints that they would encounter if they operated as true businesses—any subsequent failure to repay those loans never becomes the school's problem.

Instead, virtually all student loans come with the backing of the federal government. In case of default, the schools remain protected. So far, graduate student default rates have remained below those for colleges and vocational schools, but across the board, all rates are climbing. (I wonder if low J.D. default rates are attributable, in part, to lawyers' better understanding of the procedural steps that can forestall default. Attorneys also grasp the counterproductive futility of defaulting: educational debt survives bankruptcy, and forcing the government to pursue a default just adds monetary penalties and collection costs to the tab.)

IBR Is No Panacea

Income-based tuition repayment plans may become an important potential relief valve to some indebted graduates. But the IBR program is new and comes with lots of caveats. For example, during the time that a graduate remains in the program, interest on his or her overall debt continues to accrue. Exiting the system before completing the requisite repayment period (typically 25 years; 10 years for public service jobs) can produce an even greater debt than existed upon graduation.

Meanwhile, though those who make it all the way to the end of the repayment period are off the hook for their loans and accrued interest, the debt that is forgiven through IBR is considered taxable income. If Congress doesn’t fix that problem, the result will be a big tax bill for a person who, by definition of ongoing participation in the IBR program, can’t afford to pay it.

Moreover, the forgiven amounts still have to come from the federal treasury at taxpayer expense, so there never was or will be a free lunch—except for the schools that received tuition but thereafter had no financial skin in the game. It has the feel of a law school bailout, doesn't?

A Better Way?

Maybe the following three-step approach would help to restore a functioning market: 1.) allow educational loans to become dischargeable in bankruptcy; 2.) in the course of such a proceeding, require the bankruptcy court to determine whether educational debt was a significant factor in the debtor’s need for bankruptcy protection; and 3.) in those cases where it is such a factor, permit the federal government guarantor to seek recompense from the educational institution whose conduct lies at the heart of the mess. (Requiring need-blind admissions as a prerequisite to participation in the federal loan guaranty program generally might counteract a school's temptation to bias admissions in favor of those who can afford to pay.)

Most people profess confidence in free markets; some do it with an evangelistic zeal. If these true believers really want to give the market a chance to work in the student debt setting, they will support a serious effort to cure the system's current failures. Personal educational debt in this country currently exceeds $1.2 trillion—more than all consumer credit card debt combined. Every day, that bubble is growing. Just ask a law student.

Steven J. Harper is an adjunct professor at Northwestern University and author of "The Lawyer Bubble: A Profession in Crisis" (Basic Books, April 2013), and other books. He retired as a partner at Kirkland & Ellis in 2008, after 30 years in private practice. His blog about the legal profession, The Belly of the Beast, can be found at http://thebellyofthebeast.wordpress.com/. A version of the column above was first published on The Belly of the Beast.

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