In a heterogeneous life cycle economy with human capital accumulation, the option to discharge student loans under a liquidation regime helps alleviate
some of the risk of investing in human capital. However, exclusion from borrowing is especially costly for high school graduates with low ability and human capital, for whom the gains from this insurance option are large. Replacing liquidation with reorganization induces significant allocational consequences across education groups. Overall, reorganization improves welfare relative to liquidation. Poor high school graduates with low ability and human capital benefit the most. However, an economy with partial dischargeability is desirable on welfare grounds.
Journal of Human Capital