Saturday, July 29, 2006

Review: The Two Income Trap

Note: The first chapter of The Two Income Trap is available online.

The thesis of this book is that the increasing number of bankruptcy in America isn't due to excessive consumption, but because of excessive spending on important things: houses in good school districts, health insurance, college, and pre-school. The authors assert that for women, having a child at all is a bigger predictor of eventual bankruptcy than all other factors combined.

They point out (quite rightly), that middle income households have stretched themselves to the limit by bidding excessive amounts for houses, thereby ensuring financial disaster if one of them lose their job, for instance, or one of their family has a medical emergency. 87% of bankruptcies have their root causes in either:
  1. Job Loss
  2. Medical problems
  3. Divorce or Separation
Yet the financial media (amongst others) insists it is living beyond your means that creates the problems. By building a profile of an average family in the 1950s and an average family in the 2000s, Warren and Tyagi point out that the average family has spent less on discretionary items: clothing, groceries, fancy vacations and big televisions. Spending on transportation has gone up because both parents work, and more is spent on dining out, but that's made up by the savings brought about by Costco.

Their studies show that the big consumer is that of a house. By buying a big house in the suburbs rather than renting, American households participate in a bidding war for the best schools for their children in a safe location. The result is that it takes most of both incomes to provide for the family, and if a financial disaster happens there is no safety net.

Warren & Tyagi then prescribe a bunch of policy decisions: re-regulating the financial industry so that interest rates are capped, forcing banks and financial institutions to return to the 1950s standards for lending money seems to be their favorite prescription. Given how powerful the financial lobby is, I doubt that this policy will make it very far. The new bankruptcy bill passed last year, for instance, was practically written by the credit card companies.

They give no credence to the concept of universal healthcare, something I find a big pity --- 30% of bankruptcies are caused by medical emergencies. They also tepidly promote universal disability insurance as part of social security. (Note that California has already implemented this --- I've used this feature personally, so I know how useful it is) They also promote school vouchers as a means to de-couple schools from property values so parents aren't trapped by a big mortgage if they want good schools. I'm very skeptical of this proposal, since my guess is that the good schools will have their fees bid up to the same level as that of housing, so it'll all balance out.

Around where I live, there's quite a number of folks who buy houses in good school districts and then send their kids to private school, something I don't quite understand, but Asian parents do have a tendency to want to brag about how much they spend on their kids and can be extremely competitive in this regard.

Warren & Tyagi don't do much in terms of telling you what to do personally about this trap. They do advocate renting for a few additional years if you can't afford to buy right away, which is very sound advice, and to carry disability insurance if your state or your company does not provide, which is very sound advice. (Note that disability insurance is very expensive, precisely because you're more likely to need it than almost any other kind --- one in 3 Americans, for instance, will use the disability insurance feature of social security in their lifetimes --- and the elimination period for that insurance is a year!) Other than that, I guess they tell you not to get divorced.

In any case, The Two Income Trap confirms what I've guessed for awhile: buying a house isn't an investment decision in many parts of the country, it's a consumption decision. Recommended.
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