Subprime defaults and financial literacy

[MichaelB]

IN AMERICA'S subprime-mortgage meltdown, why did some borrowers manage to struggle on, keeping up with their payments, while others defaulted? Subprime borrowers were all, by definition, people with poor credit histories, prone to financial problems, yet their ability to repay differed widely. A study from the Federal Reserve Bank of Atlanta has found that what makes the difference is the borrower's basic numeracy. They gave a simple quiz to a group of subprime borrowers who had similar personal circumstances and had taken out the same type of loan. They found that those who flunked the test were much more prone to defaulting than the numerate, who were much more likely to manage to keep paying.

From this weeks “The Economist” magazine, referencing a Fed Study
Fed link here Working Paper 2010-10
The Economist story here http://www.economist.com/business-finance/displaystory.cfm?story_id=16121350


The quiz is only 5 questions. Lots of possible opinions can be drawn. I wonder how to improve the financial literacy of a country.

 

[REWahoo]

I wonder how to improve the financial literacy of a country.

Include it as required school curriculum.

Short of that, I suggest one step in the right direction would be having more programs like Jr. Achievement in our schools. When I was working I volunteered to teach a seventh grade "Personal Finance" program which was a meager one hour per week over a period of six weeks. This program gave the kids a hands-on taste of banking, budgets, buying, credit, debt, expenses, income, interest rates, opportunity costs, saving, and taxes.

My favorite part of the course was the final day when we divided the class into six different family groups, each having a successively larger annual income, starting at $20K and ending at $120K. Each group was given a budget worksheet listing broad expense categories and a schedule showing of the cost of various choices. For example, each family was required to budget for transportation and the schedule showed the cost of riding the bus, buying a used car, buying a new inexpensive car or buying a new luxury SUV. It was very interesting to see the reactions of each group as they struggled to make ends meet, even the family making $120K.

Reactions of the students was universal - all were amazed at how difficult it was to live on their income. Some were almost in tears. One made a comment I don't think I'll ever forget: "I think I'll just stay home and live with momma..."

Of course six hours of classroom information only scratched the surface but this is the type of curriculum that could make a huge difference in the ability of future generations to manage their finances.

 

[audreyh1]

What a great story REWahoo!

Audrey

 

[Alan]

What a great story REWahoo!

Audrey

+1

 

[FUEGO]

" 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."

Maybe we can start giving a 5 question math quiz and factoring in the results in the interest rates we pay on debt. Just another metric right up there with a credit score. Or maybe let our lenders see a copy of our SAT/ACT Math scores? "I got a 800 can you give me a 50 bp reduction on that rate?"

 

[REWahoo]

These dang word problems are tough!

1. 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?
2. 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?
3. 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?
4. If 5 people all have the winning numbers in the lottery and the prize is $2 million, how
much will each of them get?
5. 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?

I hate to admit I once believed the folks Leno interviews on the street were faking it...

 

[clifp]

These dang word problems are tough!

I hate to admit I once believed the folks Leno interviews on the street were faking it...

Really, I always figured a producer was coaching them to give the right answers..

 

[audreyh1]

These dang word problems are tough!

1. 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?

..

$250. The recommended retail list price for the sofa is actually $500, and the "half price" sale is based on this recommended manufacturer's list price whereas the shop normally sells items for 40% off anyway as listed on their "great bargains" tag.

Audrey

 

[FUEGO]

2. 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?

This question assumes the disease, once contracted, can never be contracted again. Otherwise, one person could (and very likely will) contract the disease again. Hence the number of people out of the 1,000 population that get the disease would be something less than 100.

3. 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?

The answer should probably be a little over $9,000 to account for all those junk fees, sales/use tax, etc. that are tacked on to new car purchases.

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

Probably closer to $200,000 each after the present value is taken instead of an annuity over 20-30 years, and after paying huge amounts of tax.

5. 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?

How often does interest compound? Monthly, yearly, at the end of the 2 year period? The 10% interest per year is simply the rate of accumulation of interest, and doesn't specify when the interest is paid.

I think all these questions are best answered by "it depends"!

(I got 5 of 5 in spite of the ambiguity of the questions)

 

[REWahoo]

I think all these questions are best answered by "it Depends"!

I think yours is full...

 

[FUEGO]

I think yours is full...

I think I raised some valid points and I don't think the Atlanta Fed has considered that there may be some level of interpretation allowed for all of these questions. A truly savvy consumer would ask the types of questions I'm asking. I think I will submit a proposal to provide consulting services to the Fed (not thefed) for a couple million bucks to really get to the bottom of this thing. These are important questions that really get to the underpinnings of modern consumer finance.

 

[brewer12345]

These dang word problems are tough!

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

I hate to admit I once believed the folks Leno interviews on the street were faking it...

Like they said in the movie:

"A million point two dollars..."

"Five hundred thousand a piece"

"Four hundred thousand, Delmar"


REW, financial literacy is something I really want to make into a volunteer effort when I finally shed my present set of shackles. Did you have a curriculum to work with, or did you have to make the stuff up yourself? Was the school receptive or did you have to sell it? I admire you for doing this and I would sorely love to do a bunch of it myself.

 

[REWahoo]

REW, financial literacy is something I really want to make into a volunteer effort when I finally shed my present set of shackles. Did you have a curriculum to work with, or did you have to make the stuff up yourself? Was the school receptive or did you have to sell it? I admire you for doing this and I would sorely love to do a bunch of it myself.

Junior Achievement has a well-designed curriculum and is well-respected, at least in the local school system here. The organization did all the ground work and coordination, all the volunteers had to do was get familiar with the material and show up at the school at the scheduled time.

If you go to the Junior Achievement website and click on "programs", you can drill down and see what programs are available at the elementary, middle and high school level. As you will see, it is fairly comprehensive. Not all the programs are taught at every school as their are limits on the number of volunteers available and the time the school system will allot to the JA program.

For me it was a very rewarding experience - I had the feeling some of the teachers, who stayed in the classroom during the sessions, learned something as well.

 

[brewer12345]

Junior Achievement has a well-designed curriculum and is well-respected, at least in the local school system here. The organization did all the ground work and coordination, all the volunteers had to do was get familiar with the material and show up at the school at the scheduled time.

If you go to the Junior Achievement website and click on "programs", you can drill down and see what programs are available at the elementary, middle and high school level. As you will see, it is fairly comprehensive. Not all the programs are taught at every school as their are limits on the number of volunteers available and the time the school system will allot to the JA program.

For me it was a very rewarding experience - I had the feeling some of the teachers, who stayed in the classroom during the sessions, learned something as well.

Thanks.

 

[MichaelB]

Junior Achievement is a fine option. Worth looking into. REWahoo, good post and very helpful

I remember when my kids were in high school (Venezuela). One night we were talking and they mentioned a class that had been taught by some Junior Achievement volunteers – two sales reps that worked for the same company I did (I was GM). I knew them – young but had never stood out in any way. Volunteering in Venezuela (really, South America) is not a big thing like here in the States. They were doing it as part of a Graduate Int’l Business Program they were enrolled in.

Anybody heard anything about Operation Hope? Financial Literacy is prominent among it’s objectives and looks like it is growing and accomplishing things, but the web site is a bit wordy and fuzzy. OperationHope.org - Home