The Importance of Financial Literacy

The causes of the subprime mortgage crisis, which led to the worst financial and macroeconomic crisis in the United States since the Great Depression, have been a topic of much research in the academic housing literature. I have contributed to this literature during the past few years, mainly focusing on the effects of the collapse of the housing price bubble. Others have concentrated on the expansion of mortgage credit and especially on the relaxation of underwriting standards by mortgage lenders. One of the areas not receiving as much attention from economic researchers, however, is how the capacity of borrowers to understand basic finance and mathematical concepts may have contributed to the mortgage crisis.

Why should we expect financial literacy or mathematical ability to have an impact on mortgage market outcomes? Because over the past few decades, mortgage credit has been made available to a segment of our population that had traditionally been denied the opportunity to own a home.

The emergence of subprime

Through the subprime mortgage, individuals with little wealth and checkered credit histories were given access to homeownership. In general, these same people--whom we might expect to have relatively low levels of education and thus low levels of financial literacy--were more likely to take out subprime loans. …

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