In their new book, Professor Elizabeth Warren and her daughter reveal the diminishing fortunes of middle-class families and show a way out of the “Two-Income Trap”

Here’s the problem with people nowadays. They spend spend spend on fancy toys, gadgets, food, clothes, vacations, cars, boats, McMansions and that second home in the country. So if they can’t pay the bills for their indulgences, they shouldn’t cry poor mouth and expect any handouts. There’s no personal responsibility anymore, that’s the problem. Why, back in my day . . .

It’s a screed we’ve all heard before. Or maybe even said ourselves. But here’s the real problem. It’s absolutely wrong.

So say HLS Professor Elizabeth Warren and her daughter, Amelia Warren Tyagi, in a new book that shatters the myth of the overconsuming American and the immoral debtor. That stereotype is not only wrong, they say, it’s dangerous, overlooking a crisis afflicting the middle class, particularly women–responsible, moral people, yet in deep financial trouble.

The book stems from Warren’s research and interviews as part of the Harvard University-based Consumer Bankruptcy Project, which studied nearly 2,000 families who declared bankruptcy. But it also is a product of her career-long focus on families in financial trouble. To add the perspective of a businessperson–and a member of the generation facing these issues–Warren teamed with her daughter, a Wharton M.B.A. who worked for McKinsey & Co. and co-founded a health care start-up.

As they write in “The Two-Income Trap: Why Middle-Class Mothers and Fathers Are Going Broke” (Basic Books, 2003), things were different not long ago. In the 1970s, most families could survive and even thrive on one income. An average family then was left with 46 percent of its sole earner’s wages after paying for housing, health insurance and other fixed costs. Yet that family today, despite the benefit of two paychecks, has only 25 percent of its income left for discretionary purchases. The situation deteriorates further for single parents, most of whom are women, who have a mere 4 percent of income remaining after paying their fixed costs. That’s because the cost of nondiscretionary items has skyrocketed in the last 30 years, leaving many ordinary, hardworking families on the precipice of financial disaster, report the authors in a book suffused with data and enlivened by personal stories of real people who fell into a trap usually sprung by a job loss, a medical problem or a divorce.

“So many of the people in financial trouble are desperately trying to hold it all together. They are struggling to save themselves, their children and their elderly parents from the consequences of complete collapse. They work hard, but they just can’t seem to get it right,” said Warren. “Doing this kind of work is not just about numbers and regressions. It’s about human beings.”

They are people like Ruth Ann and James, who learn the peril that good intentions can bring. They married, bought a house–a fixer-upper they could afford on their two salaries–and had two kids. They didn’t have much left after paying for child care, auto, food and mortgage expenses, and they didn’t spend money they didn’t have, but they were, they believed, doing the right thing for themselves and for their children. Then James was laid off. Ruth Ann and James borrowed money from family but could not keep up with the bills. Badgered by creditors, they filed for bankruptcy–and an American success story was transformed, in many people’s eyes, to an American failure, by one unforeseen, unpreventable blow.

The story of Ruth Ann and James, like those of many members of the middle class who share their experience of financial downfall, is “thick with irony,” write Warren and Tyagi. Parents who want a house in a safe neighborhood and a good school district unwittingly pit themselves against others just like them, boosting home prices and forcing both parents to work in order to compete financially with other dual earners. Single parents, meanwhile, can rarely compete. Relying on two incomes also leaves parents with little cushion when one loses a job or faces a medical emergency. In the past, the authors report, if the sole working parent lost a job, the stay-at-home parent would often go to work to make up some of the shortfall.

The middle class today likewise can’t solve the problem by cutting spending, despite the alleged conspicuous consumption so often blamed for people’s financial woes, the authors contend. The “over-consumption myth” squares with our intuition but not with the facts, they say. In fact, the authors’ analysis reveals that the current generation spends no more than the previous one did on discretionary purchases. “It’s so much more comfortable to think that the people who are in trouble spent themselves into financial chaos,” Warren said. “But if these people were a little lessresponsible, they wouldn’t be in so much financial trouble. Financial problems in the middle class are not about too many dinners out and too many designer clothes. It’s about mortgages people couldn’t manage, it’s about health insurance, it’s about homes in safe neighborhoods.”

But with middle-class families drowning in credit card debt (exceeding six months’ take-home pay for half of the families in bankruptcy, with more than a quarter owing a year’s salary, according to “The Two-Income Trap”), many point to a lack of personal responsibility as the underlying cause of the problem. Debt–and the avoidance of paying it through declaring bankruptcy–is often cited as proof of immoral behavior, as the authors outline. But the charge of immorality should rightly fall on the lenders themselves, contend Warren and Tyagi. They cite lenders that push subprime, high-interest mortgages, often in minority neighborhoods, on those who would qualify for lower rates; that besiege people already deep in debt with offers of credit; and that employ collectors who berate children about their parents’ overdue bills.

Amelia Warren Tyagi

Credit: Susan Werner Amelia Warren Tyagi brought a business perspective to her collaboration with her mother on “The Two-Income Trap.”

“Some of these tactics are legal, some of them are illegal, but I think they are all wrong,” said Tyagi. “And putting a stop to that would make a big difference in the lives of the most vulnerable.”

Warren says she is all for personal responsibility. But she also believes in fairness. And it is patently unfair, she says, for lenders to devise applications that have confounded students in her bankruptcy class.

Outside academia, the HLS professor served as an adviser to the National Bankruptcy Review Commission, fighting against a bankruptcy bill that would have “undercut virtually every protection in the bankruptcy laws” and provided a windfall for the credit industry. Congress didn’t listen to her, she says, but instead was swayed by industry lobbying and political contributions. (The bill failed to pass in 2002 only because of an abortion-related amendment attached to it, according to Warren.)

Years ago, she was also hired as a consultant by Citibank. In a room full of executives, she urged the company to stop lending money to families in financial trouble. But, said a top executive, those people provide the company with most of its profits.

The consultation was over.

“It’s an Alice in Wonderland world, where everything is upside down,” said Warren. “The most profitable customer is the customer who looks just like the families in bankruptcy but doesn’t actually file for bankruptcy. And the least profitable customers are people who have enough money to pay in full, on time, every month.”

Despite these experiences, Warren hopes and believes that the book she wrote with her daughter will help inspire change that will bring middle-class families back from the precipice.

Out of the Trap

The authors outline a litany of traps the middle class can fall into. But they also propose potential solutions, a combination of public policy shifts and government regulations that they say will free middle-class families to achieve what they want and what they deserve.

Potentially the most controversial recommendation goes to the heart of the two-income trap: the desire of middle-class parents to send their children to good schools–and their need to buy inflated-priced homes in order to gain access to them. Since that desire–understandable and admirable as it is–can literally lead them to bankruptcy, Warren and Tyagi call for a policy that would distinguish the location of one’s home from the location of children’s schools, thereby mitigating the home-buying frenzy in many suburban neighborhoods. A taxpayer-funded voucher system that allows a child to attend any public school at no cost would broaden the housing options available to parents, who would in turn exert more influence over their children’s schools, they argue. Administrators, who often inveigh against school choice plans, may not like it, but teachers will, they say.

“I think most teachers appreciate that what really matters happens in the classroom,” said Tyagi, whose areas of expertise at McKinsey included education, “and the more control we can put back into the classroom, the easier teachers’ lives will be and the better they can do their jobs.”

Such a change, the authors acknowledge in the book, “would be a shock to the educational system, but the shakeout might be just what the system needs. . . . By selecting where to send their children (and where to spend their vouchers), parents would take control over schools’ tax dollars, making them the de facto owners of these schools.”

They also propose expanding tax dollars to cover preschool education, which is no longer a luxury but now a necessity for middle-class families, they contend. For college education, also increasingly a necessity, they call for tuition freezes and cost cutting at public universities, where spending has far outstripped the rate of inflation. And to fight the inequities they charge the credit industry with, they recommend reviving usury laws and fortifying personal bankruptcy protection.

In the end, however, families should take responsibility, the authors advise. They outline a “financial fire drill” to practice before disaster happens. It includes shifting down fixed expenses (though they say people should enjoy occasional frills while they can–they’re the easiest things to cut from the family budget if needed), such as not buying a home if two incomes are needed to pay for it. They also give families some ways out if the “fire” has already started.

But most important, they are in the prevention business, trying to prevent the outlook from getting even worse for the vast middle class–a group in which nearly everyone in America claims membership. It will get worse if nothing is done, they warn. Warren, for her part, feels that improvements will come, despite the memory of her own thwarted efforts with the bankruptcy commission. So many people are caught in the trap or face its threat that inevitably they will fight back, she says, and eventually they will win.

“Politicians can insulate themselves as much as they want; they can tell whatever story they want,” Warren said. “But the underlying reality facing the middle class is not going to change. And every day, a few hundred thousand more families come to know that reality. They will insist their politicians make changes. It may not happen today. It may not happen tomorrow. But it will happen.”