Screen Shot 2014-02-23 at 10.35.13 PM

My Rich Uncle Gets Bankruptcy; Borrowers Get Headaches

Michael Lux Blog, Student Loans 0 Comments

Not long ago there was a student loan company that set out to change the game in student loans.  They took out newspaper ads criticizing the cozy relationships between schools and lenders.  They portrayed themselves as a “conflict-free” alternative to traditional student loans.  This company was called My Rich Uncle.

What borrowers didn’t know about was My Rich Uncle’s dependence upon Goldman Sachs, Lehman Brothers, and Merrill Lynch.  When the recession hit, the big financial institution money dried up.  My Rich Uncle ceased lending, and eventually they filed for bankruptcy.

As is customary in bankruptcy proceedings, My Rich Uncle sold off their assets, including hundreds of millions of dollars in student loan debt.  The borrowers had no say in where this debt was sold off to, and they had no way of preventing it.

The fallout from this bankruptcy demonstrates the disparity between the rules that apply to student loan consumers and lenders.

My Rich Uncle loans today

For the many borrowers of My Rich Uncle loans, their loans are now serviced and owned by a multitude of companies.  In some cases, borrowers that had multiple loans with My Rich Uncle had their loans sold of to different locations.  Compounding interest and difficulty tracking down loans has been the source of many borrower headaches.

For the My Rich Uncle shareholders and company founders, the money that they owed has all been wiped off the books.  The business has failed, but because they declared bankruptcy, no individual was liable for the existing debts of the company.

Why such different outcomes for the lenders and borrowers?

It all comes down to bankruptcy.  Put simply, bankruptcy is financial last resort, but an opportunity to start fresh.  It is there, in part, to encourage risk taking and provide a safety net when things don’t work out.  Obviously, its not quite that simple, as there is an entire area of law and economic theory devoted to this subject.

However, despite the complexity of bankruptcy law, there are some basic principals that usually apply.  For example, in the United States, an individual has the ability to start a business without the risk of permanent financial ruin.  As a society we want this rule because it encourages job creation and advances our economy.

In the case of My Rich Uncle, things did not work out for the company.  Because of bankruptcy protection, the only thing that the stakeholders lost was what they put into the company.  No doubt, it was a touch loss for some, but they had the ability to move forward.

Borrowers of student loans don’t get the same bankruptcy protection. Because student loans are so difficult to remove in bankruptcy, borrowers who cannot afford their debt face wage garnishments, destroyed credit, and little hope for things to improve.

[Read More: How Student Loans delay major life events and affect the economy]

The part that makes this disparity in the rules strange is the many similarities between starting a business and going to school.   The motives are often the same, a desire to create a new opportunity and to earn more money.  As a society, we benefit from both, whether it is a new business or a better educated workforce, the economy is strengthened.

The outcome for the borrower and the lender

If a borrower has My Rich Uncle student loans and they can’t pay them back, they are out of luck.  A fresh start is nearly impossible, and the investment they made in themselves not only doesn’t pay off… it has consequences that can last a lifetime.

Yet for the lender, things are different.  Investments were made into the company, and it didn’t pay off.  However, they do get a fresh start.  The founders can move on to other opportunities, and not a single individual has to worry about the debt following them after failure.

This strange outcome leads to a very difficult question… why do we protect investors and entrepreneurs but not a bunch of kids trying to pay for college?