Discuss the government gave their assistance during the crisis

Discuss the factors which led to the financial crisis
of 2007/8 (20%)

The financial crisis of 2007/8 reviewed the most serious crisis of
financial industry, different factors had contributed and one of the factors is
financial innovation and subprime mortgage markets. The function of financial
innovation is creating new financial instruments, technologies, organization,
and markets. The outcome of financial innovations is mortgage-backed securities
products and collateralized debt obligations (CDOs) implemented during the period
of financial crisis. The amount of subprime mortgage in US market was estimated
at $ 1.3 trillion and over 7.5 million subprime mortgages is remaining to be
paid. Collateralized Debt Obligations (CDOs) did a big effect on the crisis, its
special purpose vehicle (SPV) had created securities from those purchased
assets and then sell it to investors. Many subprime mortgage bundle together
sold and dependent on US federal government support and guarantees. It had led
to a moral hazard to happen when one party behave inappropriately after the
financial transaction has engaged while another party needs to suffer for the
costs of moral hazard. The banking crisis is another main factor that led to
the financial crisis. For instance, bank runs occur is when the customers
withdraw their deposits as soon as possible because they worry the bank might
fail and it could affect the banking activity. Besides that, banking crisis
includes banking panics and systemic banking crisis, which could lead increasing
defaults in a country and all the banks. Numerous of the financial institution and
the government gave their assistance during the crisis to avoid the financial
system collapse. On September 2008, Lehman Brother filed for bankruptcy, Merrill
Lynch had sold to Bank of America at low prices and AIG had lost billion. In
addition, one of the factors contributed to the financial crisis is agency
problems and asymmetric information. Agency problems happened when mortgage originators
did not hold the actual mortgage but they sold the notes on the secondary
market to get the commissions from the loans. During
2007 to 2008, originators had got information that many of borrowers from these
loans about to default but they still sold these loans to banks. Asymmetric information occurs when the
parties engage in a transaction, there do not have the same information in
between the different parties and it could exist between investors and
companies or investment corporate. Because when investors are evaluating
companies, companies may have good or bad information while investors or stock
analyst is lack of the information lead the risk exists between investment
firms and investors. For instance, the investment firm may advice their
customer to buy a company’s stock while they knew the stock’s price is decreasing.
Banks have to estimate the exact of riskiness with intelligence that precise in
order to do a rational decision.

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Explain how these factors impacted upon Northern Rock
and the reasons for the nationalisation (20%)

Financial
innovation and subprime mortgage markets factor had led to financial crisis
while financial innovation is ongoing development on financial products to
achieve particular customer objectives and offset particular risk exposure (For
example: default of borrower) to assist obtain financing. The bundling of subprime
mortgages through securitization into collateralized debt obligations (CDO)
sale to investors. Because take advantage of collateralized debt obligations
(CDO), borrowers which less than credit worthy able to purchase house through
subprime lending. Northern Rock lending and offer cheap rates to customer had
made them became the UK’s fifth-largest mortgage lender. By the way, housing
bubbles had occurred when housing prices increased in early 2006, but it
started to decline in 2006 and 2007. After the collapsed of housing bubble had
led to mortgage delinquencies and foreclosures increase, which is bank has
right to take possession of mortgaged property when the mortgagor fail to make
payment and led the housing-related securities price decreased.  Besides that, Northern Rock faced financial
crisis because of fell the standard of underwriting to increase approved on mortgage had caused people intended to
buy houses that they could not afford led housing prices keep increased. Increased
of house value led large number of house owner borrow against their house to
earn a lot of profit. But after the people not able to repay for the mortgage
incur high delinquency rate and the value of these assets decreased at rapid
speed. Banks that were invested in these assets had started faced the lack of liquidity
and deteriorating balance sheets. Deteriorating balance sheets lead financial
institutions into insolvency and these lead to a bank panic. All depositors to
withdraw all funds immediately because they are worry and no idea which bank is
insolvent. Northern Rock started faced problems in raising funds in the money
market to replace maturing money market borrowings. The agency problem and
asymmetric problems arose when credit rating agencies gave asymmetric
information to investors while they consulted with firm on structuring products
to achieve the highest rating. Investors have taking on additional risk when
they relied on the asymmetric information. Borrowers get easier to qualify for
prime loans and make subprime to purchase the house that they not affordable.  Banks had reduced the importance on proof of
income and assets. Besides that, they had lower the mortgage underwriting
standard, loans moved from full documentation to low documentation and to no
documentation. This action had made Northern Rock accumulated a large number of
mortgages and when delinquencies rate increase made they faced liquidity
crisis. The reason that Northern Rock had nationalisation is when the subprime
housing problems rose up, banks stopped lending to each other because fear of
exposure to bad debts. Northern Rock became unable to repay loans from
the money market because they lack of fund raised after
the subprime mortgage crisis began and the global demand from investors for
securitised mortgage was declined. Northern Rock’s source of funding is
completely dried up led to liquidity problem and forced to ask Bank of England,
as lender of last resort for an emergency financial support. When run on the
bank occurred, many customers queued outside branches to withdraw their savings
and led to liquidity crisis out of control. The bank was taken into state
ownership as result of two unsuccessful bids to take over the bank and
announced was to be nationalised.

 

 

 

 

 

 

 

Research the post nationalisation outcome and evaluate
whether the net impact has been positive or negative. (20%)

Nationalisation is the process of transforming private
assets into public assets by bring private assets under the public ownership of
a national government or state. The opposite of nationalisation is privatization,
which is the process of transferring an enterprise or industry from the public
sector to private sector. Another opposite of nationalisation is demutualization,
which is the process of a customer-owned mutual organization changes legal form
to a joint stock company. On 2008, Northern Rock announced expected losses of £585.4m
for the first six months of the year. In the same time they also managed to
repay £9.4bn loan from the Bank of England, reduced amount owed to £17.5bn. On
February 2009, Britain passed legislation allowed government to nationalise
Northern Rock. After the government nationalise Northern Rock, Britain decided
sold off Northern Rock by the end of 2009 and the bank was split into two parts
(assets and banking) to help the bank back to the private sector. Northern Rock
Plc, which represents the “superior” bank by include new mortgages and savings
while the “spoiled” bank of Northern Rock is to merge with state-owned rival
Bradford & Bingley, designed to cut costs and expected to generate greater
returns. On 17 November 2011, the government announced had sold Northern Rock
to Virgin Money for £747m. Virgin Money will have to pay government an
additional £50m to £80m if they successful sells or lists the combined business
on the stock exchange in the next five years. Virgin Money had combined the two
businesses together because Virgin Money has credit cards, insurances, and
investments but lack of mortgages, savings and current accounts while Northern
Rock fulfilled their requirements. Taxpayers had injected £1.4bn into Northern
Rock plc, while the bad bank part of Northern Rock is still owes Treasury £21bn
and uncertain about the potential losses contained. The net impact for
nationalisation has been positive because through the nationalisation government
had saved the bank from bankruptcy and tried to keep reduced the job losses. One
of the advantage of nationalisation is if Northern Rock lose more money from
mortgage defaults, the taxpayer will take responsibility for the losses. However,
the government could benefit from the profits of banks if the bank does well. During
nationalisation process, government helped to enhance the company’s financial
conditions purpose to sell the company at a better price after few years later.
The main reason led to this financial crisis is financial innovation in
mortgage and poor management of bank, in fact nationalisation had helped
avoided the collapse of economic or getting worse circumstances. Through this
financial crisis, we able to aware of the disadvantage of deregulation and how
serious the damage could bring to the market. 

 

 

 

 

 

 

 

 

Present and analyse the steps which have been take to
prevent the repetition of a similar financial crisis (20%)

One of the reason led to financial crisis because most
of the commercial and investment banks had been deregulated started on 1980. The
Glass-Steagall Act was repealed in 1999 for split up the powers of commercial
and investment banking to ensure that banks cannot take risk with the deposit
money. In 1994, a credit default swap (CDS) which is a financial swap agreement
was invented by Blythe Masters from JP Morgan. It designed to transfer the
credit exposure of fixed income products between two or more parties and it was
increased in use in the early 2000s. In
the past, borrowers were able borrowed mortgage to purchase a home that they
may not affordable. Many banks had put these mortgages from housing market
together into packages of securities, created credit default swap (CDS) and
known as synthetic collateralized debt obligations (CDOs). In 2000, the
Commodity Futures Modernization Act had exempt credit default swaps from
regulation was passed. Besides that, the U.S. Securities and Exchange
Commission (SEC) and the Commodity Futures Trading Commission (CFTC) largely
exempt credit default swaps from regulation. By the end of 2007, the amount of
outstanding (CDS) was $62.2 trillion and was $25.5 trillion in early 2012. The
lack of transparency in credit defaults swaps market became a concern to
regulators. In March 2010, the Depository Trust and Clearing Corporation
(DTCC), an American post-trade financial services company which provide
clearing and settlement services to financial markets announced gave regulators
greater access to its credit default swaps database. Credit rating agencies
(CRAs) is a firms paid by the banks who employ them to rate debt instruments/securities
according to the ability of debtor to make repayment. These agencies failed to
remain committed to its own credit-rating standards led to the financial crisis
occurred. The agencies had gave their highest ratings to over three trillion dollars
of loans to homebuyers with no income proved by documents and bad credit
record. Over half a trillion dollar was losses and hundreds of billions of
dollars’ worth of triple-A securities were downgraded five levels to a
speculative grade. On January 2017, one of the rating agency “Moody’s Investors
Service agreed to pay nearly $864m to settle with US federal and state
authorities over its ratings of risky mortgage securities during 2008 financial
crisis. In addition, EU regulator fines Moody’s €1.24m for breaching credit
rating rules and European Securities and Markets Authority (ESMA) carried out its
role to independent oversee of credit rating agencies within the European
Union. ESMA published its market share calculation for EU registered credit
rating agencies (CRAs). It is designed to increase awareness of the different
types of credit ratings offered by each registered CRAs and helped issuers and
related third parties to appoint smaller CRAs. In an addition, The Basel Committee
on Banking Supervision had published Basel ? (Third Basel Accord) to avoid
repetition of the financial crisis.  Main
purpose of Basel ? is to enhance international regulation, risk management and
supervision of banks. It required banks to maintain proper leverage ratios and
minimum capital requirements to avoid the liquidity risk of banks may out of
control.

 

 

 

 

In conclusion, present an opinion as to whether or not
the factor which triggered the 2007/2008 crisis have been addressed and whether
you consider the rescue of Northern Rock to be a good or bad thing (20%)

 

My opinion toward
the factor which triggered the 2007 / 2008 crisis haven’t been addressed even after
published Basel ? had strengthens the banking supervisor and regulations. One of the
reason is the mortgage sector forced shut down after the financial crisis in
2007 / 2008, currently more and more lenders willing lend to people who were
bankruptcy. But on June 2017, emerge new
retail bank Masthaven lend to people who suffered financial problems or who do
not pay their mortgage payments. The financial innovation led a great increase
of number of default posted on credit files by mobile phone companies and more
clemency on defaults which have been registered by phone companies. There is an
obligation on brokers and lenders to check the borrower before make any
borrowing to ensure the borrowing is sensible and appropriate. Another factor
which is credit default swaps (CDS), bundle of credit default swaps are tied to
the risk of corporate defaults and it has more than doubled in the first seven
months of 2017. Traders by over-the-counter market estimated has been issuance
of $20bn to $30bn this year, compared to $15bn in the whole year of 2016 and
$10bn in year of 2015. Bespoke tranches, type of collateralized debt obligation
(CDO) that a dealer creates for a specific group of investors are created by
allow investor to pick a bundle of about 100 different “single-name” of credit
default swaps. Since the products are not graded by the rating agencies
therefore bespoke tranches possess large area of credit hedge funds and it exist
a limited investor base. But after the market of pension funds from the
institutional investors at Canada and New Zealand have joined and it might led
to the risk of defaults. For my opinion, the rescue of Northern Rock is a good
thing because after the rescue Northern Rock had split into “superior bank”,
containing deposits and quality mortgage assets while “spoiled bank” containing
the rest. The government forms UK Asset Resolution (UKAR) and lends it £48.7bn
to take on £68bn of loans from “spoiled” Northern Rock (NRAM Limited) with
purpose to repay the state bailout. On 2011, Virgin Money paid £1bn for “superior”
Northern Rock, got £14bn of mortgages, and £16.6bn of deposits. During 2013 to
2016, UKAR had sold NRAM’s unsecured loans and mortgages to One Savings Bank,
Marlin Financial Group, JPMorgan, and Cerberus. On 2017, UKAR had sold £9.7bn of
NRAM mortgages and repaid £4.6bn of the government loan and 93 percent of its
borrowers are up to date with their repayment. The rescued bank has performed
well after they get bailout even though the bank had faced financial crisis at
beginning because of poor management and subprime mortgage factor. After this
lesson, UK banks have raised more than £130bn in additional capital since 2007
and the UK’s largest four banks – HSBC, Lloyds, RBS and Barclays, had launched
rights issues to boost their capital base in 2008 to 2009.

 

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