The subprime mortgage crisis led to worldwide economic ruin, and a new study published in PNAS suggests that poor math skills among mortgage borrowers didn't help things. It reports that subprime borrowers with low math skills were twice as likely to foreclose on their loans than people with good math skills.

It's been five years since the subprime mortgage crisis paralyzed the global finance industry, and many nations are still reeling. The Eurozone is creeping toward 20 million unemployed, with one in four still lacking jobs in Spain and Greece. "American households have regained less than half of the wealth lost during the Great Recession," according to a recent report in the Business Insider.

Money-hungry investment banks have been condemned repeatedly for their role, but some have questioned whether borrowers should also share some of the blame.

"The vast majority of this literature has focused on the question of why mortgage lenders were willing to lend money to riskier and riskier borrowers," wrote the study's authors, Kristopher Gerardi (Federal Reserve Bank of Atlanta), Lorenz Goette (University of Lausanne, Switzerland), and Stephan Meier (Columbia University).

"Much less attention has been given to the other side of the issue: Why were so many borrowers willing to take out mortgages that they could not repay?"

Math literacy is an obvious answer, and the economists explored whether there was link between financial distress and numerical ability. They recruited 339 subprime borrowers from New England who signed their mortgages between 2006 and 2007, right before the financial crisis and Great Recession occurred. The authors were able to acquire detailed information on when these borrowers fell behind on payments or if they ultimately foreclosed.

Each subject was given a survey that measure basic math skills, and they were divided into four groups based on how well they did on the survey. Here are some sample questions:

During a sale, a shop is selling all items at half price. Before the sale a sofa costs \$300. How much will it cost in the sale?

If 5 people all have the winning numbers in the lottery and the prize is \$2 million, how much will each of them get?

Let's say you have \$2,000 in a savings account. The account earns ten per cent interest per year. How much will you have in the account at the end of two years?

People with the worst math abilities spent twice as much of their time in delinquency — fell behind on payments — relative to borrowers with the best math skills. The same relationship applied to the chances of foreclosure, and neither trends were dependent on socio-demographics, like age, gender, marital status, education, household income, credit scores, or employment status over the previous five years

IQ and prior knowledge of economic principles did not influence whether a person fell behind on a loan. However, higher IQs did correlate with fewer foreclosures.

"This suggests that, holding numerical ability constant, higher IQ does not prevent households from falling behind on payments, but it does help them to avert foreclosure, perhaps because borrowers with higher IQ have better strategic skills," wrote the authors.

In a separate analysis, the economists asked whether poor math skills led people to select mortgages with riskier terms.

"Examples include mortgages with interest rates that are fixed for an initial period and then reset to higher adjustable rates, high prepayment penalties, or loan-to-value ratios close to 100%, which put borrowers in vulnerable positions in the event of house price declines and make it difficult to refinance."

Initial interest rate was the only factor that influenced financial decision making, with people with higher math ability tending to select mortgages with lower interest rates.

The economists conclude that socioeconomic characteristics can be ruled out when discussing how math literacy affected financial decisions during the crisis. General forms of coginitive ability — IQ and economic prowess — can also be ignored.

"The negative correlation between NA and mortgage default is likely driven by some aspect of individual behavior that occurs after the mortgage is originated," wrote Goette and colleagues. "Possibilities include spending and savings patterns or suboptimal investments made with respect to other financial contracts that impact borrowers' ability to repay their mortgages."

Prior studies have shown that financial education during high school can improve decision-making in adulthood. The findings reported here emphasize the importance of general math education in these adult decisions, and future studies need to assess whether math and financial education with homeowners can improve foreclosure rates.

Source: Gerardia K, Goette L, Meier S. Numerical ability predicts mortgage default. PNAS. 2013.