The Impact of the Financial Crisis (2007-2009) on Financial Markets and Institutions

A Case Study of Northern Rock


Term Paper, 2010

17 Pages


Excerpt

Table of Content

Chapter 1: IMPACT OF THE CRISIS ON FINANCIAL MARKETS
1.1- BONDS MARKET.
1.2-STRUCTURED FINANCAL INSTRUMENTS
Mortgages Backed Securities (MBS)
Asset Backed Commercial Paper (ABCP)
Collateralised Debt Obligations (Cash flow) (CDO)
1.3-THE ROLE OF THE POLICY MAKERS.
Bank of England (BoE)
Financial Service Authority (FSA)
HM Treasury (HMT)
1.4.-REGULATORY REFORMS

Chapter 2: NORTHERN ROCK-CASE OF STUDY
2.1-NORTHERN ROCK CRISIS
2.2-CAUSES OF THE CRISIS
Business model
Financial turmoil
Attitude of regulators
2.3- HOW COULD THE CRISIS HAVE BEEN AVOIDED?
2.4- CONCLUSION

Chapter 1: IMPACT OF THE CRISIS ON FINANCIAL MARKETS

1.1- BONDS MARKET.

It is widely acknowledged that the 2007 – 2009 financial crises have been one of the most ferocious of our history. The financial crisis began on August – September 2007 and the Lehman brothers’ bankruptcy just confirmed that the fantastic cycle of economic growth had finished. Moreover, since September 15, 2008 the domino effect due Lehman Brothers’ collapse spread the fear among the financial markets and investors.

Financial markets had experienced important financial innovations by two main instruments: securitization and collateralized debt obligations which volumes increased significantly during the previous years of the crisis. Mainly, these instruments were collateralized by mortgages; however, the problem was the quality of them. This low quality mortgages are known as SPM. The problem become to light when the rate of default of these subprime mortgages began to rise, because of the high interest rates. At the same time, the house price in US declined; therefore, the bonds collateralised by real estate assets became less secure.

The Banks did not trust to each other due to the uncertainty about which ones had a high ratio of SPM in their MBS and their CDOs. As a result of this the market dried up. The Banks started to suffer the consequences and funding become more difficult and expensive.

On 4 September the Libor reach its maximum peak in nine years making evidence the relevance of the credit squeeze in the interbank market. As the liquidity problem worsened only the largest and most diversified financial institutions were able to obtain funds from the wholesale markets; however, they found it very difficult and expensive.

Abbildung in dieser Leseprobe nicht enthalten

Libor 3 Months

There is a negative correlation between the liquidity of the market and the Libor; therefore as the liquidity decrease the Libor increases. However, from November 2008, liquidity and Libor decreased; simultaneously, this was the result of the injection of liquidity made by monetary authorities.

Abbildung in dieser Leseprobe nicht enthalten

UK Financial Market Liquidity Index vs Libor 3 Months

Bonds had been directly hit by the financial crisis. Since the markets had lost faith on financial institutions, they found serious difficulties to issue debt through bonds (MBS, ABCP, CDO).

During those days a lot of banks were bail out by governments. Therefore, the governments had to fund themselves to face all those expenses. The governments also use bonds to obtain funds and government bonds are considered more reliable than the bonds issued by the companies.

As a result of the uncertainty caused by the credit crunch, investors sought for safer investments rather than riskier ones. Until this point, everything matches perfectly, the investors are looking for the bonds security and the governments need people to buy its bonds because they need funds.

When companies issue bonds have to compete against Government bonds, therefore they have to cover the risk by giving higher returns to the investors.

When financial sectors collapsed on 2007 the lack of confidence and uncertainty dried out the financial markets. All the financial institutions which their financing policy was dependent on wholesale markets ran out of liquidity. Therefore, they could not face their commitments against their investors.

1.2-STRUCTURED FINANCAL INSTRUMENTS

The increasingly securitization as business strategy (bringing together a large number of loans in a single package and selling it into the capital market) was the underlying factor behind the crisis. After the US subprime crisis, many bank which relied heavily in financing through issuing asset-backed commercial paper, were unable to obtain fund due to the lack of confidence on these securities.

Investment Banks base its funding on debt instruments it sold in the wholesale markets using Structured Finance Instruments. Structured finance “… involves the pooling of assets and the subsequent sale to investors of claims on the cash flows backed by these pools. Typically, several classes (or “tranches”) of securities are issued, each with distinct risk-return profiles” [Gorton and Souleles (2005)].

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Excerpt out of 17 pages

Details

Title
The Impact of the Financial Crisis (2007-2009) on Financial Markets and Institutions
Subtitle
A Case Study of Northern Rock
College
University of Westminster
Authors
Year
2010
Pages
17
Catalog Number
V377036
ISBN (eBook)
9783668545359
ISBN (Book)
9783668545366
File size
694 KB
Language
English
Notes
Tags
impact, financial, crisis, markets, institutions, case, study, northern, rock
Quote paper
Daniel Plaza (Author)Jaume Bosch (Author), 2010, The Impact of the Financial Crisis (2007-2009) on Financial Markets and Institutions, Munich, GRIN Verlag, https://www.grin.com/document/377036

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