This article argues that racial segregation is crucial to explaining the emergence of the urban underclass during the 1970s. A strong interaction between rising rates of poverty and high levels of residential segregation explains where, why and in which groups the underclass arose. This argument is developed with simulations that replicate the economic conditions observed among blacks and whites in metropolitan areas during the 1970s but assume different conditions of racial and class segregation. These data show how a simple increase in the rate of minority poverty leads to a dramatic rise in the concentration of poverty when it occurs within a racially segregated city. Increases in poverty concentration are, in turn, associated with other changes in the socioeconomic character of neighborhoods, transforming them into physically deteriorated areas of high crime, poor schools, and excessive mortality where welfare-dependent, female-headed families are the norm. Thus, policies to solve the socioeconomic problems of minorities will fail unless they are accompanied by measures for overcoming the disadvantages caused by racial discrimination and prejudice in the housing market.