Economics And Decision Making

Submitted By: Gary Hadler

he issues and reasons behind decision making are of great interest to me. I have written many articles on the subject over a long period of time. The below article looks at decision making from an economic point of view. If you wish to read some more of my articles please visit ITS Tutorial School website at http://www.tuition.com.hk/links.htm .

How do individuals and businesses in society make decisions? From the viewpoint of an economist there are three basic assumptions. Rationality, maximization and costs & benefit analysis.

Rationality: Economists start by assuming that economic decision makers act in a rational manner. What this means is that decision makers act according to reason, rather than in any odd way. For instance, if a person wanted to increase his or her income, it is assumed that he or she would try to work longer hours, rather than shorter hours. Equally if there were two identical products of washing detergent on the supermarket shelf, one price at $5.00, the other on sale at $3.00, it is assumed the shopper would buy the cheaper packet.

Maximization: A second economic assumption is that economic decision-makers attempt to maximize. This means that they try to get the best out of any economic situation. If a person chooses to work for 38 hours a week instead of 40 hours, everything else being the same including the wage, then he or she will choose to maximize leisure time by working 38 hours. Equally, a business will prefer to earn as much profit as possible, rather than a lower profit as possible.

Costs and benefits: In order to decide what is biggest in any economic situation, a decision-maker has to asses the costs and benefits of any particular course of action. For example what would be the costs and benefits of a decision by workers to buy a factory that they worked for if it was about to close down? The costs would be the money they had to put up to buy the factory from its owners. However, costs could be even greater. If the factory started to make a loss, they could not only loose all their money they had put in the firm but may have to commit more money to keep it going. Another cost would be the lost opportunity to find a new job. The benefits would be that they would still be in a job. They would get a salary. What’s more if the company were successful, they would get a share of the profits and see the value of their initial capital investments increase.

These costs and benefits relate to the individual workers who are making the decision about weather to buy the factory. The economic model of decision maker than assumes these workers would decide to support buying or not buying by weighing up these costs and benefits and making a rationale decision about how to maximize their individual utility. This is the basis of an economic decision making model.

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Integration of Meta-analysis and Economic Decision Modeling for Evaluating Diagnostic Tests

Alexander J. Sutton, PhD

Centre for Biostatistics & Genetic Epidemiology, Department of Health Sciences, University of Leicester, 22-28 Princess Road West, Leicester LE1 7RH, UK, ajs22@le.ac.uk

Nicola J. Cooper, PhD

Department of Health Sciences, University of Leicester, Leicester, England

Steve Goodacre, PhD

School of Health and Related Research, University of Sheffield, Sheffield, England

Matthew Stevenson, PhD

School of Health and Related Research, University of Sheffield, Sheffield, England

Meta-analysis of diagnostic test accuracy data is more difficult than of effectiveness data because of 1) statistical challenges of dealing with multiple measures of accuracy (e.g., sensitivity and specificity) simultaneously and 2) incorporating threshold effects. A number of meta-analysis models are in use, ranging from naïve synthesis of independent sensitivity and specificity to optimization of a hierarchical summary receiver operating characteristic (SROC) curve. Little work has been done on how such analyses should inform decision models. This article aims to present a unified framework for the synthesis of primary data and economic evaluation of alternative diagnostic testing strategies using Bayesian Markov Chain Monte Carlo simulation methods. The authors extend this previous work by using systematic review to derive model parameters, fully allowing for uncertainty in their estimation, and formally incorporating variability between study results into the decision analysis. Using a simple decision model comparing alternative testing strategies for suspected deep vein thrombosis as an example, the authors consider how to use outputs of different alternative meta-analysis models in decision models. They also explore the limitations of diagnostic test studies, particularly when there is no obvious threshold value. To correct some of the limitations of diagnostic test studies, they propose that tests with implicit and explicit thresholds should be studied using distinctly different frameworks. Specifically, when a threshold exists, quantitative threshold information should be included in meta-analysis models to aid interpretation of SROCs. Setting policy to relate to a specific point may be much more difficult for studies with implicit thresholds.

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Irrational Economic Decision-Making after Ventromedial Prefrontal Damage: Evidence from the Ultimatum Game

by Michael Koenigs and Daniel Tranel

Department of Neurology, Division of Cognitive Neuroscience, University of Iowa College of Medicine and Neuroscience Graduate Program, University of Iowa, Iowa City, Iowa 52242

Correspondence should be addressed to Dr. Michael Koenigs, Building 10, Room 7-5648, 10 Center Drive, Bethesda, MD 20892. Email: koenigsm@ninds.nih.gov

Emotion regulation is often critical for adaptive decision making. Here, we investigate whether emotion regulation defects following focal prefrontal brain damage are associated with exceptionally irrational economic decision making in situations of unfair treatment. In the Ultimatum Game, two players are given one opportunity to split a sum of money. One player (the proposer) offers a portion of the money to the second player (the responder) and keeps the rest. The responder can either accept the offer (in which case both players split the money as proposed) or reject the offer (in which case both players get nothing). Relatively low Ultimatum offers are often rejected, and this "irrational" behavior has been attributed to an emotional reaction to unfair treatment. Using the lesion method, we tested the hypothesis that damage to ventromedial prefrontal cortex (VMPC), an area critical for the modulation of emotional reactions, would result in exaggerated irrational economic decisions. Subjects acted as the responder to 22 different proposers who offered various splits of $10. Offers ranged from fair (give $5, keep $5) to extremely unfair (give $1, keep $9). The rejection rate of the VMPC group was higher than the rejection rates of the comparison groups for each of the most unfair offers ($7/$3, $8/$2, $9/$1). These results suggest that emotion regulation processes subserved by VMPC are a critical component of normal economic decision making.

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Bad Economy Or Bad Decisions?

Posted on 8:47 pm by Paul Colligan

What a day, …

Dow is down (again).

Revision3 lets GaryV and Epic Fu go.

I start agreeing with Valleywag.

And then Kent Nichols starts responding to my Tweets.

I’ve had the makings of this post rumbling around in my head for awhile. It is time to post.

If somebody makes a bad business decision, it is their fault, not the economy’s.

If you read the Valleywag piece, they mention a company that “never should have launched at all.” You can argue with their suggestion but I dare anyone reading this to tell me that every company in the New Media space is being 100% smart with their money.

There is a lot of waste in an industry that can’t afford it anymore (let alone should have allowed it back then). It is time to change.

Earlier today, Kent Nichols suggested we “add Revision3 to the ‘Dead Pool.’” I had to argue with him (hence the Tweets mentioned above) - I don’t think it is that bad. But, as we all know, Kent is one smart cookie and, well, when he says something, we need to pay attention.

There are some things that need fixing.

I have to believe there is something in the middle here. I think we can actually respond smart and pull out of this.

I see companies with shows with a few thousand downloads per episode who earnestly hope that one day they’ll be able to pay the bills on this model.

That makes as much sense as lending money to people who don’t have the ability to pay it back - and then giving yourself an obscene bonus for meeting your quota.

And then asking the government to bail you out (at my expense).

So that you can keep you bonuses.

Cause you deserve them.

For bad business decisions.

I applaud Louderback (or anyone else like him) who decides to make the hard decisions. We need to read the spreadsheets, run the numbers, and make the right decisions.

Want to flush this economy down the drain?

Blame it on your bad decisions.

Or, … start taking account for your actions.

And make the hard decisions.

And come out o.k. on the other side.

You can do this.

What do you need stop stop spending money on right now? I know those new Macbooks are as sexy as all get out but, … twenty five hundred bucks growing your audience might be money better spent.

I know it ain’t easy for all of us to build a whole business around our content (like Kent has done) and would love to just produce and let someone else pay but, … maybe the industry ain’t ready for that yet.

Take control.

Make smart decisions.

Don’t blame anything on anybody but yourself.

And then do something about it.

I could care less who you vote for.

I care a lot about what you do the rest of November 4th.

Good decisions will make for a good economy.

Be part of it.

Produce content of value.

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All talks, no decision seen at WTO meet

All talks, no decision seen at WTO meet 26 Jul 2008, 0301 hrs IST, Amiti Sen, ET Bureau

GENEVA: Uncertainty prevailed at the WTO mini-ministerial here on Friday as the talks entered the fifth day without signs of gaps narrowing between developed and developing countries on opening up trade in agriculture and industrial goods. There was, however, some progress late in the day with the group of seven countries, including India, Brazil, the EU and the US, deciding to end their ``exclusive” meeting and start negotiating again with the other 23 trade ministers waiting on the sidelines. European Union trade commissioner Peter Mandelson said: “There has been some encouraging progress.” When asked whether there could be a deal, he said a deal finally looked possible. WTO director general Pascal Lamy, however, warned talks could collapse if negotiators did not show further flexibilities in the next hours, while commerce & industry minister Kamal Nath put the ball in the court of the US and the EU and asked them to do their bit. Issues of crucial interest to India remained unresolved, both in agriculture and non-agriculture market access (Nama or industrial goods). An agreement on special products (vulnerable goods dictating the food and livelihood security of poor farmers) and flexibilities that would determine the tariff cuts which Indian industry needs to take were elusive. Disregarding whispers about India’s hard stance in the negotiations which could lead to its failure, Mr Nath said India has shown flexibility in the last four years and now the EU and the US needed to move forward. “They are charging me (that) since you have arrived you are breaking the talks. The moment you arrived, you are making things more difficult. We were all moving all right. We were happy when you won the trust vote, we thought you would come and help us,” Mr Nath said. He said India had made many concessions in the 2005 Hong Kong ministerial, such as agreeing to the developed country formula for tariff reduction in industrial products, which had been pocketed and it was time for the developed countries to give. Brushing aside speculation that the WTO DG would come out with his own draft modalities text for tariff and subsidy cuts, Mr Lamy said this was not a way for convergence and there would be no surprises. The Uruguay Round, which preceded the Doha round, was concluded on the basis of the draft produced by the then WTO DG Arthur Dunkel. The process was widely criticised by developing countries. Mr Lamy said the draft texts on farm and Nama circulated on July 10 would continue to be the basis of talks. He said revisions were required in the text, and members would decide if an overall package was acceptable. WTO spokesperson Keith Rockwell said on special products, there was no decision on the number of tariff lines and exemption of a certain percentage of these lines for tariff cuts. As per the mandate of the round, developing countries would be required to take either zero cuts or very low cuts on items designated as special products. India as part of the G-33 alliance has been asking for the freedom to designate 18% of its tariff lines as SPs and make no cuts in 6% of these tariff lines. In Nama, there was no agreement on the reduction commitments by countries and the flexibilities to be given to developing countries to protect certain sectors from tariff cuts.

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Economics and other subjects

Main articles: Law and Economics, Philosophy of economics, Natural resource economics, and Thermoeconomics

Economics is one social science among several and has fields bordering on other areas, including economic geography, economic history, public choice, energy economics, cultural economics, and institutional economics.
Law and economics, or economic analysis of law, is an approach to legal theory that applies methods of economics to law. It includes the use of economic concepts to explain the effects of legal rules, to assess which legal rules are economically efficient, and to predict what the legal rules will be.[111][112] A seminal article by Ronald Coase published in 1961 suggested that well-defined property rights could overcome the problems of externalities.[113]
The relationship between economics and ethics is complex. Many economists consider normative choices and value judgments, like what needs or wants, or what is good for society, to be political or personal questions outside the scope of economics. Once a person or government has established a set of goals, however, economics can provide insight as to how they might best be achieved.
Others see the influence of economic ideas, such as those underlying modern capitalism, to promote a certain system of values with which they may or may not agree. (See, for example, consumerism and Buy Nothing Day.) According to some thinkers, a theory of economics is also, or implies also, a theory of moral reasoning.[114]
The premise of ethical consumerism is that one should take into account ethical and environmental concerns, in addition to financial and traditional economic considerations, when making buying decisions.
On the other hand, the rational allocation of limited resources toward public welfare and safety is also an area of economics. Some have pointed out that not studying the best ways to allocate resources toward goals like health and safety, the environment, justice, or disaster assistance is a sort of willful ignorance that results in less public welfare or even increased suffering.[115] In this sense, it would be unethical not to assess the economics of such issues. In fact, state agencies all over the world, including the federal agencies in the United States, routinely conduct economic analysis studies toward that end.
Energy economics relating to thermoeconomics, is a broad scientific subject area which includes topics related to supply and use of energy in societies. Thermoeconomists argue that economic systems always involve matter, energy, entropy, and information.[116]Thermoeconomics is based on the proposition that the role of energy in biological evolution should be defined and understood through the second law of thermodynamics but in terms of such economic criteria as productivity, efficiency, and especially the costs and benefits of the various mechanisms for capturing and utilizing available energy to build biomass and do work.[117][118] As a result, thermoeconomics are often discussed in the field of ecological economics, which itself is related to the fields of sustainability and sustainable development.
Georgescu-Roegen introduced into economics, the concept of entropy from thermodynamics (as distinguished from the mechanistic foundation of neoclassical economics drawn from Newtonian physics) and did foundational work which later developed into evolutionary economics. His work contributed significantly to bioeconomics and to ecological economics.[119][120][121][122][123]
Source : Wikipedia.org

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Credit cards before 2007?

Source :www.economylab.org

i heard on the radio that if you took out a credit card before 2007 everything you own on the card will be wiped clean?
i didn't hear the full story, but for them that know..
does that count for every credit card?
if not, which ones? and why?
does anyone have any links for this thing? i've tryed looking arond but can't find anything…
can anyone tell me more on how this works and how to do it
thanks
Answer
I think what have heard about is the changes that were made to the Consumer Credit Act (1974) in 2006. Under the terms of this act, credit cards and other types of credit agreement have to be drawn up in a particular way, include specific details, be accompanied by certain bits of information. What happens if some of these things are missing? Well, it used to be that if an agreement wasn't drawn up correctly the debt could not be pursued through the courts. It would not be wiped clean as such, but the creditor would not be able to enforce it in court. The government decided this was a bad thing and changed the law to give the court the right to decide, in each case where the original agreement was not drawn up correctly, whether it should be possible to take action to recover the debt. This change took effect in 2007 - on 1 April, I think.
So, you weren't dreaming. Some people who took out credit in 2007 or earlier will have agreements they can't be taken to court for. It isn't all that common though, particularly with credit cards, since credit card companies generally know what they need to do to stay on the right side of the law. None of this is relevant if your agreement was drawn up correctly, which will have been the case in the majority of cases.

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Economic Illiteracy and Rational Voters

By John Stossel

When I speak on college campuses, students often ask what can be done about the "problem" of young people who don't care enough to vote. I always say that I don't see it as much of problem "because most of you don't know anything yet. I'm OK with you not voting!" The students laugh, but I'm not joking.
It wasn't until I was about 40 that I started to believe I had acquired a good sense of what domestic policies might serve people well. (I still have no clue about international affairs.) I only started to think I knew what ought to be done after years of reporting and reading voraciously to absorb arguments from left and right. The idea that most voters vote without having done much of that work is, frankly, scary.

I'm not alone in this concern. An economist at George Mason University, Bryan Caplan, says few people think about their vote or even see any benefit in doing so. His new book, "The Myth of the Rational Voter: Why Democracies Choose Bad Policies" , argues that most voters cast their ballot on the basis of irrational biases about economic matters. That's why so many candidates hostile to free markets, profits, free world trade and immigration get elected. People tend to acquire their wrong opinions about economic policy packaged in worldviews they inherited while growing up. They never test their views against the evidence because that would be unsettling. No one likes having his worldview challenged. So people vote for candidates who make them feel good. They vote irrationally.
Caplan stresses that most voters see no reason to do otherwise because they don't bear the consequences of their choices. This irrationality does not carry over into their personal lives because there they bear the brunt of their own decisions. But when irrationality is free, notes Caplan, people will indulge their biases.
Caplan divides them into three categories: antimarket bias, antiforeign bias, make-work bias and pessimistic bias. Antimarket bias describes people feeling that trade and profit are zero-sum games, that one person's gain is another person's loss. They haven't learned that free exchange is win-win and that in a free market, profit comes from cost-cutting innovation. Antiforeign bias, perhaps a vestige of primitive man, consists of distrusting "them" even though our prosperity increases according to how global the division of labor is. Foreigners don't want to invade us; they want to sell us useful things. Make-work bias is the belief that what makes us rich is jobs, rather than goods, and so anything that eliminates jobs is bad. If that were really true, we could prosper by outlawing all inventions created after 1920. Think of all the jobs that would create! Finally, pessimistic bias is the view that any economic problem is proof of general decline. Lots of people actually think we're poorer than our grandparents were!
As a result of these biases, people often support price controls, foreign-trade barriers and laws against job "outsourcing," and oppose immigration. Most economists are eager to demonstrate that these policies are bad for society, but most people aren't interested in evidence. They're interested in what confirms their worldview and makes them feel good. So they often vote for protectionists, anti-immigration advocates and other opponents of the free market.
Caplan's book isn't calculated to cheer up those of us who favor more market and less democracy. He offers some solutions that aren't likely to be adopted any time soon, such as permitting only the economically literate to vote, or giving them more votes, or eliminating get-out-the-vote campaigns (which serve only to get out the uneducated vote).
More practically, he thinks that "Everyone who knows some economics" should grab every opportunity to teach it. That's what I try to do with my "20/20" segments, television specials and the Stossel in the Classroom program, which brings economic ideas to high-school and college classrooms.
I hope we will create some rational voters in the process.
Copyright 2007 Creators Syndicate Inc.

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Economic Development

source:http://cepa.newschool.edu

For many lay people, economic development - by which we mean the analysis of the economic progress of nations - is what economics as a whole is designed to address. Indeed, what but to find the "nature and causes" of economic development was Adam Smith's purpose? For modern economists, however, the status of economic development is somewhat more uncomfortable: it has always been the maverick field, lurking somewhere in the background but not really considered "real economics" but rather an amalgam of sociology, anthropology, history, politics and, all-too- often, ideology.

Nonetheless, few of the greatest economists actually ignored it outright. As already noted, Adam Smith and indeed, perhaps the entire Classical School was concerned with what might be termed "economic development". Schumpeter's first famous book was entitled a Theory of Economic Development (1911). The German Historical School - and its English and American counterparts - could very well be deemed part of development economics. The entire theory of economic growth can be said to be geared towards it or even underlying it.

Nonetheless, "economic development", as it is now understood, really only started in the 1930s when, prompted by Colin Clark's 1939 quantitative study, economists began realizing that most of humankind did not live in an advanced capitalist economic system. However, the great early concern was still Europe: namely, postwar European reconstruction and the industrialization of its eastern fringes - as exemplified by the pioneering 1943 article of Paul Rosenstein- Rodan and Kurt Mandelbaum's 1947 tome. It was only some time after the war that economists really began turning their concerns towards Asia, Africa and Latin America.

To this end, decolonization was an important catalyst. Faced with a new plethora of nations whose standards of living and institutions were so different from the European, modern development theory, by which we mean the analysis not only of growth but also of the institutions which could induce, sustain and accelerate growth, began in earnest. Early development theorists - such as Bert Hoselitz, Simon Kuznets, W. Arthur Lewis, Hla Myint were among the first economists to begin analyzing economic development as a distinct subject.

The post-war formation of the United Nations - and its attendant agencies, such as the World Bank, the I.M.F., the I.L.O. and the various regional commissions - proved to be another important impetus. The commissioning of numerous studies by these institutions led to the emergence of a non-academic strand of development theory.

Development as Growth and Capital-Formation

Early economic development theory was but merely an extension of conventional economic theory which equated "development" with growth and industrialization. As a result, Latin American, Asian and African countries were seen mostly as "underdeveloped" countries, i.e. "primitive" versions of European nations that could, with time, "develop" the institutions and standards of living of Europe and North America.

As a result, "stage theory" mentality of economic development dominated discussions of economic development. As later made famous by Alexander Gerschenkron (1953, 1962) and, more crudely, Walt W. Rostow (1960), the stages theories argued that all countries passed through the same historical stages of economic development and that current underdeveloped countries were merely at an earlier stage in this linear historical progress while First World (European and North American) nations were at a later stage. "Linear stages" theories had been developed earlier by German Historicists, thus it ought not be surprising to find historians, such as Gerschenkron and Rostow, among its main adherents.

More enlightened attempts to arrive at an empirical definition of the concept of "underdevelopment", as exemplified by the work of Hollis Chenery, Simon Kuznets and Irma Adelman, led to the general conclusion that while there were not explicit "linear stages", countries tended nonetheless to exhibit similar patterns of development, although some differences could and did persist. The task of the development economist, in this light, was to suggest "short-cuts" by which underdeveloped countries might "catch up" with the developed and leap over a few stages.

By equating development with output growth, early development theorists, prompted by Ragnar Nurkse (1952), identified capital formation as the crucial component to accelerate development. The celebrated early work on the "dual economy" by Sir W. Arthur Lewis (1954, 1955) precisely stressed the role of savings in development. Early Keynesians, such as Kaldor and Robinson, attempted to call attention to the issue of income distribution as a determinant of savings and growth. Even modern Marxians such as Maurice Dobb (1951, 1960) focused on the issue of savings-formation.

Of course, savings could themselves be manipulated by government intervention - as Lewis had intimated and the Keynesians insisted. Indeed, earlier, Rosenstein-Rodan (1943) had argued that increasing returns to scale made government-directed industrialization feasible. The notion of turning "vicious circles" of low savings and low growth into "virtuous circles" of high savings and high growth by government intervention was reiterated by Hans W. Singer in his doctrine of "balanced growth" and Gunnar Myrdal in his theory of "cumulative causation". Thus, government involvement - whether by planning, socio-economic engineering or effective demand management - was regarded as a critical tool of economic development.

Other economists turned to international trade as the great catalyst to growth. Already Hla Myint, Gottfried Haberler and Jacob Viner had stressed this avenue - arguing along lines similar to the classical doctrine of Adam Smith that trade and specialization can increase the "extent of the market". However, earlier in the 1930s, D.H. Robertson had expressed his doubts on this account - and these were later reiterated by Ragnar Nurkse, H.W. Singer and Rául Prebisch.

Social Aspects of Economic Development

Although capital-formation never really left the field, the meaning of the term mutated somewhat over time. T.W. Schultz, drawing upon his famous Chicago School thesis, turned away from physical capital accumulation to emphasize the need for "human capital" formation. This led to an emphasis on education and training as pre-requisites of growth and the identification of the problem of the "brain drain" from the Third World to the First (and, as would later be stressed, from the private sector to government bureaucracies). W. Arthur Lewis and Hans W. Singer extended Schultz's thesis by arguing that social development as a whole - notably education, health, fertility, etc. - by improving human capital, were also necessary pre-requisites for growth. In this view, industrialization, if it came at the cost of social development, could never be self-sustaining.

However, it was really only in 1969 that Dudley Seers finally broke the growth fetishism of development theory. Development, he argued, was a social phenomenon that involved more than increasing per capita output. Development meant, in Seers's opinion, eliminating poverty, unemployment and inequality as well. Singer, Myrdal and Adelman were among the first old hands to acknowledge the validity of Seers's complaint and many younger economists, such as Mahbub ul Haq, were galvanized by Seers's call to redefine economic development. Thus, structural issues such as dualism, population growth, inequality, urbanization, agricultural transformation, education, health, unemployment,etc. all began to be reviewed on their own merits, and not merely as appendages to an underlying growth thesis.

Particularly worthy of note was the resurrection of the work of Chayanov on the unique structures of peasant economies. Also emergent, in this period, was a debate on the very desirability of growth. E.F. Schumacher, in a famously provocative popular book, Small is Beautiful (1973), argued against the desirability of industrialization and extolled the merits of handicrafts economies. As the world environmental crisis became clearer in the 1980s, this debate took a new twist as the very sustainability of economic development was questioned. It became clear that the very desirability of development needed to be reconsidered.

Structuralism and its Discontents

Before Seers's complaint, many economists had already felt extraordinarily uncomfortable with early development theory and the implicit assumptions behind "stages" reasoning. A new (or old - depending on one's vantage point) idea began to germinate - what may be loosely termed "structuralism". The "structuralist" thesis, succinctly, called attention to the distinct structural problems of Third World countries: underdeveloped countries, they argued, were not merely "primitive versions" of developed countries, rather they had distinctive features of their own. As mentioned, Chenery had argued a similar thesis, but nonetheless focused on the similarities of experience. The newer structuralists, in contrast, sought to bring attention to the differences. Albert O. Hirschmann (1958) was one of the early few who stressed the need for country-specific analysis of development - as was stressed later by Dudley Seers.

One of these distinctive features was that, unlike European industrialization, Third World industrialization was supposed to occur while these countries existed alongside already- industrialized Western countries and were tied to them by trade. This, speculated a few, could give rise to distinct structural problems for development.

Coincidental with H.W. Singer, the UNCLA economist, Raúl Prebisch, formulated the famous "dependency" theory of economic development, wherein he argued that the world had developed into a "center-periphery" relationship among nations, where the Third World was regressing into becoming the producer of raw materials for First World manufacturers and were thus condemned to a peripheral and dependent role in the world economy. Thus, Prebisch concluded, some degree of protectionism in trade was necessary if these countries were to enter a self-sustaining development path. Import-substitution, enabled by protection and government policy, rather than trade and export-orientation, was the preferred strategy. Historical examples of government-directed industrialization, such as Meiji Japan and Soviet Russia, were held up as proof that there was not only one path to development, as had been implied by the cruder "stages" theories.

The Prebisch-Singer thesis resounded with particularly with Marxian thinkers - who identified elements of Rosa Luxemburg's and V.I. Lenin's arguments on imperialism in it. Breaking with savings-obsessed orthodox Marxian thinkers such as Dobb, Neo-Marxians such as Paul Baran, Paul Sweezy, A.G. Frank and Samir Amin took the Prebisch-Singer thesis, merged it the Luxemburg thesis, and drew it into the modern era. Many Third World governments adopted the language and policies of the structuralists and/or the Neo-Marxians in the 1960s and 1970s, and indeed, the movement seemed to have been eminently influential. "Neo-Colonialism", "core-periphery" and "dependency" were the catch-words of the day.

However, as time moved on, these policies seemed to fail to yield their promised fruit, and a Neoclassical (or, more accurately, Neo-Liberal) countermovement initiated by the lone voices of P.T. Bauer, I.M.D. Little, Deepak Lal, Bela Balassa, Anne Krueger and Harry G. Johnson began to gain more adherents. Their thesis was simple: government intervention did not only not improve development, it in fact thwarted it. The emergence of huge bureaucracies and state regulations, they argued, suffocated private investment and distorted prices making developing economies extraordinarily inefficient. In their view, the ills of unbalanced growth, dependency, etc. were all ascribed to too much government dirigisme, not too little.

In recent years, the Neoclassical thesis has gained greater adherence, particularly in Latin America. However, the evidence is still ambivalent and disputed. Both structuralists and counter-structuralists point to fast East Asian development and disastrous African experience as proofs of their directly opposing theses.

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Mortgage loan basics

source : wikipedia

[edit] Basic concepts and legal regulation

According to Anglo-American property law, a mortgage occurs when an owner (usually of a fee simple interest in realty) pledges his interest as security or collateral for a loan. Therefore, a mortgage is an encumbrance on property just as an easement would be, but because most mortgages occur as a condition for new loan money, the word mortgage has become the generic term for a loan secured by such real property.

As with other types of loans, mortgages have an interest rate and are scheduled to amortize over a set period of time; typically 30 years. All types of real property can, and usually are, secured with a mortgage and bear an interest rate that is supposed to reflect the lender's risk.

Mortgage lending is the primary mechanism used in many countries to finance private ownership of residential property. For commercial mortgages see the separate article. Although the terminology and precise forms will differ from country to country, the basic components tend to be similar:

• Property: the physical residence being financed. The exact form of ownership will vary from country to country, and may restrict the types of lending that are possible.
• Mortgage: the security created on the property by the lender, which will usually include certain restrictions on the use or disposal of the property (such as paying any outstanding debt before selling the property).
• Borrower: the person borrowing who either has or is creating an ownership interest in the property.
• Lender: any lender, but usually a bank or other financial institution.
• Principal: the original size of the loan, which may or may not include certain other costs; as any principal is repaid, the principal will go down in size.
• Interest: a financial charge for use of the lender's money.
• Foreclosure or repossession: the possibility that the lender has to foreclose, repossess or seize the property under certain circumstances is essential to a mortgage loan; without this aspect, the loan is arguably no different from any other type of loan.

Many other specific characteristics are common to many markets, but the above are the essential features. Governments usually regulate many aspects of mortgage lending, either directly (through legal requirements, for example) or indirectly (through regulation of the participants or the financial markets, such as the banking industry), and often through state intervention (direct lending by the government, by state-owned banks, or sponsorship of various entities). Other aspects that define a specific mortgage market may be regional, historical, or driven by specific characteristics of the legal or financial system.

Mortgage loans are generally structured as long-term loans, the periodic payments for which are similar to an annuity and calculated according to the time value of money formulae. The most basic arrangement would require a fixed monthly payment over a period of ten to thirty years, depending on local conditions. Over this period the principal component of the loan (the original loan) would be slowly paid down through amortization. In practice, many variants are possible and common worldwide and within each country.

Lenders provide funds against property to earn interest income, and generally borrow these funds themselves (for example, by taking deposits or issuing bonds). The price at which the lenders borrow money therefore affects the cost of borrowing. Lenders may also, in many countries, sell the mortgage loan to other parties who are interested in receiving the stream of cash payments from the borrower, often in the form of a security (by means of a securitization). In the United States, the largest firms securitizing loans are Fannie Mae and Freddie Mac, which are government sponsored enterprises.

Mortgage lending will also take into account the (perceived) riskiness of the mortgage loan, that is, the likelihood that the funds will be repaid (usually considered a function of the creditworthiness of the borrower); that if they are not repaid, the lender will be able to foreclose and recoup some or all of its original capital; and the financial, interest rate risk and time delays that may be involved in certain circumstances.

[edit] Mortgage loan types

There are many types of mortgages used worldwide, but several factors broadly define the characteristics of the mortgage. All of these may be subject to local regulation and legal requirements.

• Interest: interest may be fixed for the life of the loan or variable, and change at certain pre-defined periods; the interest rate can also, of course, be higher or lower.
• Term: mortgage loans generally have a maximum term, that is, the number of years after which an amortizing loan will be repaid. Some mortgage loans may have no amortization, or require full repayment of any remaining balance at a certain date, or even negative amortization.
• Payment amount and frequency: the amount paid per period and the frequency of payments; in some cases, the amount paid per period may change or the borrower may have the option to increase or decrease the amount paid.
• Prepayment: some types of mortgages may limit or restrict prepayment of all or a portion of the loan, or require payment of a penalty to the lender for prepayment.

The two basic types of amortized loans are the fixed rate mortgage (FRM) and adjustable rate mortgage (ARM) (also known as a floating rate or variable rate mortgage). In many countries, floating rate mortgages are the norm and will simply be referred to as mortgages; in the United States, fixed rate mortgages are typically considered "standard." Combinations of fixed and floating rate are also common, whereby a mortgage loan will have a fixed rate for some period, and vary after the end of that period.

Historical U.S. Prime Rates

In a fixed rate mortgage, the interest rate, and hence periodic payment, remains fixed for the life (or term) of the loan. In the U.S., the term is usually up to 30 years (15 and 30 being the most common), although longer terms may be offered in certain circumstances. For a fixed rate mortgage, payments for principal and interest should not change over the life of the loan, although ancillary costs (such as property taxes and insurance) can and do change.

In an adjustable rate mortgage, the interest rate is generally fixed for a period of time, after which it will periodically (for example, annually or monthly) adjust up or down to some market index. Common indices in the U.S. include the Prime Rate, the London Interbank Offered Rate (LIBOR), and the Treasury Index ("T-Bill"); other indices are in use but are less popular.

Adjustable rates transfer part of the interest rate risk from the lender to the borrower, and thus are widely used where fixed rate funding is difficult to obtain or prohibitively expensive. Since the risk is transferred to the borrower, the initial interest rate may be from 0.5% to 2% lower than the average 30-year fixed rate; the size of the price differential will be related to debt market conditions, including the yield curve.

Additionally, lenders in many markets rely on credit reports and credit scores derived from them. The higher the score, the more creditworthy the borrower is assumed to be. Favorable interest rates are offered to buyers with high scores. Lower scores indicate higher risk for the lender, and higher rates will generally be charged to reflect the (expected) higher default rates.

A partial amortization or balloon loan is one where the amount of monthly payments due are calculated (amortized) over a certain term, but the outstanding principal balance is due at some point short of that term. This payment is sometimes referred to as a "balloon payment" or bullet payment. The interest rate for a balloon loan can be either fixed or floating. The most common way of describing a balloon loan uses the terminology X due in Y, where X is the number of years over which the loan is amortized, and Y is the year in which the principal balance is due.

Other loan types:

• Assumed mortgage
• Balloon mortgage
• Blanket loan
• Bridge loan
• Budget loan
• Buydown mortgage
• Commercial loan
• Endowment mortgage
• Equity loan
• Flexible mortgage
• Foreign National mortgage
• Graduated payment mortgage loan
• Hard money loan
• Jumbo mortgages
• Offset mortgage
• Package loan
• Participation mortgage
• Reverse mortgage
• Repayment mortgage
• Seasoned mortgage
• Term loan or Interest-only loan
• Wraparound mortgage
• Negative amortization loan
• Non-conforming mortgage

[edit] Loan to value and downpayments

Upon making a mortgage loan for purchase of a property, lenders usually require that the borrower make a downpayment, that is, contribute a portion of the cost of the property. This downpayment may be expressed as a portion of the value of the property (see below for a definition of this term). The loan to value ratio (or LTV) is the size of the loan against the value of the property. Therefore, a mortgage loan where the purchaser has made a downpayment of 20% has a loan to value ratio of 80%. For loans made against properties that the borrower already owns, the loan to value ratio will be imputed against the estimated value of the property.

The loan to value ratio is considered an important indicator of the riskiness of a mortgage loan: the higher the LTV, the higher the risk that the value of the property (in case of foreclosure) will be insufficient to cover the remaining principal of the loan.

[edit] Value: appraised, estimated, and actual

Since the value of the property is an important factor in understanding the risk of the loan, determining the value is a key factor in mortgage lending. The value may be determined in various ways, but the most common are:

1. Actual or transaction value: this is usually taken to be the purchase price of the property. If the property is not being purchased at the time of borrowing, this information may not be available.
2. Appraised or surveyed value: in most jurisdictions, some form of appraisal of the value by a licensed professional is common. There is often a requirement for the lender to obtain an official appraisal.
3. Estimated value: lenders or other parties may use their own internal estimates, particularly in jurisdictions where no official appraisal procedure exists, but also in some other circumstances.

[edit] Equity or homeowner's equity

The concept of equity in a property refers to the value of the property minus the outstanding debt, subject to the definition of the value of the property. Therefore, a borrower who owns a property whose estimated value is $400,000 but with outstanding mortgage loans of $300,000 is said to have homeowner's equity of $100,000.

[edit] Payment and debt ratios

In most countries, a number of more or less standard measures of creditworthiness may be used. Common measures include payment to income (mortgage payments as a percentage of gross or net income); debt to income (all debt payments, including mortgage payments, as a percentage of income); and various net worth measures. In many countries, credit scores are used in lieu of or to supplement these measures. There will also be requirements for documentation of the creditworthiness, such as income tax returns, pay stubs, etc; the specifics will vary from location to location. Many countries have lower requirements for certain borrowers, or "no-doc" / "low-doc" lending standards that may be acceptable in certain circumstances.

[edit] Standard or conforming mortgages

Many countries have a notion of standard or conforming mortgages that define a perceived acceptable level of risk, which may be formal or informal, and may be reinforced by laws, government intervention, or market practice. For example, a standard mortgage may be considered to be one with no more than 70-80% LTV and no more than one-third of gross income going to mortgage debt.

A standard or conforming mortgage is a key concept as it often defines whether or not the mortgage can be easily sold or securitized, or, if non-standard, may affect the price at which it may be sold. In the United States, a conforming mortgage is one which meets the established rules and procedures of the two major government-sponsored entities in the housing finance market (including some legal requirements). In contrast, lenders who decide to make nonconforming loans are exercising a higher risk tolerance and do so knowing that they face more challenge in reselling the loan. Many countries have similar concepts or agencies that define what are "standard" mortgages. Regulated lenders (such as banks) may be subject to limits or higher risk weightings for non-standard mortgages. For example, banks in Canada face restrictions on lending more than 75% of the property value; beyond this level, mortgage insurance is generally required (as of April 2007, there is a proposal to raise this limit to 80%).

[edit] Repaying the capital

There are various ways to repay a mortgage loan; repayment depends on locality, tax laws and prevailing culture.

[edit] Capital and interest

The most common way to repay a loan is to make regular payments of the capital (also called principal) and interest over a set term. This is commonly referred to as (self) amortization in the U.S. and as a repayment mortgage in the UK. A mortgage is a form of annuity (from the perspective of the lender), and the calculation of the periodic payments is based on the time value of moneycompounded daily, yearly, or semi-annually; prepayment penalties may apply; and other factors. There may be legal restrictions on certain matters, and consumer protection laws may specify or prohibit certain practices. formulas. Certain details may be specific to different locations: interest may be calculated on the basis of a 360-day year, for example; interest may be

Depending on the size of the loan and the prevailing practice in the country the term may be short (10 years) or long (50 years plus). In the UK and U.S., 25 to 30 years is the usual maximum term (although shorter periods, such as 15-year mortgage loans, are common). Mortgage payments, which are typically made monthly, contain a capital (repayment of the principal) and an interest element. The amount of capital included in each payment varies throughout the term of the mortgage. In the early years the repayments are largely interest and a small part capital. Towards the end of the mortgage the payments are mostly capital and a smaller portion interest. In this way the payment amount determined at outset is calculated to ensure the loan is repaid at a specified date in the future. This gives borrowers assurance that by maintaining repayment the loan will be cleared at a specified date, if the interest rate does not change.

[edit] Interest only

The main alternative to capital and interest mortgage is an interest onlyinvestment-backed mortgageendowment mortgage if an endowment policy is used, similarly a Personal Equity Plan (PEP) mortgage, Individual Savings Account (ISA) mortgage or pension mortgage. Historically, investment-backed mortgages offered various tax advantages over repayment mortgages, although this is no longer the case in the UK. Investment-backed mortgages are seen as higher risk as they are dependent on the investment making sufficient return to clear the debt. mortgage, where the capital is not repaid throughout the term. This type of mortgage is common in the UK, especially when associated with a regular investment plan. With this arrangement regular contributions are made to a separate investment plan designed to build up a lump sum to repay the mortgage at maturity. This type of arrangement is called an or is often related to the type of plan used:

Until recently it was not uncommon for interest only mortgages to be arranged without a repayment vehicle, with the borrower gambling that the property market will rise sufficiently for the loan to be repaid by trading down at retirement (or when rent on the property and inflation combine to surpass the interest rate).

[edit] No capital or interest

For older borrowers (typically in retirement), it may be possible to arrange a mortgage where neither the capital nor interest is repaid. The interest is rolled up with the capital, increasing the debt each year.

These arrangements are variously called reverse mortgages, lifetime mortgages or equity release mortgages, depending on the country. The loans are typically not repaid until the borrowers die, hence the age restriction. For further details, see equity release.

[edit] Interest and partial capital

In the U.S. a partial amortization or balloon loan is one where the amount of monthly payments due are calculated (amortized) over a certain term, but the outstanding capital balance is due at some point short of that term. In the UK, a part repayment mortgage is quite common, especially where the original mortgage was investment-backed and on moving house further borrowing is arranged on a capital and interest (repayment) basis.

[edit] Foreclosure and non-recourse lending

In most jurisdictions, a lender may foreclose the mortgaged property if certain conditions - principally, non-payment of the mortgage loan - obtain. Subject to local legal requirements, the property may then be sold. Any amounts received from the sale (net of costs) are applied to the original debt. In some jurisdictions, mortgage loans are non-recourse loans: if the funds recouped from sale of the mortgaged property are insufficient to cover the outstanding debt, the lender may not have recourse to the borrower after foreclosure. In other jurisdictions, the borrower remains responsible for any remaining debt. In virtually all jurisdictions, specific procedures for foreclosure and sale of the mortgaged property apply, and may be tightly regulated by the relevant government; in some jurisdictions, foreclosure and sale can occur quite rapidly, while in others, foreclosure may take many months or even years. In many countries, the ability of lenders to foreclose is extremely limited, and mortgage market development has been notably slower.

[edit] Mortgage lending: United States

[edit] United States mortgage process

In the U.S., the process by which a mortgage is secured by a borrower is called origination. This involves the borrower submitting an application and documentation related to his/her financial history and/or credit history to the underwriter. Many banks now offer "no-doc" or "low-doc" loans in which the borrower is required to submit only minimal financial information. These loans carry a higher interest rate and are available only to borrowers with excellent credit. Sometimes, a third party is involved, such as a mortgage broker. This entity takes the borrower's information and reviews a number of lenders, selecting the ones that will best meet the needs of the consumer.

Loans are often sold on the open market to larger investors by the originating mortgage company. Many of the guidelines that they follow are suited to satisfy investors. Some companies, called correspondent lenders, sell all or most of their closed loans to these investors, accepting some risks for issuing them. They often offer niche loans at higher prices that the investor does not wish to originate.

If the underwriter is not satisfied with the documentation provided by the borrower, additional documentation and conditions may be imposed, called stipulations. The meeting of such conditions can be a daunting experience for the consumer, but it is crucial for the lending institution to ensure the information being submitted is accurate and meets specific guidelines. This is done to give the lender a reasonable guarantee that the borrower can and will repay the loan. If a third party is involved in the loan, it will help the borrower to clear such conditions.

The following documents are typically required for traditional underwriter review. Over the past several years, use of "automated underwriting" statistical models has reduced the amount of documentation required from many borrowers. Such automated underwriting engines include Freddie Mac's "Loan Prospector" and Fannie Mae's "Desktop Underwriter". For borrowers who have excellent credit and very acceptable debt positions, there may be virtually no documentation of income or assets required at all. Many of these documents are also not required for no-doc and low-doc loans.

• Credit Report
• 1003 — Uniform Residential Loan Application
• 1004 — Uniform Residential Appraisal Report
• 1005 — Verification Of Employment (VOE)
• 1006 — Verification Of Deposit (VOD)
• 1007 — Single Family Comparable Rent Schedule
• 1008 — Transmittal Summary
• Copy of deed of current home
• Federal income tax records for last two years
• Verification of Mortgage (VOM) or Verification of Payment (VOP)
• Borrower's Authorization
• Purchase Sales Agreement
• 1084A and 1084B (Self-Employed Income Analysis) and 1088 (Comparative Income Analysis) - used if borrower is self-employed

[edit] Predatory mortgage lending

There is concern in the U.S. that consumers are often victims of predatory mortgage lending [2]. The main concern is that mortgage brokers and lenders, operating legally, are finding loopholes in the law to obtain additional profit. The typical scenario is that terms of the loan are beyond the means of the borrower. The borrower makes a number of interest and principal payments, and then defaults. The lender then takes the property and recovers the amount of the loan, and also keeps the interest and principal payments, as well as loan origination fees.

[edit] Option ARM

An option ARM provides the option to pay as little as the equivalent of an amortized payment based on a 1% interest rate, (please note this is not the actual interest rate). As a result, the difference between the monthly payment and the interest on the loan is added to the loan principal; the loan at this point has negative amortization. In this respect, an option ARM provides a form of equity withdrawal (as in a cash-out refinancing) but over a period of time.

The option ARM gives a number of payment choices each month (for example, the equivalent of an amortized payment where the interest rate 1%, interest only based on actual interest rate, actual 30 year amortized payment, actual 15 year amortized payment). The interest rate may adjust every month in accordance with the index to which the loan is tied and the terms of the specific loan. These loans may be useful for people who have a lot of equity in their home and want to lower monthly costs; for investors, allowing them the flexibility to choose which payment to make every month; or for those with irregular incomes (such as those working on commission or for whom bonuses comprise a large portion of income).

One of the important features of this type of loan is that the minimum payments are often fixed for each year for an initial term of up to 5 years. The minimum payment may rise each year a little (payment size increases of 7.5% are common) but remain the same for another year. For example, a minimum payment for year 1 may be $1,000 per month each month all year long. In year 2 the minimum payment for each month is $1,075 each month. This is a gradual increase in the minimum payment. The interest rate may fluctuate each month, which means that the extent of any negative amortization cannot be predicted beyond worst-case scenario as dictated by the terms of the loan.

Option ARM mortgages have been criticized on the basis that some borrowers are not aware of the implications of negative amortization; that eventually option ARMs reset to higher payment levels (an event called "recast" to amortize the loan), and borrowers may not be capable of making the higher monthly payments; and that option ARMs have been used to qualify mortgages for individuals whose incomes cannot support payments higher than the minimum level.

[edit] Costs

Lenders may charge various fees when giving a mortgage to a mortgagor. These include entry fees, exit fees, administration fees and lenders mortgage insurance. There are also settlement fees (closing costs) the settlement company will charge. In addition, if a third party handles the loan, it may charge other fees as well.

[edit] The United States mortgage finance industry

Mortgage lending is a major category of the business of finance in the United States. Mortgages are commercial paper and can be conveyed and assigned freely to other holders. In the U.S., the Federal government created several programs, or government sponsored entities, to foster mortgage lending, construction and encourage home ownership. These programs include the Government National Mortgage Association (known as Ginnie Mae), the Federal National Mortgage Association (known as Fannie Mae) and the Federal Home Loan Mortgage Corporation (known as Freddie Mac). These programs work by buying a large number of mortgages from banks and issuing (at a slightly lower interest rate) "mortgage-backed bonds" to investors, which are known as mortgage-backed securities (MBS).

This allows the banks to quickly relend the money to other borrowers (including in the form of mortgages) and thereby to create more mortgages than the banks could with the amount they have on deposit. This in turn allows the public to use these mortgages to purchase homes, something the government wishes to encourage. The investors, meanwhile, gain low-risk income at a higher interest rate (essentially the mortgage rate, minus the cuts of the bank and GSE) than they could gain from most other bonds.

Securitization is a momentous change in the way that mortgage bond markets function, and has grown rapidly in the last 10 years as a result of the wider dissemination of technology in the mortgage lending world. For borrowers with superior credit, government loans and ideal profiles, this securitization keeps rates almost artificially low, since the pools of funds used to create new loans can be refreshed more quickly than in years past, allowing for more rapid outflow of capital from investors to borrowers without as many personal business ties as the past.

The greatly increased rate of lending led (among other factors) to the United States housing bubble of 2000-2006. The growth of lightly regulated derivativecollateralized debt obligations and credit default swaps, is widely reported as a major causative factor behind the 2007 subprime mortgage financial crisis. instruments based on mortgage-backed securities, such as

[edit] Second-layer lenders in the US

A group called second-layer lenders became an important force in the residential mortgage market in the latter half of the 1960s. These federal credit agencies, which include the Federal Home Loan Mortgage Corp., the Federal National Mortgage Association, and the Government National Mortgage Association, conduct secondary market activities in the buying and selling of loans and provide credit to primary lenders in the form of borrowed money. They do not have direct contact with the individual consumer.

[edit] Federal Home Loan Mortgage Corporation

The Federal Home Loan Mortgage Corporation, sometimes known as Freddie Mac, was established in 1970. This corporation is designed to promote the flow of capital into the housing market by establishing an active secondary market in mortgages^[1]. It may by law deal only with government-supervised lenders such as savings and loan associations, savings banks, and commercial banks; its programs cover conventional whole mortgage loans, participations in conventional loans, and FHA and VA loans.

[edit] Federal National Mortgage Association

The Federal National Mortgage Association, known in financial circles as Fannie Mae, was chartered as a government corporation in 1938, rechartered as a federal agency in 1954, and became a government-sponsored, stockholder-owned corporation in 1968^[1]. Fannie Mae, which has been described as "a private corporation with a public purpose", basically provides a secondary market for residential loans. It fulfills this function by buying, servicing, and selling loans that, since 1970, have included FHA-insured, VA-guaranteed, and conventional loans. However, purchases outrun sales by such a wide margin that some observers view this association as a lender with a permanent loan portfolio rather than a powerful secondary market corporation.

[edit] Government National Mortgage Association

The Government National Mortgage Association, which is often referred to as Ginnie Mae, operates within the Department of Housing and Urban Development. In addition to performing the special assistance, management, and liquidation functions that once belonged to Fannie Mae, Ginnie Mae has an important additional function — that of issuing guarantees of securities backed by government-insured or guaranteed mortgages. Such mortgage-backed securities are fully guaranteed by the U.S. government as to timely payment of both principal and interest^[1].

[edit] Competition among US lenders for loanable funds

To be able to provide homebuyers and builders with the funds needed, financial institutions must compete for deposits. Consumer lending institutions compete for loanable funds not only among themselves but also with the federal government and private corporations. Called disintermediation, this process involves the movement of dollars from savings accounts into direct market instruments: U.S. Treasury obligations, agency securities, and corporate debt. One of the greatest factors in recent years in the movement of deposits was the tremendous growth of money market funds whose higher interest rates attracted consumer deposits.^[2]

To compete for deposits, US savings institutions offer many different types of plans^[2]:

• Passbook or ordinary accounts — permit any amount to be added to or withdrawn from the account at any time.
• NOW and Super NOW accounts — function like checking accounts but earn interest. A minimum balance may be required on Super NOW accounts.
• Money market accounts — carry a monthly limit of preauthorized transfers to other accounts or persons and may require a minimum or average balance.
• Certificate accounts — subject to loss of some or all interest on withdrawals before maturity.
• Notice accounts — the equivalent of certificate accounts with an indefinite term. Savers agree to notify the institution a specified time before withdrawal.
• Individual retirement accounts (IRAs) and Keogh accounts—a form of retirement savings in which the funds deposited and interest earned are exempt from income tax until after withdrawal.
• Checking accounts — offered by some institutions under definite restrictions.
• Club accounts and other savings accounts—designed to help people save regularly to meet certain goals.

[edit] Mortgages in the UK

Main article: UK mortgage terminology

[edit] The mortgage loans industry and market

There are currently over 200 significant separate financial organizations supplying mortgage loans to house buyers in Britain. The major lenders include building societies, banks, specialized mortgage corporations, insurance companies, and pension funds. Over the years, the share of the new mortgage loans market held by building societies has declined. Between 1977 and 1987, it fell drastically from 96% to 66% while that of banks and other institutions rose from 3% to 36%. The banks and other institutions that made major inroads into the mortgage market during this period were helped by such factors as:

• relative managerial efficiency;

• advanced technology, organizational capabilities, and expertise in marketing;

• extensive branch networks; and

• capacities to tap cheaper international sources of funds for lending.^[3]

By the early 1990s, UK building societies had succeeded in greatly slowing if not reversing the decline in their market share. In 1990, the societies held over 60% of all mortgage loans but took over 75% of the new mortgage market – mainly at the expense of specialized mortgage loans corporations. Building societies also increased their share of the personal savings deposits market in the early 1990s at the expense of the banks – attracting 51% of this market in 1990 compared with 42% in 1989.^[4] One study found that in the five years 1987-1992, the building societies collectively outperformed the UK clearing banks on practically all the major growth and performance measures. The societies' share of the new mortgage loans market of 75% in 1990-91 was similar to the share level achieved in 1985. Profitability as measured by return on capital was 17.8% for the top 20 societies in 1991, compared with only 8.5% for the big four banks. Finally, bad debt provisions relative to advances were only 0.4% for the top 20 societies compared with 2.8% for the four banks.^[5]

Though the building societies did subsequently recover a significant amount of the mortgage lending business lost to the banks, they still only had about two-thirds of the total market at the end of the 1980s. However, banks and building societies were by now becoming increasingly similar in terms of their structures and functions. When the Abbey National building society converted into a bank in 1989, this could be regarded either as a major diversification of a building society into retail banking – or as significantly increasing the presence of banks in the residential mortgage loans market. Research organization Industrial Systems Research has observed that trends towards the increased integration of the financial services sector have made comparison and analysis of the market shares of different types of institution increasingly problematical. It identifies as major factors making for consistently higher levels of growth and performance on the part of some mortgage lenders in the UK over the years:

• the introduction of new technologies, mergers, structural reorganization and the realization of economies of scale, and generally increased efficiency in production and marketing operations – insofar as these things enable lenders to reduce their costs and offer more price-competitive and innovative loans and savings products;

• buoyant retail savings receipts, and reduced reliance on relatively expensive wholesale markets for funds (especially when interest rates generally are being maintained at high levels internationally);

• lower levels of arrears, possessions, bad debts, and provisioning than competitors;

• increased flexibility and earnings from secondary sources and activities as a result of political-legal deregulation; and

• being specialized or concentrating on traditional core, relatively profitable mortgage lending and savings deposit operations.^[6]

[edit] Mortgage types

The UK mortgage market is one of the most innovative and competitive in the world. Unlike some other countries, there is little intervention in the market by the state or state funded entities and virtually all borrowing is funded by either mutual organisations (building societies and credit unions) or proprietary lenders (typically banks). Since 1982, when the market was substantially deregulated, there has been substantial innovation and diversification of strategies employed by lenders to attract borrowers. This has led to a wide range of mortgage types.

As lenders derive their funds either from the money markets or from deposits, most mortgages revert to a variable rate, either the lender's standard variable rate or a tracker rate, which will tend to be linked to the underlying Bank of England (BoE) repo rate (or sometimes LIBOR). Initially they will tend to offer an incentive deal to attract new borrowers. This may be:

• A fixed rate; where the interest rate remains constant for a set period; typically for 2, 3, 4, 5 or 10 years. Longer term fixed rates (over 5 years) whilst available, tend to be more expensive and/or have more onerous early repayment charges and are therefore less popular than shorter term fixed rates.
• A capped rate; where similar to a fixed rate, the interest rate cannot rise above the cap but can vary beneath the cap. Sometimes there is a collar associated with this type of rate which imposes a minimum rate. Capped rate are often offered over periods similar to fixed rates, e.g. 2, 3, 4 or 5 years.
• A discount rate; where there is set margin reduction in the standard variable rate (e.g. a 2% discount) for a set period; typically 1 to 5 years. Sometimes the discount is expressed as a margin over the base rate (e.g. BoE base rate plus 0.5% for 2 years) and sometimes the rate is stepped (e.g. 3% in year 1, 2% in year 2, 1% in year three).
• A cashback mortgage; where a lump sum is provided (typically) as a percentage of the advance e.g. 5% of the loan.

To make matters more confusing these rates are often combined: For example, 4.5% 2 year fixed then a 3 year tracker at BoE rate plus 0.89%.

With each incentive the lender may be offering a rate at less than the market cost of the borrowing. Therefore, they typically impose a penalty if the borrower repays the loan within the incentive period or a longer period (referred to as an extended tie-in). These penalties used to be called a redemption penalty or tie-in, however since the onset of Financial Services Authority regulation they are referred to as an early repayment charge.

[edit] Self Cert Mortgage

Mortgage lenders usually use salaries declared on wage slips to work out a borrower's annual income and will usually lend up to a fixed multiple of the borrower's annual income. Self Certification Mortgages, informally known as "self cert" mortgages, are available to employed and self employed people who have a deposit to buy a house but lack the sufficient documentation to prove their income.

This type of mortgage can be beneficial to people whose income comes from multiple sources, whose salary consists largely or exclusively of commissions or bonuses, or whose accounts may not show a true reflection of their earnings. Self cert mortgages have two disadvantages: the interest rates charged are usually higher than for normal mortgages and the loan to value ratio is usually lower.

[edit] 100% Mortgages

Normally when a bank lends a customer money they want to protect their money as much as possible; they do this by asking the borrower to fund a certain percentage of the property purchase in the form of a deposit.

100% mortgages are mortgages that require no deposit (100% loan to value). These are sometimes offered to first time buyers, but almost always carry a higher interest rate on the loan.

[edit] Together/Plus Mortgages

A development of the theme of 100% mortgages is represented by Together/Plus type mortgages, which have been launched by a number of lenders in recent years.

Together/Plus Mortgages represent loans of 100% or more of the property value - typically up to a maximum of 125%. Such loans are normally (but not universally) structured as a package of a 95% mortgage and an unsecured loan of up to 30% of the property value. This structure is mandated by lenders' capital requirements which require additional capital for loans of 100% or more of the property value.

[edit] UK mortgage process

UK lenders usually charge a valuation fee, which pays for a chartered surveyor to visit the property and ensure it is worth enough to cover the mortgage amount. This is not a full survey so it may not identify all the defects that a house buyer needs to know about. Also, it does not usually form a contract between the surveyor and the buyer, so the buyer has no right to sue if the survey fails to detect a major problem. For an extra fee, the surveyor can usually carry out a building survey or a (cheaper) "homebuyers survey" at the same time.^[7]

[edit] Mortgage insurance

Mortgage insurance is an insurance policy designed to protect the mortgagee (lender) from any default by the mortgagor (borrower). It is used commonly in loans with a loan-to-value ratio over 80%, and employed in the event of foreclosure and repossession.

This policy is typically paid for by the borrower as a component to final nominal (note) rate, or in one lump sum up front, or as a separate and itemized component of monthly mortgage payment. In the last case, mortgage insurance can be dropped when the lender informs the borrower, or its subsequent assigns, that the property has appreciated, the loan has been paid down, or any combination of both to relegate the loan-to-value under 80%.

In the event of repossession, banks, investors, etc. must resort to selling the property to recoup their original investment (the money lent), and are able to dispose of hard assets (such as real estate) more quickly by reductions in price. Therefore, the mortgage insurance acts as a hedge should the repossessing authority recover less than full and fair market value for any hard asset.

[edit] Islamic mortgages

Main article: Islamic economic jurisprudence

The Sharia law of Islam prohibits the payment or receipt of interest, which means that practising Muslims cannot use conventional mortgages. However, real estate is far too expensive for most people to buy outright using cash: Islamic mortgages solve this problem by having the property change hands twice. In one variation, the bank will buy the house outright and then act as a landlord. The homebuyer, in addition to paying rent, will pay a contribution towards the purchase of the property. When the last payment is made, the property changes hands.^{[citation needed]}

Typically, this may lead to a higher final price for the buyers. This is because in some countries (such as the United Kingdom and India) there is a Stamp DutyStamp Duty in such transactions was removed in the Finance Act 2003 in order to facilitate Islamic mortgages.^[8] which is a tax charged by the government on a change of ownership. Because ownership changes twice in an Islamic mortgage, a stamp tax may be charged twice. Many other jurisdictions have similar transaction taxes on change of ownership which may be levied. In the United Kingdom, the dual application of

An alternative scheme involves the bank reselling the property according to an installment plan, at a price higher than the original price.

All of these methods are still compensating the lender as if they were charging interest, but the loans are structured in a way that in name they are not, but they share the financial risks involved in the transaction with the homebuyer.^{[citation needed]}

[edit] Other terminologies

Like any other legal system, the mortgage business sometimes uses confusing jargon. Below are some terms explained in brief. If a term is not explained here it may be related to the legal mortgage rather than to the loan.

Advance This is the money you have borrowed plus all the additional fees.

Base rate In UK, this is the base interest rate set by the Bank of England. In the United States, this value is set by the Federal Reserve and is known as the Discount Rate.

Bridging loan This is a temporary loan that enables the borrower to purchase a new property before the borrower is able to sell another current property.

Disbursements These are all the fees of the solicitors and governments, such as stamp duty, land registry, search fees, etc.

Early redemption charge / Pre-payment penalty / Redemption penalty This is the amount of money due if the mortgage is paid in full before the time finished.

equity This is the market value of the property minus all loans outstanding on it.

First time buyer This is the term given to a person buying property for the first time.

Loan origination fee A charge levied by a creditor for underwriting a loan. The fee often is expressed in points. A point is 1 percent of the loan amount.

Sealing fee This is a fee made when the lender releases the legal charge over the property.

Subject to contract This is an agreement between seller and buyer before the actual contract is made.

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