The Next 'Big Short': COVID-19, Student Loan Discharge in Bankruptcy, and the SLABS Market

Abstract

Even before the spread of the COVID-19 pandemic, student loan debt—totaling over $1.64 trillion—was a cause for concern, as it is the second largest source of consumer debt in the United States, trailing only mortgage debt. And like collateralized mortgage debt, there is a market for collateralized student debt. Student loan asset-backed securities (SLABS) are the securitized form of student loan debt, repackaged as a marketable financial instrument. As with any investment vehicle, asset-backed securities like SLABS come with risk, particularly when borrowers default on their loans or have their debt discharged through bankruptcy proceedings. However, historically, SLABS have been a relatively sure bet—yielding consistent returns on investment—given that many student loans are guaranteed by the government and that student loan debt obligations are difficult for borrowers to escape. This is because there has been a long-standing and near-total prohibition on student loan discharge via bankruptcy proceedings. A spate of recent decisions rendered in the United States Bankruptcy Courts and two federal circuit courts of appeal could eliminate that prohibition. In turn, this decision could negatively impact the SLABS market, and in a broader sense, the United States economy. This Article addresses this possibility, especially in light of the fact that rising unemployment in the wake of the COVID-19 crisis is sure to increase the rate of default on student loans. Part II of this Article describes the present student loan crisis in terms of available statistics and common student loan repayment programs. Next, Part III chronicles the development and operation of bankruptcy law in the context of student loans. Part III also explains the general unwillingness to discharge student loans in bankruptcy proceedings via the Brunner test. Part IV focuses on student loan asset-backed securities: what they are, how they operate, and how they generate profit. This final section draws the connection between student loan discharge via bankruptcy and its potential impacts on the SLABS market and the economy at large. This Article concludes with observations about how the current crisis levels of student loan debt, when combined with rising unemployment and recent bankruptcy court decisions, could impact the stability of the SLABS market and the broader economy.