The Two Income Trap – Book Review

by Mike Holman

two income trapThe “Two Income Trap” is a financial theory put forth by authors Elizabeth Warren and Amelia Warren Tyagi which proposes that middle class working couples with kids are more likely to stretch their budget to buy expensive houses in good school areas than couples without kids. Because both parents are working, there is no backup plan if there is some type of financial emergency so if one person loses their job then the family’s financial security is put at risk which can end up in bankruptcy.

This book is a well written, extensively researched look at current generation middle class Americans and the reasons why they are not doing as well financially as the previous generation. It debunks the commonly held perception that over-consumption on consumer items and frivolous expenses is the reason why middle class families have increasing debt loads and higher bankruptcy rates than the previous generation. Instead it shows using extensive research that spending on normal consumer items hasn’t changed very much from the previous generation and in fact the main spending difference is on real estate.

Why are they doing this? One reason is that parents want the best for their kids and are willing to spend more money to buy houses in better school areas. The other reason is because they can. Compared to the previous generation a lot more mothers are in the workforce which increases the amount of money a couple can spend on a house. Combined with lower interest rates and the easier credit available to the current generation and you have a recipe for skyrocketing interest rates.

To order this book:

From the United States then please use this link for Amazon.com

If you are from Canada then please use this link for Amazon.ca

The problems occur if a major event happens to the family – divorce, unemployment, medical crisis are all events that in some cases can lead to bankruptcy because the families typically can’t cope with the loss of one income.

Solutions

  • The authors suggest that allowing students to go to school wherever they want will reduce the pressure on the parents to live in an expensive area. A voucher system would allow the parents to decide what school would get their funding and could possibly even allow the parents a say in running the school.
  • Reduce available credit by regulating the lending industry so that families can’t qualify for loans with high interest rates they can barely afford with no down payment.

Interesting Points

  • One comparison I found quite interesting was between a hypothetical family with two incomes who maxed out their credit to buy an expensive house and a second family that can live on one income for the essentials but blows the second income on vacations, big screen tvs etc. In the case where both families suffered a loss of one income, the first family would be hardest hit because they wouldn’t be able to cut back enough on the non-essentials since they have committed so much of their budget to fixed costs like housing. The second family who wastes their second income ironically could handle losing the second income because that money is not committed to anything such as a mortgage. All they have to do is stop going on expensive vacations and buying big screen televisions and they will be fine.
  • Subprime mortgages – even though the book was published in 2003 the section on subprime mortgages could have been written this year. They mention how in 2002 Citibank’s subprime lending subsidiary was prosecuted for deceptive marketing practices and fined $240 million.

What I didn’t like

This book is a bit of a downer because it focuses a lot of the research on families that went bankrupt. It tends to really accentuate the negative to the point of absurdity. There was one example that I found a bit ridiculous – “Gayle” who had three kids and was divorced had fallen into the two income trap when still married and bought an expensive house that required two salaries. Once the divorce occurred (after Dad got laid off) there wasn’t enough money for her to keep the house but in her mind it was the most important thing for her kids to stay in the same house even though they were clearly on the path to bankruptcy. I agree with the authors that she was part of the two income trap when the house was bought, but hanging on to something she had no hope of affording is what I call the stupid trap. Sometimes you have to look at reality and make the choices that are best for you and your family no matter how hard they are.

Another negative which was not a major problem but a bit annoying was the authors’ use of statistics. One issue is that they almost always used comparative percentages to make things look as bad as possible and never put the numbers in context. For example they would say something like “The number of single mothers declaring bankruptcy went up 600% from 1994 to 2002″ which is fine but how about letting us know the percent of bankrupt single mothers as a percent of all single mothers? Another trick they did was to extrapolate data – using the previous example they would finish off by saying “If this trend continues then by the end of the decade, one out of every ten single mothers will be bankrupt”. Looking at a trend from 1994 to 2002 (how did they come up with that time period?) and then extrapolating to 2010 is not good math.

Conclusion

Quibbles about depression inducing statistics aside, I really enjoyed this book because I thought it made a great case toward its central thesis and disproved the idea that today’s average middle class family is increasing debt because of televisions. There are a lot of thought provoking ideas in the book which made it a very interesting read.

If learning about why seemingly well off families get into financial trouble is interesting to you then I would recommend this book.

To order this book:

From the United States then please use this link for Amazon.com

If you are from Canada then please use this link for Amazon.ca

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{ 15 comments… read them below or add one }

1 MillionDollarJourney

Hmm.. maybe the authors are writing about my family. :) We have two incomes, and have just built in a nice neighborhood that is zoned for good schools. I guess time will tell if we planned well enough for maternity leave!

2 Four Pillars

MDJ – I can’t imagine the authors had you in mind when they wrote the book – but if they did – beware! bankruptcy is right around the corner!

Mike

3 SavingDiva

This books sounds like the kind of “bad stats” book that I hate! UGH!!!!

With that being said, I’m sure it will sell a lot of copies because Americans love to read these books and feel superior to the poor people that went bankrupt….

4 Four Pillars

Hi SD – although it is a bit negative it’s still a pretty good read.

The book was published in 2003 and I’m not sure how well it did in terms of sales.

Mike

5 Mr. Cheap

Elizabeth Warren is interviewed in “Maxed out” and “The Secret History of Credit Cards” (http://www.pbs.org/wgbh/pages/frontline/shows/credit/). I think the work she’s doing is interesting, but unfortunately she blends academia and activism a bit too closely for my tastes (and the clear political agenda makes some of her conclusions suspect, as you found in this book – she’s trying to prove a point rather then investigating an area and letting the data fall where it falls).

I think behind many bankruptcies you could probably find a situation like Gayle’s. The problems are barrelling along the highway towards them and they refuse to do anything about it until its far too late (then they cry and claim victim status). I think in any discussions about these issues, we need to acknowledge that the people involved have often made very poor choices.

6 telly

Ah yeah, my husband and I sound a lot like the 2nd couple in your example but we’re still holding out on that plasma tv!

I think the concept of buying in “good neighbourhoods” is an interesting one but I find it a bit confusing (maybe because I’m not a parent). I’ve heard this idea get thrown around by my coworkers and relatives in the US A LOT. Oddly enough, I always thought we were immune to this in Canada and that our school systems were pretty fair for the most part, all around. I didn’t grow up in an afluent neighbourhood and I’m doing just as well (or better!) than the kids that did. Hmmm…

My cousin and her husband purchased a house in a very expensive neighbourhood in the US 3 years ago for the great school systems even though they didn’t have children yet. They both make great incomes but even still, they were pushing 25-30% of gross monthly income on mortgage & property tax. Three years later, they’re still partying with no kids ;) and figure they will likely move out of the area as it’s a bit too “stuffy” for them. I had to laugh. $6k/yr on property taxes alone for a “great school system” they will probably never use. :O

The author’s theory of allowing children to go to whatever schools they want will NEVER fly. Why would people pay an arm and a leg for their home and their ungodly property taxes if their kids have to mingle with the kids from the other side of the tracks? :(

Property taxes in the US can be mind numbing. I know someone that pays $12k / yr in taxes (that’s more than our mortgage & taxes combined!) on their less than $1/2MM house in Ann Arbor, MI. But hey, the kids will likely get into U of M someday. ;)

Anyway, sorry for babbling. Great review!

7 Four Pillars

Telly, I’m not a big fan of the school rating system. Some parents swear that the difference between two schools is going to affect their child for the rest of their lives…I beg to differ.

There are too many other factors at play – if you have a stupid kid it won’t matter much what school they go to. Motivation of the kid is another big factor.

That’s interesting about property tax – I didn’t know they were so much higher in the US. And they make fun of us for our high income taxes? :)

Mike

8 WoolyWoman

Interesting, I had no idea! I often wonder how people can afford to live where they do live. Especially in a small town like ours where you can’t imagine how everyone makes so much money. Fortunately housing prices have been relatively affordable in most places, but now there are starting to be large homes popping up everywhere and the prices range from $500k – $750k. Yikes!
Also great to think about so we don’t fall into this trap. We have already decided to move before the new baby gets old enough for kindergarten because our neighbourhood is sketchy :):)

9 Four Pillars

Hi Wooly – when you start posting about the house hunt then I’ll email you reminders of this post/book. :)

Mike

10 telly

I agree Mike. I’ve heard plenty of stories about kids that went to schools in higher end neighbourhoods that ended up dropping out of school because they got involved in “rich kid drugs”. Every neighbourhood has it’s own set of problems and every school has smart kids and not-so-smart kids, as well as kids that apply themselves and kids that don’t.

11 Four Pillars

Telly – I agree. More money = more drugs.

Mike

12 Gates VP

Hey guys;

I’ve got a “big thought” here (and we know how that can go), so I’ll try to be brief. I’ve only been here a month

There are two Americas (not North and South, haha), two very distinctly American lifestyles. There are two Canadas, but to a much smaller extent. Lack of universal healthcare and less government support of social programs (at many levels) has exacerbated the “two Americas” difference.

There is a deep-founded belief that education (i.e.:”going to college”) is the path from the bad america to the good america. In a land where a college degree can be the difference between funded healthcare or no healthcare at all, that’s a big deal. So parents do everything they can to get into the good school systems.

Now, from a Canadian perspective this seems pretty nuts. Canadian schools (based on my Winnipeg/Saskatoon experience) fall under one of 4 categories: private, rural, big city “rich”, big city “not-so-rich”. But all of the public schools get much of the same funding. The “rich” schools might have more active parents or more possibility for “ski/band” trips, and the “poor” schools are more likely to get special programs for pregnant mothers or extra opportunities for technical vocational schools nearby. All things considered, kids have “pretty good” opportunities no matter where they go.

The US is totally different. I’m living in KC, MO right now. Kids in Johnson county (KS) have access to one of the best public library systems in the US. The schools are top-notch, filled with opportunity and 75% of the kids go to college. Cross State Line road and suddenly you’ll get high schools with 10% throughput to college on top of drop out rates of 30%+ You get schools with metal detectors and security guards.

And Kansas City isn’t really bad, some cities have it worse.

So it’s no surprise that people “kill themselves” to live in these areas, picking the wrong spot isn’t a matter of missing out on ski trips, it’s a huge difference. Now maybe it’s a self-fulfilling prophecy, with schools being funded at the county level, active parents seek out active counties and the good “attracts” the good.

Of course, there’s also a whole class of people who will spend 3 hours/day commuting to have their kids in good schools, ignorant of the fact that their presence good likely “make up” for many school deficiencies.

Either way, I’m not trying to invalidate other’s comments here. I just think that it’s important to recognize that the American reality can be quite different from the Canadian reality.

13 Four Pillars

Great comment Gates – I was hoping for some comments from the US to let us know what is going on down there – sounds like it’s a bit different than up here.

So did you get a new job?

Mike

14 Gates VP

Thanks Mike;

Kind of a new job. I worked for these guys doing general software consulting. We also made this neat Social Networking advertising platform (Cubics) that went critical and garnered serious interest from an on-line advertising firm (Adknowledge) in Kansas City.

So I’m doing some new stuff and some old stuff (there’s always new stuff) and I’m learning a whole bunch and having an exciting if stressful time. I’m making better money, but really, with a year or two of this type of work and I don’t think money will be the issue: I’ve added more relevant bullet points to my resume in the last 12 months than I did in the 2 years prior :)

If I haven’t posted in a long time, I’ve still been reading, but I’m typing this into my laptop on the floor of my new empty apartment. My wife (we got married over x-mas) is sleeping on our blow-up bed as our stuff careens across the midwest in a moving truck. This is a sampling of the excitement from my last two months :)

15 Four Pillars

Wow, sounds pretty exciting.

I remember you mentioning a fiance – congrats on the wedding! – It’s always nice to get it over with! :)

Mike

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