The Fear of All Sums

In an article of the same title as our post the Economist Magazine discusses a recent study which gives evidence that innumeracy is at the heart of the subprime mortgage crisis and economic meltdown.

The research article is by economists at the Federal Reserve Bank of Atlanta (you can see the full article here).  What they show is:

We find a large and statistically significant negative correlation between numerical ability and various measures of delinquency and default. Foreclosure starts are approximately two-thirds lower in the group with the highest measured level of numerical ability compared with the group with the lowest measured level. The result is robust to controlling for a broad set of sociodemographic variables and not driven by other aspects of cognitive ability or the characteristics of the mortgage contracts.

— from the abstract of the article

What are they saying?  They are saying that there is a strong correlation between your ability to do basic math and your ability to stay out of foreclosure.

Mmmm, pi!

Interestingly, it is not for the reason you might think.  You might have guessed that people with good math skills make a better choice of mortgage (e.g. don’t take an adjustable rate mortgage).  But actually, that wasn’t the difference!  As the Economist explains:

Even accounting for a host of differences between people—including attitudes to risk, income levels and credit scores—those who fell behind on their mortgages were noticeably less numerate than those who kept up with their payments in the same overall circumstances. The least numerate fell behind about 25% of the time. For those who did best on the test, the number of payments they missed was almost 12%. A fifth of the least numerate group had been in foreclosure, but only 7% of those who were more numerically adept had.

Surprisingly, the least numerate were not making loan choices that differed much from their peers. They were about as likely to have a fixed-rate mortgage as the more numerically able. They did not borrow a larger share of their income. And loans were about the same fraction of the house’s value.

Stephan Meier, one of the study’s authors, reckons that the innumerate may be worse at managing their daily finances, leaving them with little room for manoeuvre when things get difficult. Those better at sums might, for instance, have put a bit more aside in more plentiful times. Normally, such differences might not matter much. But in bleaker circumstances, a small pot of savings may be all that stands between homeownership and foreclosure.

— The Economist

Also interesting is how they did the study.  They collected a large number of people and (in addition to gathering information about the peoples’ education, finances, mortgages, foreclosures, etc.)  had them do a simple on basic numeracy skills.

For example, here’s a question to test your skills:

To figure out if you are numerate, check out a short version of the test here.