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==Historical background==
==Historical background==


The initial [[liquidity crisis]] can in hindsight be seen to have resulted from the incipient [[subprime mortgage crisis]]. One of the first victims was [[Northern Rock]], a major British bank.<ref>{{cite web | url=http://www.bankofengland.co.uk/publications/news/2007/090.htm | title=News Release: Liquidity Support Facility for Northern Rock plc| author= HM Treasury, Bank of England and Financial Services Authority | date= September 14, 2007}}</ref> The bank's inability to borrow additional funds, to payoff maturing debt obligations led to a [[bank run|run]] in mid-September 2007. The highly [[leverage]]d nature of its business, unsupportable without fresh infusions of cash, led to its takeover and provided an early indication of the troubles that would soon befall other banks and financial institutions.
The initial [[liquidity crisis]] can in hindsight be seen to have resulted from the incipient [[subprime mortgage crisis]]. One of the first victims was [[Northern Rock]], a major British bank.<ref>{{cite web | url=http://www.bankofengland.co.uk/publications/news/2007/090.htm | title=News Release: Liquidity Support Facility for Northern Rock plc| author= HM Treasury, Bank of England and Financial Services Authority | date= September 14, 2007}}</ref> The bank's inability to borrow additional funds, to payoff maturing debt obligations led to a [[bank run|run]] in mid-September 2007. The highly [[leveraged | Leverage (finance)]] nature of its business, unsupportable without fresh infusions of cash, led to its takeover and provided an early indication of the troubles that would soon befall other banks and financial institutions.


Excessive unsecured lending, which was a hallmark of the [[United States housing bubble]], resulted in a very large number of [[subprime mortgage]]s. These high risk [[loan]]s had been perceived to be mitigated by [[securitization]]. Rather than ''mitigating'' the risk, however, this strategy appears to have had the effect of broadcasting and amplifying it in a [[domino effect]]. The damage from these failing securitization schemes eventually cut across a large swath of the housing market and the housing business and led to the subprime mortgage crisis. The accelerating rate of [[foreclosure]] caused an ever greater number of homes to be dumped onto the market. This glut of homes decreased the value of other surrounding homes which themselves became subject to foreclosure or abandonment. The resulting spiral underlay a developing financial crisis.
Excessive unsecured lending, which was a hallmark of the [[United States housing bubble]], resulted in a very large number of [[subprime mortgage]]s. These high risk [[loan]]s had been perceived to be mitigated by [[securitization]]. Rather than ''mitigating'' the risk, however, this strategy appears to have had the effect of broadcasting and amplifying it in a [[domino effect]]. The damage from these failing securitization schemes eventually cut across a large swath of the housing market and the housing business and led to the subprime mortgage crisis. The accelerating rate of [[foreclosure]] caused an ever greater number of homes to be dumped onto the market. This glut of homes decreased the value of other surrounding homes which themselves became subject to foreclosure or abandonment. The resulting spiral underlay a developing financial crisis.

Revision as of 10:31, 29 September 2008

The financial crisis of 2007–2008, generally referred to in Britain as "the credit crunch" and in the United States as "the credit crisis", first became apparent on August 9, 2007 when a loss of confidence by investors in the value of securitized mortgages resulted in a liquidity crisis which prompted the massive injection of capital into financial markets by the Federal Reserve and the European Central Bank.[1][2]

Historical background

The initial liquidity crisis can in hindsight be seen to have resulted from the incipient subprime mortgage crisis. One of the first victims was Northern Rock, a major British bank.[3] The bank's inability to borrow additional funds, to payoff maturing debt obligations led to a run in mid-September 2007. The highly Leverage (finance) nature of its business, unsupportable without fresh infusions of cash, led to its takeover and provided an early indication of the troubles that would soon befall other banks and financial institutions.

Excessive unsecured lending, which was a hallmark of the United States housing bubble, resulted in a very large number of subprime mortgages. These high risk loans had been perceived to be mitigated by securitization. Rather than mitigating the risk, however, this strategy appears to have had the effect of broadcasting and amplifying it in a domino effect. The damage from these failing securitization schemes eventually cut across a large swath of the housing market and the housing business and led to the subprime mortgage crisis. The accelerating rate of foreclosure caused an ever greater number of homes to be dumped onto the market. This glut of homes decreased the value of other surrounding homes which themselves became subject to foreclosure or abandonment. The resulting spiral underlay a developing financial crisis.

Initially the companies affected were those directly involved in home construction and mortgage lending such as Northern Rock and Countrywide Financial. Financial institutions which had engaged in the securitization of mortgages such as Bear Stearns then fell prey. The crisis further accelerated in late summer following the placement of Fannie Mae and Freddie Mac into federal conservatorship. It then began to affect the general availability of credit to non-housing related businesses and to larger financial institutions not directly connected with mortgage lending. At the heart of many of these institution's portfolios were investments whose assets had been derived from bundled home mortgages. Exposure to these mortgage-backed securities, or to the credit derivatives used to insure them against failure, threatened an increasing number of firms such as Lehman Brothers, AIG, Merrill Lynch, and HBOS.[4][5][5][6] Other firms that came under pressure included Washington Mutual, the largest savings and loan in the United States, and the remaining large investment firms, Morgan Stanley and Goldman Sachs.[7][8]

Week of September 14, 2008

On Sunday, September 14, it was announced that Lehman Brothers would file for bankruptcy after the administration had refused any bailout package. At the same time, the sale of Merrill Lynch to Bank of America was announced.[5]

The beginning of the work week was marked by extreme instability in global stock markets, with dramatic drops in market values on Monday, September 15, and Wednesday, September 17.

On September 16, the large insurer AIG who had underwritten many credit default swaps suffered a liquidity crisis following the downgrade of its credit rating. The Federal Reserve stepped in to prevent the company's collapse and announced the creation of a credit facility of up to US$85 billion in exchange for warrants for a 79.9% equity stake and the right to suspend dividends to previously issued common and preferred stock.

On September 16, the Reserve Primary Fund, a large money market mutual fund, lowered its share price below $1 because of exposure to Lehman debt securities. This resulted in demands from investors to return their funds as the financial crisis mounted.[9] By the morning of September 18, money market sell orders from institutional investors totalled $0.5 trillion, out of a total market capitalization of $4 trillion, but a $105 billion liquidity injection from the Federal Reserve averted an immediate collapse.[10] On September 19 the U.S. Treasury offered temporary insurance (akin to FDIC insurance of bank accounts) to money market funds.[11]

Toward the end of the week, short selling of financial stocks was suspended by the Financial Services Authority in the United Kingdom and by the Securities and Exchange Commission in the United States.[12] Similar measures were taken by authorities in other countries.[13]

Troubled Asset Relief Program

Main article: Proposed bailout of U.S. financial system (2008)

A plan, the Troubled Asset Relief Program, was floated on September 19 for the United States government to purchase illiquid assets (aka toxic assets) resulting from the subprime mortgage crisis from troubled financial institutions.[14][15] The value of these complicated securities is extremely uncertain.[16]

Consultations of the Secretary of the Treasury, the Chairman of the Federal Reserve, and the Chairman of the U.S. Securities and Exchange Commission with Congressional leaders and the President of the United States coupled with development of plans to advance a comprehensive solution to the problems created by illiquid assets and other measures resulted in some restoration of confidence in markets on September 19, 2008.[17][18]

At the close of the week the Secretary of the Treasury and President Bush announced a proposal for the federal government to buy up to US$700 billion of illiquid mortgage backed securities with the intent to increase the liquidity of the secondary mortgage markets and reduce potential losses encountered by financial institutions owning the securities. The draft proposal of the plan was received favorably by investors in the stock market. Details of the bailout remain to be approved by Congress.[19][20][21][22] It is being called the greatest economic crisis since the Great Depression. [23]

Week of September 21, 2008

On Sunday, September 21, the two remaining investment banks, Goldman Sachs and Morgan Stanley, with the approval of the Federal Reserve, converted to bank holding companies, a status subject to more regulation, but with readier access to capital.[24] On September 21, Treasury Secretary Henry Paulson announced that the original proposal, which would have excluded foreign banks, had been widened to include foreign financial institutions with a presence in the US. The US administration was pressuring other countries to set up similar bailout plans.[25] On Monday and Tuesday during the week of September 22, appearances were made by by the Secretary of the Treasury and the Chairman of the Board of Governors of the Federal Reserve before Congressional committees and on Wednesday a prime time presidential address was delivered by the President of the United States on television. Behind the scenes, negotiations were held refining the proposal which had grown to 42 pages from its original 3 and was reported to include both an oversight structure and limitations on executive salaries, with other provisions under consideration. On September 25, agreement was reported by congressional leaders on the basics of the package;[26] however, general and vocal opposition to the proposal was voiced by the public.[27] On Thursday afternoon at a White House meeting attended by congressional leaders and the presidential candidates, John McCain and Barack Obama, it became clear that there was no congressional consensus, with Republican representatives and the ranking member of the Senate Banking Committee, Richard C. Shelby, strongly opposing the proposal.[28] The alternative advanced by conservative House Republicans was to create a system of mortgage insurance funded by fees on those holding mortgages; as the working week ended, negotiations continued on the plan, which had grown to 102 pages and included mortgage insurance as an option.[29][30][31] On Thursday evening Washington Mutual, the nation's largest savings and loan, was seized by the Federal Deposit Insurance Corporation and most of its assets transferred to JPMorgan Chase.[32] Wachovia, one of the largest US banks, was reported to be in negotiations with Citigroup and other financial institutions.[33]

Week of September 28, 2008

In the wee hours of Sunday morning an announcement was made by the Secretary of the Treasury and congressional leaders that agreement had been reached on all major issues: the total amount of $700 billion remained with provision for the option of creating a scheme of mortgage insurance.[34] It was reported on Sunday, September 28, that action would be taken regarding the British mortgage lender Bradford & Bingley.[35] Grupo Santander, the largest bank in Spain, is slated to take over the offices and savings accounts while the mortgage and loans business will be nationalized.[36] Rescue plans were reportedly being considered for Wachovia, the fourth largest banking chain in the United States, and Fortis, a Benelux banking, insurance, and investment management company, the 20th largest business in the world by revenue.[37] Fortis was partially nationalized on September 28, 2008, with Belgium, the Netherlands and Luxembourg investing a total of 11.2 billion euros (16.3 billion U.S. dollars) in the bank. Belgium will purchase 49% of Fortis's Belgian division, with the Netherlands doing the same for the Dutch division. Luxembourg has agreed to a loan convertible into a 49% share of Fortis's Luxembourg division.[38]

Financial predictions

A number of forecasts and predictions have been made by economists and financial leaders regarding the likely course of events, depending upon various scenarios. These relate to future events which are not certain. Some scenarios that have had significant discussion include:

  1. If the current liquidity crisis continues and nothing were to be done, then a number of commentators have suggested the results would be dire, with the mildest predictions being a extended recession.[39]

Timeline of events

Background

Events of 2007

  • Liquidity crisis emerges August 9, 2007[2]

Events of 2008

References

  1. ^ Floyd Norris (August 10, 2007). "A New Kind of Bank Run Tests Old Safeguards". The New York Times.
  2. ^ a b Larry Elliott (August 5 2008). "Credit crisis - how it all began] Suddenly, one August day last year shook the world, turning an Edwardian summer of prosperity into a grim financial crisis". The Guardian. {{cite web}}: Check date values in: |date= (help)
  3. ^ HM Treasury, Bank of England and Financial Services Authority (September 14, 2007). "News Release: Liquidity Support Facility for Northern Rock plc".
  4. ^ "Pain Spreads as Credit Vise Grows Tighter" article by Louis Uchitelle in The New York Times September 18, 2008
  5. ^ a b c "Lehman Files for Bankruptcy; Merrill Is Sold" article by Andrew Ross Sorkin in The New York Times September 14, 2008
  6. ^ "Lloyds Bank Is Discussing Purchase of British Lender" article by Julia Werdigier in The New York Times September 17, 2008
  7. ^ "Washington Mutual Is Said to Consider Sale" article by Geraldine Fabrikant in The New York Times September 17, 2008
  8. ^ "As Fears Grow, Wall St. Titans See Shares Fall" article by Ben White and Eric Dash in The New York Times September 17, 2008
  9. ^ "Money Market Funds Enter a World of Risk" article by Tara Siegel Bernard in The New York Times September 17, 2008
  10. ^ "Almost Armageddon: Markets Were 500 Trades from a Meltdown article by Michael Gray in the New York Post
  11. ^ "Treasury Announces Guaranty Program for Money Market Funds"
  12. ^ "S.E.C. Issues Temporary Ban on Short-Selling" article by Vikas Bajaj and Jonathan D. Glater in The New York Times September 19, 2008
  13. ^ "Australian short selling ban goes further than other bourses". NBR. 2008-09-22. Retrieved 2008-09-22. {{cite news}}: Check date values in: |date= (help); Italic or bold markup not allowed in: |publisher= (help)
  14. ^ "Vast Bailout by U.S. Proposed in Bid to Stem Financial Crisis" article by Edmund L. Andrews in The New York Times September 18, 2008
  15. ^ "Paulson Argues for Need to Buy Mortgages" article by David Stout in The New York Times September 19, 2008
  16. ^ "Plan’s Mystery: What’s All This Stuff Worth?" article by Vikas Bajaj in The New York Times September 24, 2008
  17. ^ "Stocks Surge as U.S. Acts to Shore Up Money Funds and Limits Short Selling" article by Graham Bowley in The New York Times September 19, 2008
  18. ^ "Congressional Leaders Were Stunned by Warnings" article by David M. Herszenhorn in The New York Times September 19, 2008
  19. ^ "Bush Officials Urge Swift Action on Rescue Powers}" article by Edmund L. Andrews in The New York Times September 19, 2008
  20. ^ Draft Proposal for Bailout Plan (September 21, 2008). New York Times
  21. ^ "Rescue Plan Seeks $700 Billion to Buy Bad Mortgages" article by The Associated Press in The New York Times September 20, 2008
  22. ^ "$700 Billion Is Sought for Wall Street in Vast Bailout" article by David M. Herszenhorn in The New York Times September 20, 2008
  23. ^ "No Bailing Out the Bad Guys". AsianWeek. Retrieved on 2008-09-25.
  24. ^ "Shift for Goldman and Morgan Marks the End of an Era" article by Andrew Ross Sorkin and Vikas Bajaj in The New York Times September 21, 2008
  25. ^ Schwartz, Nelson D. (2008-09-22). "Foreign Banks Hope Bailout Will Be Global". The New York Times. {{cite news}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
  26. ^ "Lawmakers Agree on Outline of Bailout" article by David M. Herszenhorn in The New York Times September 25, 2008
  27. ^ "Lawmakers’ Constituents Make Their Bailout Views Loud and Clear" article by Sheryl Gay Stolberg in The New York Times September 24, 2008
  28. ^ "Talks Implode During Day of Chaos; Fate of Bailout Plan Remains Unresolved" article by David M. Herszenhorn, Carl Hulse, and Sheryl Gay Stolberg in The New York Times September 25, 2008
  29. ^ "Conservatives Viewed Bailout Plan as Last Straw" article by Carl Hulse in The New York Times September 26, 2008
  30. ^ "Politics Take Hold of Bailout Proposal" article by David M. Herszenhorn in The New York Times September 26, 2008
  31. ^ "House Republicans Support a Plan That Would Insure Troubled Mortgages" article by Edmund L. Andrews in The New York Times September 26, 2008
  32. ^ "Government Seizes WaMu and Sells Some Assets" article by Eric Dash and Andrew Ross Sorkin in The New York Times
  33. ^ "Wachovia, Looking for Help, Turns to Citigroup" article by Ben White and Eric Dash in The New York Times September 26, 2008
  34. ^ "Breakthrough Reached in Negotiations on Bailout" article by David M. Herszenhorn and Carl Hulse in The New York Times September 27, 2008
  35. ^ "Britain Close to Takeover of Another Lender" article by Landon Thomas, Jr. in The New York Times September 28, 2008
  36. ^ "Taxpayers must risk billions for Bradford & Bingley" article by Philip Webster, Patrick Hosking and Tim Reid in The Times of London September 29, 2008
  37. ^ "Bradford & Bingley made every mistake in the book" article by David Wighton in The Times of London August 29, 2008
  38. ^ van der Starre, Martijn (2008-09-29). "Fortis Gets EU11.2 Billion Rescue From Governments". Bloomberg. Retrieved 2008-09-29. {{cite news}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
  39. ^ "Credit Enters a Lockdown" "Economic memo" by Peter S. Goodman in The New York Times September 25, 2008

The initial articles and some subsequent material were adapted from the Wikinfo article "Financial crisis of 2007-2008" http://www.wikinfo.org/index.php?title=Financial_crisis_of_2007-2008 released under the GNU Free Documentation License Version 1.2

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