A common argument used by advocates of the death penalty is that the threat of capital punishment serves as a crime deterrent because the fear of such a harsh sentence scares potential perpetrators from breaking the law. That logic does  not work for crime, so why should lenders assume that similar logic will help reduce student loan default?

On Tuesday, the U.S. Supreme Court heard oral arguments in United Student Aid Funds Inc. vs. Espinosa. The case  concerns the plight of Francisco Espinosa, who declared bankruptcy in 1992 with $18,000 in federal student loan debt he had taken out to attend Arizona I.T.T. Institute while working as an airline ramp agent. Following a court-approved deal, he spent five years repaying the $13,250 he owed in principal and a judge declared the case closed. Three years later, and eight years after the bankruptcy agreement was finalized, United Student Aid Funds (USA Funds), the loan holder, began proceedings to collect the unpaid interest. This pursuit came despite the fact that it never filed a protest when a judge denied its request to add the interest payments to the initial bankruptcy agreement. Lawsuits ensued and the case has been making its way through the court system ever since. See the Chronicle ($) for all the gritty details.)

The case rests on narrow legal grounds. It revolves around whether the interest portion of the debt should have been forgiven in bankruptcy given that Espinosa did not claim attempt to demonstrate that his debt represented an “undue hardship,” the standard required by law for student loans to be discharged in bankruptcy. A victory for USA Funds means just upholding a law that is already on the books and one that is only under consideration because it brought the suit in the first place. A loss could weaken the undue hardship requirement, but borrowers rarely use this standard anyway.

So what is driving the case? It is not money—a few hours of time for the lawyers involved easily exceeds the profit from collecting a 15 year old debt worth about $4,000. The answer is the message it sends to other borrowers.

Just as the death penalty supposedly sends a message to would-be criminals everywhere, so too does the Espinosa case have a clear edict to struggling borrowers—fail to pay back a penny of your loans and you will be pursued to the ends of the Earth (or at least as far as the U.S. system of justice reaches). Sure the penalties aren’t as high as those stemming from capital punishment, and the concern about false punishment are less likely to occur, but the similar threat and use of fear to create deterrence is still present.

What is also particularly troubling about this case is that the entity pursuing Espinosa is the same one that was supposed to help him stay out of default in the first place. USA Funds has a whole section on its Web site devoted to default prevention, trumpeting its “innovative debt management” that helps students and schools with financial literacy and other solutions to avoid default. It certainly seems a bit strange that a company apparently so focused on helping borrowers should then switch gears and engage in such a harsh pursuit of one of the individuals it is expected to help—especially someone who repaid the vast majority of what he owed.

USA Funds’ behavior can be explained by the design of the federal student loan system and the incentives within it. In addition to receiving payments for loan default prevention, USA Funds and other similar entities known as guaranty agencies, are also paid to collect on loans that have not been repaid. That creates a tension between the two competing priorities of preventing default or reaping the benefits of collecting on loans no longer in repayment.

But the incentives are not equally balanced. USA Funds received $218.7 million last year in loan collections. That’s more than five times the $40.6 million it received to prevent default. Sure, this is the product of a screwed up incentive structure designed by Congress, but it would be foolhardy to think that USA Funds lobbyists did not play a role in crafting or maintaining this system.*

Rather than continuing down the path of deterrence through fear of punishment, something that may not work anyway, everyone involved would be better served by a streamlined system that focused on helping struggling borrowers, not providing a cash cow for collection. That means eliminating the conflict of interest that currently exists for default prevention and collection. It also entails making it easier for borrowers to repay their debt—through plans that tie payments to income and the use of automated deductions just like taxes. Such a system would not only reduce administration and implementation costs but also focus on assisting borrowers, not scaring them into repayment. Threatening legal action on old debt is not a deterrence, it’s a heavy-handed fear tactic.

*There is a group of guaranty agencies that have tried to fix some of these imbalanced incentives. USA Funds is not part of that association.