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Federal Reserve chair questions student debt bankruptcy policy

Tennessee residents who have ever received student loans for college may recall being warned that student loans must be paid even if the borrower ever declares bankruptcy. Though bankruptcy can dismiss other types of debt, student loans are banned from discharge. The chairman of the Federal Reserve does not agree with this policy, according to statements he made at a Senate banking committee on March 4.

The Federal chair, Jerome Powell, brought up the subject in response to a question about whether student debt can hurt the economy. Powell stated that he does not understand the policy that prevents student debt from discharge in bankruptcy. Admitting that he does not have the power to change this policy, he suggested that Congress should look into it.

Congress first began passing laws that banned student loan debt from bankruptcy discharge in the 1970s. Student loans are only allowed to be discharged if the bankruptcy filer has 'undue hardship" as defined by the courts. Since Congress never defined undue hardship, the courts decide and have generally always set a high standard for meeting the criteria.

Powell said that as student debt continues to grow, it could hold back economic growth. Others have also expressed concern about rising student debt, including former Federal Reserve chair Janet Yellen. The Department of Education is currently seeking opinions and ideas about the way bankruptcy treats student loans.

Even though student debt is usually not allowed to be dismissed in bankruptcy, credit card debt and medical debt are two types of debt that are allowed. While chapter 7 bankruptcy liquidates assets to pay creditors and then discharges any remaining debt, chapter 13 bankruptcy does not involve liquidation. Instead, some debt must be paid on an affordable payment schedule for a few years, after which remaining debt is discharged.

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