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The Credit Crunch...A Brief Description of where it all went wrong!
The nationalisation of Northern Rock signalled the beginning of the latest financial crisis, beginning in 2006 when they were ‘granting mortgages at six times income when other lenders were holding the line at between three and four’ (Brummer.2009.Pg11). At first industry figures were sceptical, however Northern Rock soon increased its market share and banks and lenders were soon imitating. Northern Rock ‘was the business model to follow’ (Brummer.2009.Pg11). February 2007, saw the architect of Northern Rock’s business model and enormous growth, retire. The business model came under scrutiny and was identified as being unusual due to its ‘heavy use of securitised notes’ (Shin.2009.Pg104) and because it was borrowing 75% of its’ money from other banks in the wholesale markets. Northern Rocks model, depended on the liquidity of the wholesale markets.
In the US the boom in sub-prime mortgage lending, resulted in many people not being able to finance their mortgages. The industry was facing a crisis’ (Brummer.2009.Pg13). Banks were hesitant to lend to each other, and when they did they attached a high rate of interest. An increase in CDOs backed by mortgage collateral caused uncertainty. Northern Rock’s business model was weak due to securitisation whereby lenders were ‘turning whole loans into marketable securities’ (Watson.2008.Pg5) beginning with financial institutions creating loans, which are then sold to other institutions who ‘create large pools of similar credits’ (Watson.2008.Pg5). A ‘securitization sponsor’ (Watson 2008.Pg5) bundles up the loans into a trust, which it then sells. This process creates ‘diversified portfolios...and economies of scale’ (Watson 2008.Pg5). If for any ‘reason the source of funding is disrupted then the banks involved suffer immediately’ (Brummer.2009.Pg16) Securitisation was largely to blame for ‘depositors waiting in line outside the branch offices of a United Kingdom bank called Northern Rock to withdraw their money’ (Shin.2009.Pg101).
In August 2007, banks ceased trading with each other as panic spread across the financial markets, resulting in a ‘passive destruction’ (O’Connor.1987.Pg105) as the ‘leaving central banks to pump in vast sums of money to avoid its total meltdown’ (Brummer.2009.Pg57). Northern Rock was nationalised, switching ownership ‘from the private to the public sector’ (Jones.2004.Pg478). In an attempt to recuperate losses, banks increased interest rates and despite the Bank of England lowering interest rates the number of firms failing increased.
Martin Young
29/7/2010
References:
Brummer (2008). The Crunch. 2nd ed. London: Random House Business BooksJones (2004). Business Economics and Managerial Decision Making. Sussex: John Wiley and Sons Ltd.
Shin. (2009). Reflections on Northern Rock. Journal of Economic Perspectives. 23 (1), 101-119O'Connor (1987). The Meaning of Crisis. Oxford: Basil Blackwell Ltd.Watson. (2008). A securitization Primer for first time issuers. Journal of Financial Economics. 23 (3), 1-32
In the US the boom in sub-prime mortgage lending, resulted in many people not being able to finance their mortgages. The industry was facing a crisis’ (Brummer.2009.Pg13). Banks were hesitant to lend to each other, and when they did they attached a high rate of interest. An increase in CDOs backed by mortgage collateral caused uncertainty. Northern Rock’s business model was weak due to securitisation whereby lenders were ‘turning whole loans into marketable securities’ (Watson.2008.Pg5) beginning with financial institutions creating loans, which are then sold to other institutions who ‘create large pools of similar credits’ (Watson.2008.Pg5). A ‘securitization sponsor’ (Watson 2008.Pg5) bundles up the loans into a trust, which it then sells. This process creates ‘diversified portfolios...and economies of scale’ (Watson 2008.Pg5). If for any ‘reason the source of funding is disrupted then the banks involved suffer immediately’ (Brummer.2009.Pg16) Securitisation was largely to blame for ‘depositors waiting in line outside the branch offices of a United Kingdom bank called Northern Rock to withdraw their money’ (Shin.2009.Pg101).
In August 2007, banks ceased trading with each other as panic spread across the financial markets, resulting in a ‘passive destruction’ (O’Connor.1987.Pg105) as the ‘leaving central banks to pump in vast sums of money to avoid its total meltdown’ (Brummer.2009.Pg57). Northern Rock was nationalised, switching ownership ‘from the private to the public sector’ (Jones.2004.Pg478). In an attempt to recuperate losses, banks increased interest rates and despite the Bank of England lowering interest rates the number of firms failing increased.
Martin Young
29/7/2010
References:
Brummer (2008). The Crunch. 2nd ed. London: Random House Business BooksJones (2004). Business Economics and Managerial Decision Making. Sussex: John Wiley and Sons Ltd.
Shin. (2009). Reflections on Northern Rock. Journal of Economic Perspectives. 23 (1), 101-119O'Connor (1987). The Meaning of Crisis. Oxford: Basil Blackwell Ltd.Watson. (2008). A securitization Primer for first time issuers. Journal of Financial Economics. 23 (3), 1-32