The Bleak House of Loan Repayment

May 26th, 2013 / By Deborah J. Merritt

Kyle wrote last week about the billions of dollars that the federal government invests in legal education. On the same day his post appeared, the Court of Appeals for the Ninth Circuit issued an opinion that illustrates the long shadow cast by these loans. Here’s what happened to one law school graduate, Michael Hedlund.

Michael grew up in Klamath Falls, Oregon, a small town in the scenic Northwest. He earned a BS in business administration from the University of Oregon, but had trouble finding a job when he graduated into the 1992 recession. Michael decided to obtain a law degree, hoping he might join the practice his father and brother had established in Klamath Falls. He enrolled in Willamette University’s College of Law and graduated in 1997, ranked in the middle of his class. Michael took a bar review course, sat for the July 1997 exam, and obtained work as a legal intern in the Klamath County District Attorney’s office. The DA promised him a full-time position once he obtained his law license.

Unfortunately, Michael failed his first two attempts to pass the bar. On his third try, he suffered the type of mishap usually reserved for television scripts: Mike stopped for coffee on his way to the July 1998 bar exam, locked his keys inside the car, and was unable to get to the exam on time. The DA’s office hired a different attorney, and Michael decided to end his legal career.

Despite these setbacks, Michael Hedlund obtained a good “JD Advantage” job. He became a counselor for the Klamath County Juvenile Department. In that position, Michael “reviews police records, meets with accused juveniles and their parents, recommends whether or not they need to be on probation, appears in court, at least in preliminary matters in juvenile cases, and supervises juveniles to ensure compliance with any probation order (p. 11).” Michael started working full-time for the Department in 1998 and still works there today.

Michael married in 2000 and became a father in 2001. According to his facebook page, his third child was born in 2009. Michael’s facebook profile shows him proudly posing with one of his daughters. The young family lives in the town where Michael grew up; grandparents and other relatives live nearby.

The only dark clouds in this sunny small-town sky were Michael Hedlund’s law school loans.

The Loans

When Michael Hedlund started law school in 1994, Willamette’s annual cost of attendance was $24,500. By his third year, the cost was $27,170. (Those figures appear on the original loan agreements.) Michael financed most of this cost through federally guaranteed loans.

Interest started to accumulate on some of the loans during law school; more interest accrued when Michael obtained deferrals while trying to pass the bar. Even after landing his full-time counseling job, Michael had trouble making payments. By 2003, Michael owed $85,246 to one loan servicing company (the Pennsylvania Higher Education Assistance Authority or “PHEAA”) and $18,755 to a second servicer (The Educational Resources Institute or “TERI”). When both servicers garnished his wages simultaneously, leaving Michael’s family unable to pay for necessities, he petitioned for bankruptcy.

TERI quickly settled with Michael, agreeing to accept $50 per month to pay down the loan. PHEAA offered to amortize its loan over thirty years, requiring Michael to make monthly payments of $417.67. It also offered to reduce payments to $307.43 per month during the early years, with higher payments later in the repayment course. Michael refused both of these options, maintaining that he couldn’t afford either one.

Why couldn’t Michael Hedlund make monthly payments of just a few hundred dollars a month? Even with his full-time, JD advantage job, he was earning just $19.17 per hour at the time of the 2003 bankruptcy hearing. After taxes and other deductions, Michael netted $2,317 per month. His wife worked a few hours a week but, with no college degree and a baby at home, she didn’t contribute much. $28,000 per year of net income for a family of three isn’t much. In fact, if Michael qualified for the Department of Education’s new “Pay As You Earn” program, he would pay no more than $90 per month on both the PHEAA and TERI loans. Unfortunately for Michael, that program didn’t exist in 2003, when PHEAA was demanding repayment.

Court Decisions

Since Michael and PHEAA couldn’t work out a repayment plan, the bankruptcy court conducted a trial in December 2003. The court made an oral ruling a few days later, finding that Michael could not afford to pay more than $225 per month to PHEAA. After examining the loan balance, remaining life of the loan (15 years), and interest rate (4.22%), the judge discharged the portion of Michael’s debt over $30,000.

PHEAA appealed, and a bankruptcy appellate panel reversed. Michael, in turn, appealed to the Ninth Circuit. The case languished in the court of appeals for almost six years. The court devoted some of that time to finding a pro bono attorney for Hedlund (who had appealed pro se) and to encouraging mediation between the parties, but other years just passed. In 2010, the court finally ruled that the bankruptcy judge had not made sufficient findings; it vacated the lower court decisions and sent the case back to the original judge. 2010 WL 737641 (CA9 2010).

The parties elected to proceed with the original 2003 record on remand. Judge Radcliffe, who rendered the original decision, died before he could issue a new ruling. The substitute judge, Judge Brandt, delivered his decision in summer 2011. Brandt’s ruling was virtually identical to the one delivered by Judge Radcliffe eight years earlier: He concluded that Michael could afford to pay $240 per month to PHEAA for fifteen years. He accordingly discharged all but $32,080 of Michael’s debt to PHEAA.

PHEAA appealed to the district court, which reversed the bankruptcy judge and reinstated Michael’s full debt. Michael appealed once again to the Ninth Circuit, which ruled for him last week. Barring a successful appeal to the Supreme Court, Michael Hedlund’s debt to PHEAA has been reduced. Where does that leave him? And what does the outcome tell us about educational loans, repayment plans, and the financial status of law school graduates?

Michael Hedlund Today

Michael Hedlund won partial discharge of his debt to PHEAA, but his financial status remains modest. If his salary from the Klamath County Juvenile Department kept pace with inflation–a dubious assumption for many state and local government jobs–he’s earning about $50,390 today. He’ll pay $240 per month to PHEAA, plus $50 per month to TERI, for a total of $3,480 per year. That’s almost 7% of his gross income devoted to repayment of law school loans, even after a partial discharge.

And, although Michael’s county job appeared secure ten years ago, Klamath County now faces a serious budget crisis. The county recently cut the Juvenile Department’s budget by 10.8%, and the department is transitioning to a “new, revenue-generating rehabilitation program.” Either of those changes might affect Michael’s job or salary.

Is Michael an Outlier?

It’s tempting to view Michael Hedlund as an unusual law graduate, one of the few who failed the bar and was unable to secure high-paying employment. Michael, however, is far from alone in his struggles.

Graduates of low-ranking law schools frequently fail the bar. ABA statistics, available in hard copy, show that Willamette’s bar passage rate for first-time takers was just 65% for the July 1997 Oregon bar, when Michael Hedlund first took the exam. Michael was one of 34 Willamette graduates to fail the Oregon bar on their first try that summer. The school’s most recent statistics show that 27.4% of its first-time takers fail the Oregon bar. According to data collected by US News, bar passage rates are even lower for at least 22 other law schools. Going to law school doesn’t guarantee a law license, as numerous graduates discover each year.

Nor is Michael Hedlund’s salary unusually low. Even if his wife cares full-time for their children, generating no outside income, Michael’s estimated salary almost exactly matches our country’s median household income of $50,502 in 2011. An occupational expert testified at Michael’s trial that “he was well-placed for his skills, that his wages and benefits were excellent for the Klamath Falls area, there were no higher paying jobs available to him, and that the area’s employment situation was unlikely to change in the near future (p. 16).” Even if Michael relocated, which he was willing to do, the expert concluded that increased living costs would outweigh any higher salary. This was true, not only because of the low cost of living in Klamath Falls, but because Michael benefited from free child care and subsidized housing provided by family members in that town.

What if Michael had persevered in his quest to become a lawyer? If he had passed the bar and found a lawyering job, both significant hurdles, he probably would be earning more today than in his JD advantage job as a juvenile counselor. But not that much more. A 2012 Economic Survey by the Oregon State Bar found that 25% of attorneys in Southern Oregon (where Michael lives) earn $63,000 a year or less (p. 15). It would be hard to stretch even $63,000 to pay back Michael’s loans while supporting his family.

The Klamath County District Attorney’s office, meanwhile, is facing the same budget crisis that is hurting the Juvenile Department. Attorneys in the DA’s office will take pay cuts of 5-14% during the coming year, just the first step in addressing an ongoing fiscal crisis.

The sobering fact is that some JD advantage jobs–and even some attorney positions–pay only $50,000 to $60,000 per year for experienced workers. For graduates who land in those jobs, law school loans are financially devastating.

What About IBR or PAYE?

Income Based Repayment and Pay As You Earn, two current programs for managing student loans, did not exist when Michael petitioned for bankruptcy in 2003. The government did, however, offer the Income Contingent Repayment Plan (ICRP). Both of the bankruptcy judges who reviewed Michael’s case concluded that ICRP would not give him sufficient relief. That plan would have demanded payments of more than $300 per month, more than the judges believed Michael could afford.

Judge Brandt, furthermore, suggested that no debtor should have to accept a program like ICRP. That program, Brandt declared, “simply is going to substitute a nondischargeable tax debt based on loan forgiveness for the student loan debt. And that tax debt is going to hit as much as 25 years further out, even when young debtors are likely to be dealing with their own children needing help with college or as they’re getting ready for retirement or hoping to get ready for retirement or potentially both (p. 31).” The ICRP solution, therefore, was no solution at all.

The government’s most recent loan restructuring program, Pay As You Earn, would have treated Michael much more favorably. As indicated above, he would have paid no more than $90 per month with a $40,000 salary and 3-person family. With a 5-person family and $50,000 salary–Michael’s likely situation today–he would pay no more than $72 per month. Of course, as Judge Brandt noted, Michael would owe taxes on the forgiven portion of his loan–a liability that would hit just as Michael and his wife prepared to send their daughters to college. More important, PAYE simply isn’t available to Michael: Congress limited access to graduates who obtained their first educational loans after October 1, 2007.

If Michael hadn’t defaulted on his loans, he would qualify for today’s Income-Based Repayment Plan and Public Service Loan Forgiveness Program. For the latter program, Michael wouldn’t be able to count any of the thirteen years he has already spent counseling juvenile offenders. He could, however, make reduced payments (currently about $108 per month, based on his income and family size) while working for another ten years in public service, then obtain full loan forgiveness. Those benefits, however, aren’t available to debtors who defaulted or settled with creditors under earlier, harsher loan programs.

Bleak House

This is Michael Hedlund’s Bleak House: Loan repayment plans that stretched more than thirty years past his law school graduation, ten years of bankruptcy-related litigation, and a partial discharge that will likely require payments until at least 2028–thirty-one years after Michael received his JD.

It is a bleak outcome for taxpayers and the economy as well. Here is a healthy, well educated father of three who lives modestly and has no addictions (p. 32). He is providing his family with the country’s median household income, while living in a low-cost town with other family nearby. Yet he is swimming in student debt, even after a partial discharge from the bankruptcy court. He won’t repay all of his federally guaranteed loans. Nor will he and his family buy the cars, dishwashers, ipods, and other goods that keep our economy healthy.

What can we learn from this story? First, large law school loans and unmanageable debt are not new phenomena. Michael Hedlund graduated from law school in 1997, more than a decade before the current downturn in legal employment. Law school was expensive even then; Michael’s total cost of attendance for three years at Willamette was $77,140. Given the school’s low bar passage rate, together with the salaries available for attorneys and JD advantage workers in Oregon, the price was simply too high.

Second, the changing tides of loan repayment programs have left some graduates–like Michael Hedlund–stranded on the beach. When Michael petitioned for bankruptcy, the government offered a repayment plan (ICRP) with payments that were too high for Michael to meet. Today, he would qualify for plans that would allow payments well below what he is paying under his partial discharge. Michael graduated at a bad time: law school tuition was already high, but loan repayment plans were still stringent. Politics, however, rarely looks backward to help those who are already in trouble.

Third, the very different repayment plans demonstrate the aimlessness of our loan repayment policies. After reviewing Michael Hedlund’s individual circumstances, two bankruptcy judges concluded that Michael could afford to pay no more than $290 per month (including the $50 owed to TERI) on his student loans. ICRP, the government program in effect in 2003, would have required payments of about $340 per month. Those payments would have paid off Michael’s loan, plus interest, in just over twenty years–but the payments were more than Michael could afford.

The repayment terms offered today, in contrast, would have allowed Michael to pay $92 (PAYE) or $134 (IBR) per month in 2003, based on his income and family size at that time. With his larger family and current salary he would pay only $72 (PAYE) or $108 (IBR) per month. These amounts are all less than half the amount that the bankruptcy court calculated Michael could afford–although they carry the prospect of significant tax liability at the end of the repayment period. A public servant like Michael, though, could avoid even that burden through today’s Public Service Loan Forgiveness program.

Where does the truth lie? Can Michael afford to pay $72 per month, $134 per month, $290 per month, or $340 per month? Do the lower amounts, offered by today’s repayment plans, represent thoughtful subsidies, political manna, bets that the economy will improve, or reckless accounting? Was ICRP too harsh or was the bankruptcy court too generous? What policies are driving these government programs and where are they taking us?

Finally, it is clear that law school was too expensive in 1997 for students like Michael Hedlund, and it is even more costly today. When law schools set tuition and admissions policies, they need to focus on the bottom quarter of their future graduates–not just the top quarter or even the median. Before classes start, of course, we don’t know who will fall into that bottom quarter. Class rank, furthermore, doesn’t correlate precisely with outcome; Mike Hedlund graduated in the middle of his class but may have obtained less than the median outcome.

Still, we know there will be law graduates who fail the bar, graduates who choose (or resign themselves to) JD advantage jobs, and graduates who earn less than $60,000 after years of experience. Law schools owe a duty to these graduates as well as to the more financially successful ones.

That reminder is especially important today, with law school applications significantly depressed. As schools struggle to maintain enrollments and budgets, will they admit more students at risk of failing the bar? How much will those students pay? Even with tuition discounts, many students pay more today than Michael Hedlund did. And with tighter job markets and inflation, entry-level salaries are lower–even for licensed lawyers. IBR, PAYE, and Public Service Loan Forgiveness offer tempting lifelines, but how long will those programs endure? Too many of our law graduates are living in bleak houses of bankruptcy, loan repayment, and underemployment.

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