Financial numeracy and subprime defaults

The Economist reports on a recent study that shows sub-prime mortgage defaults are more common among people with lower financial numeracy - basically folks who can't do the math too well.

You can take the numeracy test as well. It's not very long.

Note to my MBA students - if you didn't score 5/5 then I don't want to know.

Breaking the bank...

Breaking the Bank is an excellent documentary on PBS (produced by Frontline) that documents the hour by hour collapse of Lehman and the back room deals done as more banks imploded. A lot of focus is paid on the buyout of Merrill by B of A, which started out as a great deal until the true state of the mess that was Merrill's balance sheet became apparent.

You can watch it online, and I strongly recommend it to all my students. My only disagreement with the documentary was in the closing minutes where it is stated that basically the whole mess was Wall Street's fault, and now the Feds are running the show. I fundamentally disagree with this take. I, like many (or most) other economists put a large amount of the blame for the mess not on the lack of government regulation, but on the very poor and misguided regulation that encouraged subprime lending and allowed firms to abdicate their responsibility for risk management.

Anyhow, check out the show, its compelling viewing.

Robert Shiller on sub primes...

Robert Shiller talks about sub prime mortgages here. He argues that a consumer protection agency should promote plain vanilla debt products for consumers - including sub prime loans. I think this is quite reasonable. In the same way that the junk bond market was hugely successful by financing lower credit quality borrowers, the sub prime loan market can also be successful and fill a gap in the market place. The key is to ensure that those making the loans fully bear the risk of the loans that they are making, and that those taking the loans fully understand the terms.

Felix Salmon disagrees and thinks this is a bad idea. But I think Felix is off the mark here. His criticisms of Shiller's argument are all based on sub prime borrowers getting loans that they couldn't repay. A transparent sub prime market where lenders bear risk would reduce the chance of this happening.

Essential Reading on the current mess

My colleague Craig Newmark, has put together an excellent listing of articles discussing the current situation. Many are written by some of the brightest and smartest names in economics. This really is a fantastic resource and makes excellent reading.

The first post is here. The second is here .

What went wrong?

The Economist talks about "What went wrong" - basically a combination of leverage and perpetual optimism that financial assets could only go up.

A better index to describe subprime woes

Evan Davis of the Beeb has a nice blog about finance related stuff. This article talks about an index that measures the performance of the subprime market. The picture is pretty grim. The line basically drops off the bottom of the chart.

link here Evanomics

Northern Rock is nationalized

In a surprise move, the British government has nationalized the Northern Rock Building Society (link to FT article). A building society is like a savings and loan, but it is basically a bank now. Northern Rock had grown aggressively through a practice of making loans and funding them in the commercial paper market. With the subprime collapse they got hit on both sides of the balance sheet.

There had been some talk of a buyout by Virgin. But according to the Government, the numbers didn't add up. Apparently the shareholders didn't agree with this. Their shares were trading for 90p (about $2) and will now be worthless.

This is the first nationalization of a bank for 25 years or so. But the Northern Rock was the first British bank in 100 years to suffer a bank run.

Freezing loan rates = bad idea

Freezing prices in a free market is never a good idea. Here Richard Thaler argues why Hilary Clinton's idea to freeze interest rates on subprime loans is just bad economics. I'm inclined to agree with him.

For those who are not familiar with Thaler - he is a renowned behavioral economist from U. Chicago.

Thanks to Newmark's door for this link