[lbo-talk] definitive evidence on the housing bubble

Wojtek Sokolowski sokol at jhu.edu
Thu Feb 3 08:11:02 PST 2005


Jerry Brown:
> It's not surprising that compound interest escapes people, as they pointed
> out in the Frontline program, the credit card companies make it as
difficult as
> possible to figure it out. Were there not regulations requiring it, they
> wouldn't even disclose the interest charges.
>

I do not think that concealment of simple ignorance explain it. people are certainly familiar with the effect of interest on the principal from other walks of life e.g. car loans that routinely show the total amount to be repaid i.e. the principal + interests over the life of the loan. All computers and many hand held calculators have financial functions that can easy calculate time value of money. Therefore the information is easily available to anyone with basic arithmetic skills.

A more likely explanation is that people cognitively frame their credit card debt in a way that minimizes the extent of that debt i.e. by concentrating on the marginal effect of every purchase ("its is just a few dollars") while losing sight from the big picture. Another example is the endowment effect (see my previous posting) that prevents them form using their savings to reduce their credit card debt and thus avoid paying high interest charges.

Cognitive framing is a far superior explanation of economic behavior that the rationality (or lack thereof) assumption.

Wojtek



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