The exact cause of the massive defaults and foreclosures in the U.S. subprime mortgage market is still unclear. This paper investigates whether a particular aspect of borrowers ’ financial literacy, their numerical ability, may have played a role. We measure several aspects of financial literacy and cognitive ability in a survey of subprime mortgage borrowers who took out mortgages in 2006 and 2007, and match these measures to objective data on mortgage characteristics and repayment performance. 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 to the group with the lowest measured level. The result is robust to controlling for a broad set of socio-demographic variables and is not driven by other aspects of cognitive ability, or the characteristics of the mortgage contracts. Our results raise the possibility that limitations in certain aspects of financial literacy played an important role in the subprime mortgage crisis.

The lackluster economic recovery during the past two-and-a-half years has spurred discussion about whether a “debt overhang ” and the ensuing process of deleveraging have held back consumption and the broader economy over the past few years and whether such forces will remain a headwind against economic growth for some time to come. Given that the tail of the distribution played such an important role in the financial crisis, it is important to look at highly indebted households to assess the nature and implications of the deleveraging that has occurred since the bursting of the credit bubble. This paper uses household survey data from the Panel Study of Income Dynamics to examine the run-up in household borrowing and subsequent deleveraging. Consistent with earlier literature, I find that high indebtedness was concentrated in areas with high realized house price growth over the preceding half-dozen years, leaving the most-indebted households particularly vulnerable to the possibility that the growth represented a bubble. Following the bursting of the bubble, highly indebted households had larger declines in spending than their less-indebted counterparts despite having smaller changes in net worth, suggesting that their indebtedness weighed on consumption above and beyond what would have been predicted by simple wealth effects. Preliminary data from the 2011 wave of the PSID show essentially no reduction since 2009 in the share of households that report they are somewhat or very likely to have problems paying their mortgages over the coming year. The data also suggest that highly indebted households have made fairly limited progress in reducing leverage over the past few years, consistent with the view that it could take a long time to restore their balance sheets to their pre-crisis condition. I thank John Soroushian for research assistance and Doug Elmendorf, David Romer, and Justin Wolfers for comments and discussion. All views expressed are my own and not those of the Brookings Institution or its affiliates

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This paper models the causes of the 2008 financial crisis together with its manifestations, using a Multiple Indicator Multiple Cause (MIMIC) model. Our analysis is conducted on a cross-section of 107 countries; we focus on national causes and consequences of the crisis, ignoring crosscountry “contagion ” effects. Our model of the incidence of the crisis combines 2008 changes in real GDP, the stock market, country credit ratings, and the exchange rate. We explore the linkages between these manifestations of the crisis and a number of its possible causes from 2006 and earlier. We include over sixty potential causes of the crisis, covering such categories as: financial system policies and conditions; asset price appreciation in real estate and equity markets; international imbalances and foreign reserve adequacy; macroeconomic policies; and institutional and geographic features. Despite the fact that we use a wide number of possible causes in a flexible statistical framework, we are unable to link most of the commonly-cited causes of the crisis to its incidence across countries. This negative finding in the cross-section makes us skeptical of the accuracy of “early warning ” systems of potential crises, which must also predict their timing. Keywords: empirical, data, cross-section, credit; stock; country; model; international; MIMIC.

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Abstract: The exact cause of the massive defaults and foreclosures in the U.S. subprime mortgage market is still unclear. This paper investigates whether a particular aspect of borrowers ’ financial literacy—their numerical ability—may have played a role. We measure several aspects of financial literacy and cognitive ability in a survey of subprime mortgage borrowers who took out mortgages in 2006 or 2007 and match these measures to objective data on mortgage characteristics and repayment performance. 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. Our results raise the possibility that limitations in certain aspects of financial literacy played an important role in the subprime mortgage crisis.

This paper presents three main findings that reconfirm that securitization had an effect on subprime mortgage lenders ' screening standards around the FICO score of 620. First, using data on securitized and bank-held loans, we document a consistent and robust discontinuity in both securitization and default rates at the 620 threshold in the low documentation subprime market which confirms results established in our previous work. No such pattern exists in full documentation subprime loans or prime loans. Some recent work pools mortgages across prime and subprime markets, thereby obscuring this connection between the ease of securitization and screening in the low documentation subprime market. Second, we provide new evidence from the time series evolution of the securitization market for subprime loans that reinforces the role of ease of securitization on lenders ' screening standards. Finally, we explain that there are other dimensions besides securitization rates that impact the ease of securitization. Importantly, these dimensions are more likely to be captured by the number of securitized loans (unconditional securitization rates) which we analyzed in our earlier work. On examining one such aspect – the time it takes to securitize a loan-- we identify discontinuities that are consistent with greater ease of securitization above the 620 threshold in the low documentation subprime market. Note:

and do not necessarily reflect the views of the Board of Governors of the Federal Reserve System or other members of its staff. 1 Financial Statistics for the United States and the Crisis:

Misstatement of income on mortgage loan applications (the “liar-loan ” problem) is thought to have been a contributor to the boom and bust of mortgage markets. We provide nationwide measurements that reflect the degree to which incomes on mid-2000 home-purchase mortgage loan applications were overstated relative to the actual incomes of mortgage applicants. Our results suggest a substantial degree of income overstatement in 2005 and 2006, one consistent with the average mortgage application overstating income by almost 20 percent. We find the tendency to misstate income was influenced by securitization markets. We find limited evidence that income overstatement played a role in subsequent mortgage defaults. *Helpful comments were provided by seminar participants at the Federal Reserve Bank of Philadelphia. We thank Andrew Kish for outstanding research assistance. The views expressed in this paper do not necessarily represent those of the Federal Reserve Bank of Philadelphia or the Federal Reserve System. Try these handy steps to get SISA findings … (3) If you do not get [approval], try resubmitting with slightly higher income. Inch it up $500 to see if you can get the findings you want. Do the same for assets. It’s super easy! Give it a try! Internal Memo Circulated at JPMorgan Chase, as reported in The Oregonian I.

responsibility of the authors and the views expressed in it do not necessarily reflect those of the Banco de España. We thank Gabriela Álvarez for her research assistance with the database and participants at the XXVIII Finance Forum at Elche and at a Banco de España seminar, as well as an anonymous referee for their comments and discussions.