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.
In the UK, the Northern Rock crisis has been one of the most dramatic and clearest consequences of the recent financial collapse. As a result of that, the Bank of England had to act as a lender-of-last-resort and the British Government offered guarantee for deposits of a bank for the first time in the history. Northern Rock was previously a mutual building society converted to bank in 1997, however it remained focused on the mortgage market and became the eighth largest bank and the fifth largest mortgage lender in the UK. Since its demutualization, Northern Rock had grown through heavy reliance on borrowing with about 50% of its funding coming from securitization.
In order to explain the Northern Rock crisis, it is necessary to analyze several circumstances as a whole, since it was the result of a multi- dimensional problem. This paper seeks out to do so by taking a closer look at the business model, the financial turmoil, and the attitude of regulators.
Table of Contents
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
Research Objectives and Core Themes
The primary objective of this study is to examine the impact of the 2007-2009 financial crisis on global financial markets, with a specific focus on the operational failure and subsequent crisis of the British bank Northern Rock. The research investigates how reliance on short-term wholesale funding and structured financial instruments rendered specific institutions highly vulnerable to systemic market liquidity shocks.
- The transmission mechanisms of the financial crisis through securitized instruments (MBS, ABCP, CDOs).
- The specific business model of Northern Rock and its over-dependency on the wholesale money market.
- The role of policy makers, including the Bank of England, the FSA, and the HM Treasury in managing systemic risk.
- Regulatory shortcomings and the transition from Basel II to more restrictive frameworks like Basel III.
- The "Low Probability – High Impact" risk profile that led to the bank's liquidity collapse.
Excerpt from the Book
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.
Chapter Summary
Chapter 1: IMPACT OF THE CRISIS ON FINANCIAL MARKETS: This chapter analyzes how the crisis spread through securitized instruments and impacted global market liquidity, while detailing the interventions of UK policy makers.
1.1- BONDS MARKET: Discusses the collapse of market confidence and the surge in the Libor rate due to the credit squeeze in interbank lending.
1.2-STRUCTURED FINANCAL INSTRUMENTS: Explains the role of securitization and debt packaging instruments like MBS and CDOs in propagating systemic risk.
1.3-THE ROLE OF THE POLICY MAKERS: Examines the actions taken by the BoE, FSA, and HMT to stabilize the financial system and manage failing institutions.
1.4.-REGULATORY REFORMS: Outlines the limitations of Basel II and the necessity for more restrictive regulations concerning liquidity and capital requirements.
Chapter 2: NORTHERN ROCK-CASE OF STUDY: Provides a comprehensive case study of Northern Rock, detailing its business model failure and the liquidity crisis it faced.
2.1-NORTHERN ROCK CRISIS: Details the transition of Northern Rock and its extreme dependency on wholesale funding that led to its insolvency crisis.
2.2-CAUSES OF THE CRISIS: Investigates the structural reasons behind the bank's collapse, including its business model, the prevailing financial turmoil, and regulatory oversight.
2.3- HOW COULD THE CRISIS HAVE BEEN AVOIDED?: Evaluates risk management failures and suggests alternative business strategies that could have improved the firm's viability.
2.4- CONCLUSION: Summarizes the unique combination of market conditions and strategic errors that turned Northern Rock into a primary victim of the credit crunch.
Keywords
Financial Crisis, Northern Rock, Securitization, MBS, CDO, Liquidity, Wholesale Funding, Bank of England, Basel II, Credit Crunch, Subprime Mortgages, Risk Management, Financial Regulation, Interbank Market, Asset Backed Commercial Paper
Frequently Asked Questions
What is the central focus of this research paper?
The paper examines the impact of the 2007-2009 global financial crisis on financial markets, specifically looking at how specific financial institutions, such as Northern Rock, failed due to their dependency on wholesale funding and structured credit instruments.
Which financial instruments are highlighted as contributing to the crisis?
The study highlights securitization and structured finance products, specifically Mortgage Backed Securities (MBS), Asset Backed Commercial Paper (ABCP), and Collateralized Debt Obligations (CDOs).
What was the main research objective regarding Northern Rock?
The objective was to analyze the multi-dimensional causes of the Northern Rock crisis, demonstrating how its specific business strategy, focused on securitization, became unsustainable when market liquidity dried up.
What methodology is employed to analyze the events?
The authors use a case study methodology, examining historical balance sheet data, market performance trends, and the regulatory interactions between Northern Rock and the UK financial authorities.
What does the main body of the text cover?
The main body covers the mechanics of the financial market crisis, the role of policy makers (BoE, FSA, HMT), necessary regulatory reforms, and a detailed breakdown of the Northern Rock crisis, including its business model and subsequent downfall.
Which keywords best characterize this work?
Key terms include Financial Crisis, Northern Rock, Securitization, Liquidity, Risk Management, and Financial Regulation.
Why did Northern Rock face a liquidity crisis despite appearing solvent?
Although its total assets exceeded total liabilities, Northern Rock faced a liquidity crisis because it could not meet its short-term obligations when the wholesale funding markets closed, forcing it to seek emergency funding from the Bank of England.
What "Low Probability – High Impact" risk did Northern Rock overlook?
The bank ignored the extreme risk that the wholesale money markets, upon which it was heavily dependent, could suddenly dry up, which is an event with a low statistical probability but catastrophic impact for their specific business model.
How did regulators influence the outcome for Northern Rock?
The study notes that the Bank of England's restricted intervention policy and the stigma associated with emergency borrowing contributed to the decline of confidence in Northern Rock, ultimately leading to the depletion of its retail deposits.
- Arbeit zitieren
- Daniel Plaza (Autor:in), Jaume Bosch (Autor:in), 2010, The Impact of the Financial Crisis (2007-2009) on Financial Markets and Institutions, München, GRIN Verlag, https://www.hausarbeiten.de/document/377036
