Math is in the news again. It’s not about the solution of a century old math problem. It is not about the math behind an earth shaking new technology. This time the focus is on the humble basic math skills such as how to calculate the price of a sofa in a clearance sale or how to calculate the earned interest in a savings account. The math news that is in the spotlight points to a tantalizing possibility that if enough people could practice this kind of simple basic math, the deep global recession that occurred a few years ago might have been averted, or its impact might have been greatly reduced.
According to a new study published in the National Academy of Sciences, there is a strong negative correlation between basic math and quantitative skills and the likelihood of defaulting on a subprime mortgage. In other words, borrowers with lower math skills are much more likely to default on their loans and borrowers with higher math skills are much less likely to default on their loans. It is well known that a massive increase in the volume of subprime mortgage defaults in years 2006 and 2007 helped push the economy into a deep global recession in 2008.
The study is based on data from subprime mortgages originated in 2006 and 2007 in greater New England area as well as data from a phone survey involving 339 holders of these subprime mortgages. The phone interviews assessed the numerical ability, financial literacy, verbal skills and cognitive ability of the 339 participants. Numerical ability in the study refers to the proficiency of a borrower for solving basic mathematical calculations.
One of the results of the study is that the numerical ability is a strong predictor of which borrowers will be more likely to be delinquent in loan payments or to be foreclosed upon (the lower the numerical ability, the higher the likelihood of default).
“Our analysis raises the possibility that limitations in numerical ability may have significantly contributed to the massive amount of defaults on subprime mortgages in the recent financial crisis,” concluded the researchers of the study.
Could it be that the loan delinquency of the participants of the phone survey was due to other factors such as income, education and credit scores? For example, could the results of the study be due to the low credit scores of the participants? If the participants of the study had defaulted prior to the study, they would be more likely to default again.
After the researchers of the study adjusted for these factors, the connection between poor math skills and higher default rates remain the same. As a result, the researchers concluded that it is likely the effect of the math skills that is driving the results and not the credit scores and other factors.
The researchers of the study also did not find any significant connection between the poor math skills and the types of mortgage loans among the participants of the study. The correlation between poor math skills and higher loan delinquency is present across all the loan types. So it is not that the borrowers in default happened to choose risky loan types such as adjustable mortgages or negative amortization mortgages. So the study suggests that restricting these risky types of mortgages may not prevent future mortgage default epidemics.
So all eyes now point to math and quantitative skills. What kind of numerical questions were asked in the phone survey? They are not calculus problems and they are certainly not advanced math in financial modeling. They are:
- In 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 the chance of getting a disease is 10 per cent, how many people out of 1,000 would be expected to get the disease?
- A second hand car dealer is selling a car for $6,000. This is two-thirds of what it cost new. How much did the car cost new?
- 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 $200 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?
We know math is useful. In fact, this study provides empirical evidence that math pays. Having proficient level of math and quantitative skills can lead to favorable and optimal financial outcome in a person’s life. Having good number skills can help any person makes better financial decisions and better manage his or her financial affairs. At least, having good quantitative skills can help avoid costly financial dislocation that comes from defaulting on mortgages, as the study suggests.
The authors of the research study also indicated that their “results indicate possibly large benefits from increased financial education of homeowners.” Certainly, greater emphasis in financial education (and quantitative skills) in high school can have a positive effect on financial outcomes later in life.
Our view is that we do not need to wait for school reform to take place. We can make changes at the individual level. The above five questions are not math problems that can only be taught in school. These are problems that we encounter in our daily life. So in order to improve on quantitative skills, we do not necessarily need to go back to school to take a course in finance. We can improve on quantitative skills one purchase at a time and one bank transaction at a time. Come up with a right question. Then take out a calculator and a notepad and try to resolve the issue that is at hand.
Some students cannot wait for schooling to be over so that they don’t have to deal with math any more. This jaundiced view of math is unfortunate. There is school math and there is math in everyday life. This study published in the National Academy of Sciences shows that it pays to have skills in the latter.
Here’s a few news outlets that reported on the same study.
Bad at Math? It Could Cost You Your Home (from Time.com)
Did Poor Math Skills Cause Subprime Meltdown? (from a Wall Street Journal blog)
Poor Math Skills Make a Mortgage Default More Likely (from a Discover Magazine blog)
Bad at math? You’re more likely to lose your home (from CNN.com)
This is the study published in the National Academy of Sciences.