The US subprime-crisis became a headline in the global media starting in February 2007 after the US housing market had already shown first signs of a slowdown in late 2006 (DiMartino & Duca, 2007, p. 1). Previously, the US housing market had enjoyed a favorable environment, especially from 2002 to 2005, which was characterized by low interest rates, rising house values, and increasing home financing possibilities through subprime mortgages (Krinsman, 2007, pp. 13-14). However, more and more events were published during the year by US mortgage brokers, international investment banks, and central banks around the world that presented a picture which caused today’s perception of the subprime-crisis. What’s more, the subprime-crisis is far from being over: an end to the crisis is not yet in sight.
One rather unique characteristic of this crisis is that its actual basis is the delinquencies and defaults of subprime single-family home mortgages in the US (Kiff & Mills, 2007, p. 3) which is commonly not regarded to be of great relevance for the international capital markets. However, taking into account the originate and distribute business model of US mortgage brokers in connection with the securitization of these mortgages into various types of securities that are traded on a global basis, it is not surprising to observe that banks and investment funds around the world were invested into these securities. Before the crisis started, only a few banks or funds considered the liquidity of these securities when investing significant amounts of money in them because they focused on maximizing their returns. But, when larger problems in the US subprime mortgage market became evident, liquidity became the major concern for investors and investor preferences significantly shifted to safer assets such as government bonds (Fender & Hördahl, 2007, pp. 9-11). This caused severe problems in the money market, which ultimately brought the crisis across the Atlantic to Europe. Moreover, funding problems emerged and caused the first bank run in Europe in decades when depositors in Britain started to queue outside Northern Rock branches for hours to withdraw their deposits in light of fears that the bank might have to file for bankruptcy (The Economist, 2007a, para. 28).
Table of Contents
1 Introduction
1.1 Motivation and Objective
1.2 Course of the Investigation
2 Fundamentals of the Subprime-Crisis
2.1 The US Housing and Subprime Mortgage Market
2.2 Characteristics of Subprime Mortgages
2.3 Business Model of US Mortgage Brokers
2.4 Financial Instruments Underlying the Subprime-Crisis
2.5 Consequences of the Fragmented Securitization Process
3 The Development of the Subprime-Crisis
3.1 Situation of the US Housing Market up to 2007
3.2 Timeline of the Subprime-Crisis in 2007
3.3 Spillover Effects from the Mortgage Market to the Global Capital Markets
3.4 Consequences for the British Banking Market
4 Empirical Analysis About the Subprime-Crisis
4.1 History and Overview of Event Studies
4.2 Framework of an Event Study
4.3 Selection of Relevant Data
4.3.1 British Banks and Market Index
4.3.2 News about Private Financial Institutions and Central Banks
4.4 Event Study About the Subprime-Crisis
4.4.1 Event Study Methodology
4.4.2 Formulation and Testing of Hypotheses
4.4.3 Interpretation of Results
4.5 Year-round Performance of the British Banking Sector in 2007
5 Summary and Conclusion
Objectives and Key Themes
This thesis examines the impact of the US subprime crisis on the British banking sector, investigating both short-term market reactions through an event study and long-term performance shifts throughout the year 2007.
- The evolution and underlying mechanics of the US subprime mortgage market and its securitization processes.
- Chronological development of the subprime crisis and its spillover effects into global financial markets.
- Specific consequences for British financial institutions, including the liquidity crisis and bank runs.
- Empirical event study methodology analyzing stock market reactions to subprime-related news.
- Comparative performance analysis of a bank-focused portfolio versus a diversified alternative portfolio in 2007.
Excerpt from the Book
2.3 Business Model of US Mortgage Brokers
The US mortgage market can be regarded as being separated by prime and non-prime mortgages. This separation especially applies to the institutions that are involved in these markets. The prime mortgage market is dominated by the GSEs because they define the prime conforming criteria which have to be met in order for prime loans to be purchased and guaranteed by the GSEs. In contrast, the non-prime market is regarded as being separate from the prime market, as subprime brokers usually focus on subprime loans only (Danis & Pennington-Cross, 2005, p. 6).
Most mortgage lenders in the US are specialized mortgage brokers who do not retain the mortgages they originate on their own balance sheet and, consequently, bear very little credit risk in case of mortgage defaults. Nevertheless, this makes them dependent on access to the market for securitized products because they do not have sufficient equity to fund mortgages themselves for a longer period (Alexander, Grimshaw, McQueen, & Slad, 2002, p. 671). Mortgage brokers have an especially strong market position in the subprime mortgage market where about 63 percent of all mortgages are originated through mortgage brokers (Kiff & Mills, 2007, p. 11). The subprime mortgage market is characterized as having a very high concentration of subprime mortgage originators.
Summary of Chapters
1 Introduction: Defines the scope of the thesis, establishing the motivation behind analyzing the impact of the US subprime crisis on British banks.
2 Fundamentals of the Subprime-Crisis: Explores the origins of subprime mortgages, the brokers' business models, and the role of securitization in creating high-risk financial instruments.
3 The Development of the Subprime-Crisis: Provides a comprehensive timeline of 2007, detailing the deterioration of the US housing market and the resulting spillover effects on international banks, specifically Northern Rock.
4 Empirical Analysis About the Subprime-Crisis: Details the quantitative approach, using event study methodology and portfolio performance comparisons to measure the crisis's impact on British equity.
5 Summary and Conclusion: Synthesizes the theoretical and empirical findings, confirming that the British banking sector significantly underperformed during the crisis year of 2007.
Keywords
Subprime crisis, British banking market, Northern Rock, Securitization, Mortgage-backed securities, Event study, Liquidity crunch, Abnormal returns, US housing market, Credit risk, Financial contagion, Investment banking, Mortgage brokers, Capital markets, Risk-adjusted performance.
Frequently Asked Questions
What is the core focus of this research?
This thesis examines the impact of the US subprime mortgage crisis on the British banking market, focusing on how this external shock manifested in the UK through liquidity issues and equity performance.
What are the primary themes discussed?
The study covers the history of the US subprime market, the mechanics of securitization (MBS/CDOs), the contagion effects on global and British financial institutions, and the empirical measurement of stock market reactions.
What is the primary objective of this thesis?
The primary objective is to empirically determine if the subprime crisis caused significant short-term stock price reactions in the British banking sector and to compare the annual performance of bank stocks against broader, diversified market alternatives.
Which methodology is applied in the empirical analysis?
The study utilizes two primary empirical approaches: an event study using daily abnormal stock returns and a comparative year-round performance analysis using portfolio risk and return metrics.
What does the main body cover?
The main body details the evolution of the subprime crisis, specific financial instruments like ABCPs and CDOs, the collapse and bailout of Northern Rock, and the results of regression and performance modeling.
Which key terms characterize the study?
The study is characterized by terms such as securitization, liquidity crunch, event study, subprime mortgages, abnormal returns, and bank contagion.
Why was the British banking market specifically chosen for analysis?
The British banking market was chosen because it experienced uniquely severe consequences, including major asset write-downs and the first bank run in Europe in decades, making it a critical case study for crisis impact.
What was the outcome regarding the event study results?
The event study failed to prove a statistically significant relationship between the subprime-related news and short-term stock price movements, which the author attributes to the clustering of news and overlapping event windows.
- Quote paper
- Jan-Frederik Modell (Author), 2008, The impact of the subprime-crisis on european banks, Munich, GRIN Verlag, https://www.grin.com/document/91325
