I am late to write up a research paper that has not gotten the attention it warrants.

As most readers know, the 2005 bankruptcy law reform included provisions that made it virtually impossible to discharge student debt in bankruptcy. Yet borrowers who miss payments wind up paying penalty interest rates, with the result that they will carry their student debt with them to the grave.

But why do student borrowers get such harsh treatment? The justification for the bankruptcy law change was that student borrowers were prone to abusing the bankruptcy code even though they had the ability to make good on their loans. I’ve never bought the “strategic default” meme, which is almost entirely creditor urban legend to justify squeezing more blood from the stone of broke borrowers. Bankruptcy is a painful process that leaves your credit record damaged for years. And why should anyone think that student loans were more prone to abuse? If someone declared a Chapter 7 bankruptcy pre-2005, the court would take all the assets it could lay its hands on, allocate the proceeds among the various debts, and wipe out the rest. It’s not as if student loans were treated worse than any other non-collateralized loans.

Nevertheless, the argument was that student borrowers were defaulting opportunistically. If true, that higher default level would lead lenders to charge higher interest rates to cover for the cost of abusive defaults.

The prototypical strategic defaulter would be someone with few assets but high actual or expected income.

In a new Philadelphia Fed working paper, Rajeev Darolia and Dubravka Ritter constructed a database of private student loan (PSL) borrowers to see if their behavior changed as a result of the bankruptcy law reforms. We’ve embedded their article at the end of the post. Their conclusion:

Our findings contribute to this debate by providing evidence on bankruptcy filing and default behavior using a unique sample of anonymized credit bureau records. Although the 2005 bankruptcy reform reduced rates of Chapter 7 bankruptcy overall, the provisions making PSL debt nondischargeable do not appear to have reduced the bankruptcy filing or default behavior of PSL borrowers relative to other types of student loan borrowers at meaningful levels. Therefore, our analysis does not reveal debtor responses to the 2005 bankruptcy reform that would indicate widespread opportunistic behavior by PSL borrowers before the policy change. We interpret these findings as a lack of evidence that the moral hazard associated with PSL dischargeability pre-BAPCPA appreciably affected the behavior of student loan borrowers.

So why are default levels now so high? Lenders relaxed their standards and handed out more credit as a result of the 2005 bankruptcy reforms. And rising higher education costs means students are borrowing more than ever.