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A tale of two bankruptcies

16 July 2015 By Kate Duguid

U.S. colleges need better bankruptcy options. Whether they are for-profit or traditional nonprofit institutions, they have no practical path out of insolvency. That’s bad for students – and potentially for government finances, too.

In theory schools can file for bankruptcy under the same Chapter 11 rules as companies. But the U.S. Department of Education immediately disqualifies them from access to federal student aid if they do. This effectively means instant closure for institutions like for-profit group Corinthian Colleges, which depended on federally funded students for 90 percent of its revenue. In other words, the rules discourage schools from tackling financial problems until it’s too late.

Even though the bucolic Sweet Briar College in Virginia depended on federally backed students to a lesser extent, it was still vulnerable. Its closure was announced in March. The nonprofit might have tackled its financial squeeze earlier: since 2009, enrollment had fallen 8.2 percent, and the school spent an unsustainable 9 percent of its endowment last year. A bankruptcy process, though, would have offered advantages like the ability to write down debts, transparency and, if there turned out to be no way out, an orderly wind-down.

Activist alumnae raised funds, reversed the decision to close Sweet Briar and replaced its leadership. But many of the students, who numbered 561 last year, have already transferred and some faculty members have left. The school just announced that it has nearly 300 new and returning students enrolled for the fall term, but only one more year of operation is guaranteed. Corporate-style bankruptcy protection could have bought more credible breathing room and less angst for students.

More broadly, Uncle Sam is on the hook for a big chunk of the more than $1 trillion of student loans outstanding. The debt attributable to a small college like Sweet Briar is a drop in the ocean. But large for-profits raise bigger risks. The DOE could forgive up to $3.5 billion for 350,000 students who attended Corinthian in the past five years. That’s partly because of alleged fraud by Corinthian, but many of the 78,000 enrolled students could anyway be eligible for loan forgiveness.

The department has 556 schools on its financial watch list. Intensifying regulation of for-profit colleges in particular could bring more of those to the brink. The government’s student loan exposure is big enough without adding to it by essentially forcing colleges to close abruptly when they may not have to.

 

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