Was The GFC Caused By People Who Are Crap At Maths?

An individual’s likelihood of defaulting on a mortgage is directly related to their ability to perform basic mathematics calculations, a US bank has claimed. According to the study, the dramatic rise in subprime mortgage defaults in recent years can be attributed to borrowers' poor numerical ability and may have precipitated the recent global financial crisis.

Bad maths picture from Shutterstock

The GFC was partially caused by an explosion in US mortgage defaults which caused much of the industrialised world to be dragged into a lengthy recession. Until now, most research reports have focused on the risky behavior and revised policies of money lenders. However, there has been relatively little analysis of the role of borrowers and their ability to make sound financial decisions in relation to a mortgage contract.

In a bid to discover why borrowers take out mortgages they can't repay, researchers from the Federal Reserve Bank of Atlanta and the University of Lausanne in Switzerland analysed the mortgage characteristics and payment records for 339 subprime borrowers who initiated loans in the US between 2006 and 2007. The numerical ability of each borrower was assessed via a telephone survey.

The researchers found that borrowers with lower numerical ability spent more time in delinquency and experienced a greater frequency of foreclosure than individuals with higher numerical ability — even after socio-demographic variables were taken into account. This was caused by a number of factors including a lesser ability to choose the right mortgage contract, maintain a budget or think ahead.

"Optimal mortgage choice turns out to be a very complicated problem with often surprising implications," the paper explains. "Individuals with better cognitive abilities may be better able to anticipate future contingencies and choose a mortgage with payment streams that better accommodate those contingencies."

Borrowers with higher financial literacy levels were found to be much more proficient at negotiating with mortgage lenders to obtain better contract terms, such as lower interest rates and the absence of prepayment penalties.

"Our results suggest that differences in numerical ability play an important role quantitatively in terms of predicting the incidence of mortgage default and that this effect is also present for individuals who hold fixedrate mortgages," the authors conclude.

"Thus, imposing restrictions on the set of available mortgage products that could be offered to borrowers would likely not solve the problem of elevated mortgage defaults during periods of declining house prices."

See also: Pay Off Your Mortgage in Half the Time | Set Up A Phantom Mortgage To Trial Run The Expense Of Home Ownership | Twice Monthly Half Mortgage Payments Might Save You Money

Numerical ability predicts mortgage default [PNAS]


Comments

    This just in - stupid people make stupid decisions. More news at 7pm.

    "stupid people make stupid decisions"

    Yes, but....

    I like to think of it as having more in parallel with gambling mentality. When people gamble, they risk their current resources for a possible future benefit. The key to casino psychology is to make the gambling experience all about the potential benefits while minimising opportunities to think about the risk. Many people looking at those mortgages were in a similar position. People were offered amazing opportunities, which only in hindsight turned out to be too good to be true. And yes, those with poor math skills were probably more gullible. But do we blame the end users, or the professionals who should have laid out all of the alternatives in an ethical manner?

    If there is one thing I've learned from user experience research, its to be very careful when blaming the end user of a product or a service when things go wrong. Certainly they are ultimately responsible for their own decisions. But its equally important to look at the decision making context.

    Last edited 25/06/13 5:00 pm

    Financial institutions full of people who know how to crunch numbers ... they lent money to inept people, and coaxed them with sweet prose and flattery.
    The GFC was no accident.

      It's full of people who can slavishly follow formulae or click buttons have no innate understanding of basic arithmetic.

      I was asked by the VP of a bank I worked for years ago to write down the formula for a bank bill - a simple interest discount calculation that any financial professional should be able to set down. He returned 10 minutes, angered that I'd written down the "wrong formula". I looked at it and saw no problem. I was then led into a room full of credit professionals (who all probably earned at least 2-3x as much as I did) sheepishly playing with their HP-12C calculators. The problem (aside from none of them knowing 2c about simple interest): not one of them knew to multiple numbers in a simple expression before adding.

      In another situation I was applying for a mortgage with Westpac and prepped myself by making a little spreadsheet with projections of payment variations according to interest rates. I printed it out (it was the days before affordable mobile computers of any kind) and astonished the chief lending officer who was convinced that it took all of Westpac's computing hardware to crunch these numbers. Mind you, she needed two hands to drive a mouse...

      Last edited 25/06/13 6:51 pm

        Funnily enough, when I read the title "Was The GFC Caused By People Who Are Crap At Maths?" I automatically assumed it was referring to the bankers.

    Hahaha yeah, blame the people who took loans and couldn't pay back

    Not the banksters who rig the interest rates (LIBOR), not the politicians who deregulated the housing market and allowed the bubble to form, not the banks who gave loans to people they knew wouldn't pay back, not the media and speculators who kept fueling illusions in the public mind.

    There were some who saw the GFC coming, and they're giving new warnings
    https://www.youtube.com/watch?v=ksiHXSyQssI

    What has happened since 2008? Not a single bankster is behind bars, nothing has changed fundamentally, except there's more concentration of power than ever before and everyone is in debt with a stimulus bubble that is about to pop. We won't be worried about banks and corporations failing, this time entire nations will go bankrupt.

    Let's see who they blame when the Fed stops QE3/printing money (just look how the markets have reacted the past week to the fed's statements) and the economy completely collapses, who will they blame when your savings and pensions evaporate? Who will they blame when the derivatives market implodes? Will they blame cyberhackers from iran or china? Will they take us to war again like in the 30s?
    It's happened before and it's happening again
    currency wars -> trade wars -> world war

    It will definitely be something we'll tell our great grandkids about for the rest of our lives, how we survived the global economic collapse and WW3

    Was The GFC Caused By People Who Are Crap At Maths?No it was caused by greedy dicks that have no conscience...!

    Last edited 25/06/13 6:05 pm

    Of course it was. Not hard to work out what you can afford to pay. You know your lifestyle far more than your bank. Stupid people always blame others for their mistakes, rather than admitting they stuffed up.

    I understand the so called "stupid people" came from lower socioeconomic groups (typically in certain racial groups but certainly not limited to those groups) in the US. Mortgage brokers were in a position of authority due to their access to banks and knowledge of the banking system. They criminally abused that trust and ripped these "stupid people" off without mercy. I have to ask is this what "smart people" do?

      Uhh... Just thought I'd note that the article did say: "even after socio-demographic variables were taken into account. "
      As in, even after you adjust for other factors, "stupid people" made less sound judgements on the amount they were able to repay and choice of the type of mortgage that would suit them best.

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