Irrationality is responsible for the economic mess we find ourselves in right now. Irrationality plus greed, of course, and a substantial dose of ignorance. Let’s start with ignorance. I’m sad to say that many Americans have a difficult time with even simple math—around a third of American adults cannot calculate 10 percent of 1,000. People who struggle with concepts such as percents have an extremely difficult time with more complicated ideas, such as compounding of savings and, very relevant to our current crisis, adjustable rate mortgages. To make matters worse, most of us are hard-wired for optimism. Ask us how we rate as drivers, and the vast majority of us are convinced we are above average, even those of us who have gotten into multiple car accidents. As a result of our unrealistic optimism, we are convinced that our incomes will rise fast enough to keep up with our outsized mortgage, or that our adjustable rate won’t rise, or that our house’s value will indefinitely outpace inflation. We are social beings, too, and frequently judge our own decisions by seeing what other people are doing. If my neighbor added on a new kitchen through a home equity loan, I might assume that is a good idea for me, even if a more rational weighing of my finances would suggest otherwise.
