The Next 'Big Short': COVID-19, Student Loan Discharge in Bankruptcy, and the SLABS Market
40 Pages Posted: 24 Jun 2020 Last revised: 10 Jul 2020
Date Written: June 20, 2020
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. Like mortgage-backed securities, student loan asset-backed securities, or “SLABS,” are the securitized form of student loan debt, repackaged as a marketable financial instrument. Also like mortgage-backed securities, SLABS are backed by income streams generated by loans to individuals. 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 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 prohibition on student loan discharge via bankruptcy proceedings. A recent decision rendered by the Chief Judge in the United States Bankruptcy Court in the Southern District of New York could eliminate that prohibition. In turn, this decision could negatively impact the SLABS market, and in a broad 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 I of this Article describes the present student loan crisis in terms of available statistics and common student loan repayment programs. Next, Part II chronicles the development of and operation of bankruptcy law doctrine in the context of student loans. Further, the second part of this Article explains the general prohibition against discharge of student loans in bankruptcy proceedings via the Brunner Test. Part III focuses on student loan asset-backed securities: what they are, how they operate, and how they generate profit. This final section will draw 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.
Keywords: student loans, asset-backed securities, bankruptcy, Brunner Test, COVID-19, loan default, loan discharge, SLABS
JEL Classification: G01, G21, H52, K22, K35,
Suggested Citation: Suggested Citation