The Two-Income Trap

Common belief is that those who declare bankruptcy lack the self-discipline and morals to live within their means and pay their debts. After extensive studies of people who declared bankruptcy in the U.S., Elizabeth Warren and Amelia Warren Tyagi paint a very different picture of the reasons why people go bankrupt in their 2003 book The Two-Income Trap: Why Middle-Class Mothers and Fathers are Going Broke.

If we go back to the 1970s, the typical family with children had a father who earned an income and a mother who stayed home. Thirty years later, the typical family with children had both parents working. It’s natural to assume that this means the modern family is better off financially, but the authors show that this isn’t true.

According to the authors, U.S. families entered into a bidding war for housing in good neighbourhoods near good schools to give their children a safe place to grow up. Between the explosion in housing prices and other higher inflation-adjusted costs, “after an average two-income family makes its house payments, car payments, insurance payments, and child care payments, they have less money left over, even though they have a second, full-time earner in the workplace.”

The effective marketing of debt by financial institutions has certainly played a role in egging families on to larger purchases. “Just a generation ago, the average family simply couldn’t get into the kind of financial hole that has become so familiar today” because “the average family couldn’t borrow very much money.” Easy access to high-interest debt has changed all that.

So, adding a second income does not give more disposable income than people in the 1970s had. But living on two incomes adds significant risk. Now there are two people who might lose their jobs, and the family can’t maintain the life they want for their kids on just one income. While in the 1970s a mother could step into the workplace if her husband fell too ill to work, two-income families have no such safety net now.

The authors certainly aren’t calling for a return to the single-income family. They want some measures that will help the typical two-income family. They would like to see public schools give parents more choice of where to send their kids. This would make it possible to send kids to a good school but live in a less expensive neighbourhood.

Another measure they’d like to see is a cap on interest rates tied to the prime rate (e.g., prime + 10%). “If a family does not have the income to qualify for a loan at a reasonable rate, then they should not get that loan.” I certainly like the idea of financial institutions being forced to be more selective when lending.

The book also contains some very detailed advice on how to proceed if you are already in financial trouble and must go bankrupt. Apparently, collection companies use some unpleasant tactics to try to collect on loans, even after the loans have been discharged by the courts.

Although this book is getting a little dated and is U.S.-centric, it still provides an interesting counter to the usual story that those who go bankrupt are self-centered and lack morals.