"Americans are not going broke over lattes!"

Home mortgages, insurance and, above all, children are driving middle-class parents into bankruptcy, says Harvard law professor and author Elizabeth Warren.

Published October 13, 2003 7:30PM (EDT)

Repossessed BMWs. Foreclosed McMansions. Pawned Rolexes.

Such is the stuff of personal bankruptcy when a go-go lifestyle built on consumer excess runs up against financial reality.

Or is it? Could it be that those tarnished icons of dead-end decadence are just as much an overhyped myth as the hordes of teenage day-traders back in 1999 who supposedly beat Wall Street's best brokers without ever leaving the comfort of their bedrooms?

The biggest predictor that a person will end up bankrupt turns out not to be a bad Prada habit or a taste for sub-zero refrigerators. It's having children, according to the mother-and-daughter authors of "The Two-Income Trap: Why Middle-Class Mothers and Fathers are Going Broke."

Elizabeth Warren, a professor at Harvard Law School, and her daughter, Amelia Warren Tyagi, a former McKinsey consultant, studied nearly 2,000 families that had gone bankrupt in the U.S. They analyzed myriad federal data detailing what Americans are actually spending their money on today compared to the legendarily more austere 1970s. What they discovered shocked even them: The effort to keep the kids in a good school district when one parent is laid off is more likely to drive Americans into bankruptcy court than all those trips to the Niketown store.

From her office at Harvard, Warren told Salon why the typical American middle-class family today is in a much more financially precarious situation than it was 30 years ago.

Why is today's two-income couple with kids more vulnerable than the single-income family of the past?

Today's two-income family has 75 percent more earnings, inflation adjusted, than their parents had a generation ago. The reason, of course, is because today's average family has two people in the workforce, instead of one. But this year, more children will live through their parents' bankruptcy than their parents' divorce.

Being a parent is the best predictor that a person will file for bankruptcy. Are parents more profligate than nonparents? What's wrong with this family? Since they're going bankrupt four times more often than their parents did a generation ago, I thought that this would be a story of overconsumption -- too many trips to the mall, too many designer toddler outfits, too many Gameboys.

The data show, however, that today's families are actually spending less on consumption that their parents spent a generation ago: 22 percent less on clothing, 21 percent less on food, including eating out, 44 percent less on appliances, less on furniture, less on floor coverings.

And I have to tell you, that finding stopped me dead in my tracks. It's counter to every conventional wisdom out there.

How can today's family possibly be less secure with two incomes?

Today's families are in financial trouble, because they're spending so much more on big fixed expenses -- mortgage, health insurance, car, preschool, after-school care and college.

What's happened is that the cost of being middle-class has shot out of the reach of ordinary families over the past generation.

Today's two-income family has 75 percent more income than the one-income family had a generation ago, but by the time they make four basic payments and their taxes they have less money to spend than their one-income parents.

Once a family builds a budget around two incomes, once they count on having both paychecks 52 weeks out of the year in order to be able to make the mortgage payment and the health insurance payment, they have a problem.

Because they have twice as many chances to get laid off, twice as many chances for someone to get too sick to go to work, and if grandma breaks a hip, or a young child becomes seriously ill, one of those two wage-earners will have to quit work to take care of the family member. So that means that they have more income, but they're actually more at risk.

How has the economic value of stay-at-home mothers been historically misunderstood both by feminists and conservatives?

A stay-at-home mother a generation ago not only took care of the children and tended the home fires, but she acted as an economic safety net for the family. If Dad lost his job, or was too sick to go to work, Mom could go to work, and could bring in a new source of revenue to the family.

She might not make as much money as he made, but the combination of her new income plus unemployment would often keep the family at about the same total income level. And if she stayed at work after he went back to work, they had extra income for a few months and could boost their earnings. The same thing if they were hit with an unexpected expense, anything from a child going to college to uninsured medical bills. They had a second source of revenue, someone who could work whose salary hadn't already been figured into the family budget, and could add that extra shot of income to the economic mix.

That made a two-parent family with one parent in the workforce and one parent at home a stronger, more secure family economically.

This is not an argument that women should stay at home. Today's mortgage costs and health insurance costs and day-care costs mean that today's families can't survive on one income and use the second income for extras. Instead, they have to commit both incomes just to making the basic payments.

Can you talk about why mortgage payments become such an enormous part of families' budgets?

Over the past generation mortgage costs have increased 70 times faster than a man's wages. Think about that. That means for many families in metropolitan areas throughout the U.S. the only way to buy a home is if both parents go into the workplace.

And you're not just talking about San Francisco and New York here?

In 75 percent of the metropolitan areas across America, a police officer cannot buy a house on one income. The same is true for a teacher or a firefighter. In other words, a one-income family in most of the United States cannot afford to be middle-class homeowners.

This is not about spa bathrooms and granite countertops. The average family in the U.S. today lives in a house that is 6.1 rooms. That's larger than the average family in the early 1970s -- they lived in a house that was 5.7 rooms -- but today's family has hardly rocketed into McMansion status.

So, we're not living that much larger than we were in the 1970s? The plague of American hyperconsumerism in recent generations is just a myth?

The overconsumption myth is just that -- a myth. It's a story that we tell ourselves. And it's a story that every credit card company that wants to press Congress to give it even more beneficial laws raises: the story of consumers who are wildly spending, and who need to be reined in. The credit card companies need protection from these wild overspenders.

When, in fact, those are the people that the credit card companies make all their money on?

When, in fact, that's exactly where they make all their profits.

I think that the reason that the story has been so tenacious is that we want to believe that it's true. If the only people who get into real financial trouble are the overspenders, then those of us who buy in bulk at Costco, and wouldn't dream of spending $200 on sneakers, surely we're safe.

And you're saying that the actual danger is the fact that people have 75 percent of two incomes locked up on fixed costs, like their mortgages?

In other words, the whole overconsumption story is a distraction. It has families focused on nickels, when it's the thousand-dollar commitments that are sinking the family economically. It gets families looking in the wrong place.

And there's a whole school of very popular financial planning built around this idea that if you don't have that latte ...

Americans are not going broke over lattes! Americans are going broke over home mortgages and health insurance. To claim that it is lattes is first to blame the families for something that is not their fault. And secondly, it removes all pressure to focus on political changes that need to be made. In the early 1980s, with no debate, Congress quietly deregulated the home mortgage-lending industry and the credit card industry.

With deregulation, a monster was born, and the monster is sub-prime lending -- that is, lending to a family once they get into financial troubles.

How big a business is that?

Nobody actually has the numbers on it, not even the Federal Reserve. Their best estimate is that it is many tens of billions of dollars. There's a whole industry that's grown up around this. And even Alan Greenspan says that it is the fastest growing part of the lending industry, this sub-prime element.

The notion is that the credit card company offers you a credit card at 6 percent interest, but if you lose your job and miss a payment, then the interest jumps to 29 percent. And once that happens a family gets its feet tangled up, and can't get out of debt.

Or, you have a mortgage at 5-1/2 percent, and when you miss a mortgage payment, there's an industry that descends on the homeowner offering to refinance to give some cash to the strapped family, but doubling or even tripling the interest rate on the payments.

Don't try to borrow your way out of debt. It never works. A family in financial trouble should never, underline never, take out a second mortgage or refinance the mortgage on their home. Companies are making billions in profits by talking families into putting their homes on a roulette wheel, and the companies come out the winner. Home mortgage foreclosures are up more than 300 percent over the past 22 years. It's really scary.

So, all these seemingly respectable financial institutions have become like loan sharks?

They have! They're making profits that would make Jimmy the Leg Breaker drool. In the early '80s, these mortgage-lending tactics and credit-card rates would have been illegal. The executives would have gone to prison for having sold these financial products.

It's time for Congress to reinstitute interest-rate caps. Virtually every civilized nation on earth has caps on interest that can be charged to consumers, except the United States. I believe in personal responsibility, but I also believe in a fair fight, and today, the typical middle-class family is no match for a mortgage company and a credit card company out to steal from them.

With sub-prime mortgages, at what rate are people then paying their mortgages?

In 2001, when standard mortgage loans were in the 6.5 percent range, Citibank's average mortgage rate was 15.6 percent.

Average! Average! So, half of them were above that on a home mortgage. That's an extra $420,000 on an average $175,000 home. In some sense, you just laugh and shake your head. I do. But some part of me is furious over this. Hardworking middle-class families are being cheated out of their retirement, out of the opportunity to send their kids to college, out of the very roof over their heads by rapacious lenders, whose only notion is more profits, more profits, more profits.

In the U.S. today, you cannot buy a toaster that has a 1 in 12 chance of burning down your house. It's not legal according to the Consumer Products Safety Commission. But you can buy a home mortgage that has a 1 in 12 chance of costing you your house. Either way the family is out on the street. The mortgage industry needs to be regulated at least as aggressively as the toaster industry.

I may need a food taster if you print that, somebody to start my car, but that's OK with me.

A big part of your argument is based on this idea that parents are putting more money into their homes because they want to be in a good school district. But how do you determine why people are buying the homes that they do? Isn't it possible that people just wanted a more expensive home in a classier neighborhood, and now they can't pay the mortgage? How do we know it's because of the school district?

It's two halves of the data. One half is that median families aren't buying houses that are much bigger than a generation ago, notwithstanding all the talk about McMansions and spa bathrooms. A family today is more likely to live in a house that's more than 25 years old -- old wiring, old paint, old plumbing. They're not getting more.

The other half is to look at the studies of what a good school district yields in terms of prices. A 5-point increase on fourth-grade reading scores will translate into thousands of dollars in the value of a home in that school district, as opposed to the neighboring school district that didn't have the rise.

Housing prices strongly mirror the perceived strength of the school district. It's the only thing that fits the rest of the housing data. The houses haven't gotten much bigger. They're not newer. They don't have a whole lot more amenities. The average new house built in the U.S. is larger, but that's not what the median-income family is buying. The median-income family is buying a little bit more house for a whole lot more money.

How do you think that the public school system could be reformed to stop the bidding war for housing in good school districts? And how do you think that could be accomplished politically, because obviously if so many parents have made this enormous investment in buying these houses to get into good school districts, if suddenly the whole system goes into flux that's going to massively undercut their investment. Aren't people going to freak out?

There's obviously some risk. But let me offer a different way to think about it. Mortgage costs for families with children have grown at twice the rate of [those for] people with no children. As long as school assignments are made by ZIP codes, parents will behave rationally. They will buy the most expensive ZIP code that they can afford and try to get their children educated. If school assignments throughout a region were made on some other basis than ZIP codes -- by test scores, by interests, by needing a tuba player for the high school band -- then parents who can afford $50,000 homes, $250,000 homes or $1 million homes would have the same educational opportunities for their children. And that means that parents could shop for homes that they could afford, and then look for schools that better matched their children, regardless of ZIP codes.

How do you get there? I've actually been talking to a lot of folks in Washington about this. I'll give you the very short version: Up until the 1950s, highways were always local.

You paid for them with local taxes; they weren't even statewide by and large. Somebody had the idea of building the big federal interstate system, and the way that they did it is that they just put up federal dollars, and said if you'll build according to this plan, then we'll give you a lot of federal matching dollars.

It would be possible today for Congress to agree to put up a commitment: 10 years of money to the first 10 school districts that want to try regional school choice. You give the principals some money to work with beyond what they get from the local tax dollars, and let the schools differentiate themselves from each other.

I think that this is the last best hope for keeping middle-class parents in the public school system. I'm really worried that the public school system is in grave danger.

You write that nearly nine out of 10 of these families who'd filed for bankruptcy did it because of job loss, medical problems, divorce or separation. These problems are obviously not new. So, why is there so much more personal bankruptcy now?

It's two things that are happening simultaneously. The first is that today's family is more highly leveraged. With larger fixed expenses, they have less room to cut back.

When you lose a job, it's not possible to say: "Oh, we're just going to pay 20 percent of the mortgage this month."

The other part of it is that risk has actually increased. The chances of losing a job are greater today than they were a generation ago. The chances of having an ill family member are greater.

Because people live longer?

Because people live longer and because things that killed people a generation ago don't today. And that's the good news, right? But it has an economic ramification. And hospitals have changed. They send people home quicker and sicker. And that means a family member has got to be there to take care of them.

One of the men in your book ends up living in an efficiency apartment with no furniture, and he has two ex-wives and five kids. Doesn't this case promote the overconsumption myth in a different way? Some people would look at this guy and say: "This guy shouldn't have had five kids. He can't support them."

And now he's broke. So, they won. They're exactly right!

I can only deal with the realities. Some guy got married in his 20s, and had two kids. Got divorced, married again in his 30s, they had three more kids. Should he not have? Maybe. But I don't know what we're supposed to do about that today.

It's a fair point. We tried to write these families up -- warts and all. But the point that we were actually trying to make with the story is the position that his ex-wife is in. Maybe she shouldn't have been foolish enough to marry someone who'd been married before. But if that's the standard, I don't know where we're going to go.

Our real point was her financial world has been turned upside down. She cannot afford the house that she is living in, trying to keep three children in middle-class schools. And the solution to her problems is not to squeeze him harder for child support.

Divorced women trying to support children are in economic chaos, and once again the conventional wisdom is that the law just needs to squeeze ex-husbands harder and the women's financial problems will be solved.

Our data showed that's just not so. The money is just not there. You could put this ex-husband in chains, but that's not going to produce enough money to pay her mortgage payments.

You're right: Maybe he shouldn't have had children. But we don't get to say after the fact to the children that "Gee, you shouldn't have been born."

Do you think that the overconsumption myth makes it easy to continue scapegoating bankrupt people, rather than, say, reforming the lending industry?

The people we interviewed would not tell their parents that they had filed. They would not tell their brothers and sisters.

They hid it from the neighbors and often tried to hide it from their own children. When we interviewed people, they would sometimes say: "I'll help you with your study, but you can't say the word, because I can't run the risk that one of the children will pick up the extension phone and hear you." Or, others would say, "because I can't bear to hear it."

These people were deeply humiliated, and most of them believed that they were the only ones.

It really is like the perfect political issue where no one will ever take action, because they're all too ashamed.

But you know, things change. There was a time when people didn't want to talk about divorce because it was so shameful. There was a time when people didn't want to talk about AIDs because it was so shameful. We've seen stigma undermine families before. And those things can change.

The families who are filing for bankruptcy are hardworking, play-by-the-rules people, who are doing the best that they can for their families. They do everything that they can to avoid bankruptcy.

I have no doubt that there are some people who misbehave. I just don't think that's the typical debtor who files for bankruptcy. In fact, I think it's pretty rare.

By Katharine Mieszkowski

Katharine Mieszkowski is a senior writer for Salon.

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