Economic Boom in U.S. Bankruptcies; Financial ills plague the middle class, bedeviled by high-cost housing and related services and rising interest rates as well as the lure of cheap credit

Insight on the News, March 1, 2004

Byline: Christopher Whalen, SPECIAL TO INSIGHT

If you want to understand why the widely reported U.S. "economic recovery" feels less than convincing, go buy yourself a copy of a new book, The Two-Income Trap: Why Middle-Class Mothers and Fathers Are Going Broke, by Elizabeth Warren and Amelia Warren Tyagi.

Warren, a law professor at Harvard University and author of The Fragile Middle Class, and her daughter Tyagi, a former McKinsey & Co. consultant, have collaborated on this book to argue that two-parent, middle-class, working families are on the brink of financial disaster. The reason? The demographic wave known as the baby boom has bid up the cost of housing and related services to unmanageable levels. Warren argues that families have boosted income and used easily available consumer credit to keep pace with the rising costs, but many families considered by the banking industry to be solidly middle class and of high credit quality in fact are insolvent.

The number of families declaring bankruptcy or receiving a foreclosure against their house has shot up dramatically, Warren and Tyagi report. But, for every American family declaring insolvency, another seven families have financial problems that would warrant a bankruptcy filing. Contrary to popular myth, American families aren't in financial trouble because they're squandering second incomes on luxuries, Warren reveals. On the contrary, both incomes are almost entirely committed to necessities such as home and car payments, health insurance and education.

One of the most respected bankruptcy-law experts in the United States, Warren is vice president of the American Law Institute and on the executive committee of the National Bankruptcy Conference. She directed the National Bankruptcy Review Commission's study of federal bankruptcy laws and drafted its report to Congress. The National Law Journal named the celebrated author and teacher one of its "fifty most influential women lawyers in America."

Ominously, during an interview with Bill Moyers on Feb. 8, Warren reported that more middle-class American families will go through bankruptcy in 2004 than ever. Warren reports that 90 percent of the bankruptcy filings this year will be made by middle-class families, including some 9 million American households in divorce roughly one new filing every five minutes. By no coincidence, the Daily Bankruptcy News reports that consumer debt now equals 110 percent of disposable income, in comparison with 85 percent of disposable income 10 years ago and 65 percent 20 years ago. The consumer is exposed to rising interest rates, says Daily Bankruptcy News, because 40 percent of consumer debt is priced at floating rates.

Warren warns that when an unforeseen event such as serious illness, job loss or divorce occurs, middle-class American families have no discretionary income to fall back on and little or no savings. The Internet bubble of the late 1990s and the related swings in the value of the equity markets may have seemed gigantic at the time, but this important book suggests that the biggest bubble of all namely, the market for U.S. homes may be the next bubble set to deflate.

The author particularly is critical of the credit-card issuers and other pro-viders of consumer credit, accusing them of raping America's middle class, first through usurious interest rates on credit products and later by using the courts to take away their homes and other property. Warren likens the U.S. consumer-credit industry to a vampire draining the life's blood from American families. She warns that the banking industry in the United States is using its vast financial and political clout to push through bankruptcy-reform legislation that would remove most protections against creditors that consumers now enjoy.

Significantly, during the interview with Moyers, Warren told how during the last year of the Clinton administration she met with Hillary Clinton in New York City to discuss the bankruptcy-reform proposal then pending before Congress. After Warren described to the first lady how the consumer-credit industry gradually was destroying America's middle-class families, Hillary Clinton returned to Washington and single-handedly, says Warren, convinced President Bill Clinton to change his position.

In December 2000, President Clinton vetoed the most sweeping changes in the bankruptcy law in 20 years be-cause he said it was unfair to ordinary debtors and working families who fall on hard times, according to the Associated Press. Warren notes, however, that after Hillary Clinton was elected to the Senate from New York she switched sides and voted for so-called bankruptcy reform, illustrating the crushing political and financial power of the banking industry. Warren claims that the consumer-credit industry has spent tens of millions of dollars since then to buy approval of the proposal on Capitol Hill.

The powerful point made by Warren and Tyagi is that the negative effects of the "new economy bubble" still are working their way through the U.S. economy. Not only home prices, but the cost of all manner of local services, have been driven to extreme levels compared with household income during the middle age of the baby boomers. Indeed, Warren's book confirms the warning of cultural conservatives that the children of the boomers are spending and borrowing to keep pace with their more-affluent parents, in many cases creating a population with no savings and little equity in their homes the latter once having been the great repository of American wealth.