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January-February 2004

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Jumbo-Mortgage Blues
The Middle-Class Trapdoor

In 2001, more men and women went bankrupt than filed for divorce or graduated from college (1.5 million versus 1.1 million and 1.2 million, respectively). In 2002 those who declared bankruptcy far outnumbered those who suffered heart attacks or were diagnosed with cancer. At present rates, one in every seven children in America will live through a bankruptcy between now and the end of the decade. And it's not the working poor, credit-crazy youth, spendthrift "DINKs" (dual income, no kids), or fixed-income seniors who are swelling the ranks of the insolvent. The hardest hit are middle-class families, says Gottlieb professor of law Elizabeth Warren.

Some blame "affluenza"—the disease of overconsumption—and the "immoral debtor" for this rash of bankruptcies. "Too many trips to the mall, too many designer toddler outfits, too many Gameboys," as Warren herself initially thought. But government statistics and data from the 2001 Consumer Bankruptcy Project (Warren was one of 12 investigators) told a different story. In The Two-Income Trap: Why Middle-Class Mothers and Fathers Are Going Broke, Warren and her daughter, business consultant Amelia Warren Tyagi, propose a counterintuitive explanation. When working parents have to commit both incomes to middle-class basics—a nice home in a safe neighborhood with good schools—they double their financial risk. Without the safety net of a mother at home ready to enter the workforce if disaster strikes, two-income families are more likely to go bankrupt than those getting by on a single wage.

"The whole economic picture was one that surprised me, because it's not the story we tell ourselves about what's happened to middle-class families," Warren says. "The irony of the story is that the two-income family is the most successful economic model in America. Mom and Dad both have good educations and good jobs—that's the twenty-first-century version of the American success story and the middle class." But in fact, "the cost of being middle class is out of reach for many of these families."

The myth of rampant spending actually distracts people from what will bankrupt them, says Warren. "The overconsumption myth is a comforting myth, because families who buy pasta in bulk and don't eat out and wouldn't dream of spending $200 on a pair of sneakers say to themselves, 'We'll be all right.' But the reality is they won't be all right. If they have built a budget around two incomes, they now have double the chance that someone will lose a job and double the chance that someone will be too sick to go to work"—two of the "Big Three" reasons that 87 percent of bankrupt families cite for financial meltdown (divorce is the third).

High fixed costs are the culprit. "Huge mortgages are driving families into financial ruin," and a failing educational system is to blame, Warren explains. Families compete to buy houses in a shrinking number of decent school districts. This triggers real-estate bidding wars—fueled by dual wages—driving up prices astronomically. "Mortgage costs for families have risen 70 times faster than a man's income over the past generation," Warren notes—so an average father's salary can buy a home in only one of four American cities. Although household incomes, bolstered by mothers' wages, have shot up 75 percent since the 1970s, today's families actually have less discretionary money to spend than their parents did. Between monster mortgages, tuition for nursery school and college, and the other costs of raising middle-class kids, "couples with children are nearly three times more likely to go bankrupt," Warren says.

Sending working mothers home is not the answer, she asserts: "Families trying to live on one income can barely hang on to the ragged edge of the middle class." Instead, she and Tyagi propose several reforms.

First, reward middle-class and lower-income families who bank money by exempting all savings—not only those for retirement, medical care, or college tuition—from taxes, they say. Cap consumer-interest rates, and outlaw "predatory lending" that targets families in financial trouble. (Since high-cost credit became legal 25 years ago, credit-card debt has increased 6,000 percent.) Re-regulate a mortgage industry that approves loans that soak up 40 to 50 percent of family income, and perpetrates "loan-to-own" scams by lending to ineligible borrowers and waiting for foreclosures—which have tripled in two decades.

Warren and Tyagi also advocate metropolitan school-choice programs, so that parents, rather than bureaucrats, decide where children attend school, regardless of address. If nursery school is essential, expand the public-school system to include it, and if day care is subsidized, offer tax credits for stay-at-home parents. Finally, restore public universities to their original mission of affordability and access by freezing tuition and opening admission to all. Such reforms are necessary to secure the middle class, Warren believes: "The American middle class is strong, but it's not infinite in its capacity to withstand economic pressure."

~Harbour Fraser Hodder

Elizabeth Warren e-mail address: ewarren@law.harvard.edu

Amelia Warren Tyagi e-mail address: amelia.tyagi@verizon.net

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Jumbo-Mortgage BluesThe Middle-Class Trapdoor

Jumbo-Mortgage Blues
The Middle-Class Trapdoor