The Trillion-Dollar Lie

Universities built palaces and financiers made fortunes in part through a lie: that student loans can't be discharged in bankruptcy. But a series of court cases is helping unravel the scam

Stefanie Gray explains why, as a teenager, she was so anxious to leave her home state of Florida to go to college.

“I went to garbage schools and I’m from a garbage low-income suburb where everyone sucks Oxycontin all day,” she says. “I needed to get out.”

She got into Hunter College in New York, but both her parents had died and she had nowhere near enough to pay tuition, so she borrowed. “I just had nothing and was poor as hell, so I took out loans,” she says.

This being 2006, just a year after the infamous Bankruptcy Bill of 2005 was passed, she believed news stories about student loans being non-dischargeable in bankruptcy. She believed they would be with her for life, or until they were paid off.

“My understanding was, it’s better to purchase 55 big-screen TVs on a credit card, and discharge that in a court of law, then be a student who’s getting an education,” she says.

Still, she asked for financial aid: “I was like, ‘My parents are dead, I'm a literal fucking orphan, I have no siblings. I'm just taking out this money to put my ass through school.”

Instead of a denial, she got plenty of credit, including a slice of what were called “direct-to-consumer” loans, that came with a whopping 14% interest rate. One of her loans also came from a company called MyRichUncle that, before going bankrupt in 2009, would briefly become famous for running an ad disclosing a kickback system that existed between student lenders and college financial aid offices.

Gray was not the cliché undergrad, majoring in underwater basket-weaving with no plan to repay her loans. She took geographical mapping, with the specific aim of getting a paying job quickly. But she graduated in the middle of the post-2008 crash, when “53% of people 18 to 29 were unemployed or underemployed.”

“I couldn't even get a job scrubbing toilets at a local motel,” she recalls. “They told me straight up that I was over-educated. I was like, “Literally, I'll do your housekeeping. I don't give a shit, just let me make money and not get evicted and end up homeless.”

The lender Sallie Mae at the time had an amusingly loathsome policy of charging a repeating $150 fee every three months just for the privilege of applying for forbearance. Gray was so pissed about having to pay $50 a month just to say she was broke that she started a change.org petition that ended up gathering 170,000 signatures.

She personally delivered those to the offices of Sallie Mae and ended up extracting a compromise out of the firm: they’d still charge the fee, but she could at least apply it to her balance, as opposed to just sticking it in the company’s pocket as an extra. This meager “partial” victory over a student lender was so rare, the New York Times wrote about it.

Gray still owed a ton of student debt — it had ballooned from $36,000 to $77,000 — and collectors were calling her nonstop, perhaps with a little edge thanks to who she was. “They were telling me I should hit up people I know for money, which was one thing,” she recalls. “But when they started talking about giving blood, or selling plasma… I don’t know.”

Sallie Mae ultimately sued Gray four times. In doing so, they made a strange error. It might have slipped by, but for luck. “By the grace of God,” Gray said, she met a man in the lobby of a courthouse, a future state Senator named Kevin Thomas, who took a look at her case. “Huh, I’ve got some ideas,” he said, eventually pointing to a problem right at the top of her lawsuit.

Sallie Mae did not represent itself in court as Sallie Mae. The listed plaintiff was “SLM Private Credit Student Loan Trust VL Funding LLC.” As was increasingly the case with mortgages and other forms of debt, student loans by then were typically gathered, pooled, and chopped into slices called tranches, to be marketed to investors. Gray, essentially, was being sued by a tranche of student loan debt, a little like being sued by the coach section of an airline flight.

When Thomas advised her to look up the plaintiff’s name, she discovered it wasn’t registered to do business in the State of New York, which prompted the judge to rule that the entity lacked standing to sue. He fined Sallie Mae $10,000 for “nonsense” and gave Gray another rare victory over a student lender, which she ended up writing about herself this time, in The Guardian.

Corporate creditors sometimes play probabilities and mass-sue even if they don’t always have great cases, knowing a huge percentage of borrowers either won’t show up in court (as with credit card holders) or will agree to anything to avoid judgments, the usual scenario with student borrowers.

Gray, however, was “scrappy and didn’t “take any shit,” and won. She didn’t establish any particularly important precedent with her case, except that student lenders can, in fact, lose in court. This It bleeds, we can kill it moment turned out to matter more than it seemed at the time.

The passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was a classic demonstration of how America works, or doesn’t, depending on your point of view. While we focus on differences between Republicans and Democrats, it’s their uncanny habit of having just a sliver of enough agreement to pass crucial industry-friendly bills that really defines the parties.

Whether it’s NAFTA, the Iraq War authorization, or the Obama stimulus, there are always just enough aisle-crossers to get the job done, and the tally usually tracks with industry money with humorous accuracy. In this law signed by George Bush, sponsored by Republican Chuck Grassley, and greased by millions in donations from entities like Sallie Mae, the crucial votes were cast by a handful of aisle-crossing Democrats, including especially the Delawareans Joe Biden and Tom Carper. Hillary Clinton, who took $140,000 from bank interests in her Senate run, had voted for an earlier version.

Party intrigue is only part of the magic of American politics. Public relations matter, too, and the Bankruptcy Bill turned out to be the poster child for another cherished national phenomenon: the double-lie.

In our country the surface political debate is often transparently simplistic and absurd, but serves a purpose by keeping the public’s eyes averted from more devastating underlying realities. With bankruptcy, Bush set the cover story. “In recent years too many people have abused the bankruptcy laws,” Bush declared at the signing ceremony. “They walked away from debts even when they had the ability to repay them.”

News outlets similarly stressed that the bill targeted bad people, deadbeats who had money and not only stiffed Visa and Mastercard, but maybe their kids, too. NBC spoke of bankruptcy as “the last refuge of gamblers, impulsive shoppers, divorced or separated fathers avoiding child support, and multimillionaires who buy mansions in states with liberal homestead exemptions.”

Years later, pundits still debate whether there really ever was an epidemic of debt-fleeing deadbeats, or whether legislators in 2005 who just a few years later gave “fresh starts” to bankrupt Wall Street banks ever cared about “moral hazard,” or if it’s fair to cut off a single Mom in a trailer when Donald Trump got to brag about “brilliantly” filing four commercial bankruptcies, and so on.

In other words, we argue the why of the bill, but not the what. What did that law say, exactly? For years, it was believed that it absolutely closed the door on bankruptcy for whole classes of borrowers, and one in particular: students. Nearly fifteen years after the bill’s passage, journalists were still using language like, “The bill made it completely impossible to discharge student loan debt.”

Even I did this, writing multiple features about student loans stressing their absolute non-dischargeability. In 2017, I interviewed a 68 year-old named Veronica Martish who filed for personal bankruptcy — as I put it, “not to get free of student loans, of course, since bankruptcy protection isn’t available for students” — and described her being chased by collectors to her deathbed. “By the time I die, I will probably pay over $200,000 toward an $8000 loan,” she said. “They chase you until you’re old, like me. They never stop. Ever.”

I got it wrong. Beginning in the 2010s, judges all over the U.S. began handing down decisions in cases like Gray’s that revealed lenders had essentially tricked the public into not asking basic questions, like: What is a “student loan”? Is it anything a lender calls a student loan? Is a school anything a lender calls a school? Is a student anyone who takes a class? Can lenders loan as much as they want, or can they only lend as much as school actually costs? And so on.

The phrase “Just asking questions” today often carries a negative connotation. It’s the language of the conspiracy theorist, we’re told. But sometimes in America we’re just not told the whole story, and it’s left to individual people to fill in the blanks. In a few rare cases, they find out something they weren’t supposed to, and in rarer cases still, they learn enough to beat the system. This is one of those stories.

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