Discussion on the Financial Crisis

FINANCIAL CRISIS
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Financial Crisis
The financial crisis that occurred between 2007 and 2009 was a credit crunch culmination that had begun in 2006 and developed in 2007. Finance sector failure was a key factor in the previous financial crisis. However, the bankers were not the only people to blame, but also regulators and the central bankers. They had failed to keep imbalances in the economy at bay and an oversight on financial institutions (Allen & Carletti, 2010,). One of the most erratic errors by the regulators was to allow the Lehman Brothers of the United States to go into bankruptcy. The bankruptcy led to an increased panic in markets. The absence of trust led to a decrease in lending. Non-financial firms were not able to borrow and could not pay workers and suppliers as they had to freeze spending to enable them hoard cash. It resulted in a seizure in the operational economy. Progressively, majority of governments globally had to intervene in the bankruptcy of most financial institutions. Regulators were forced to rescue other company's scores to stem the presence of the panic in 2007.


After a period of increased rates of interest between 1970 and 1990, there came a period when the interest rates reduced. Despite the previous experience, a steady continuous growth and presence of low inflation led to investors believing that the interest will stay at a low level (Acharya, Philippon, Richardson, & Roubini, 2009). The new approach encouraged individuals to believe in a sustainable long-term interest level at a low level. People were then encouraged to own homes as shown in the chart above. The chart below shows that the demand resulted in an increase in prices of property by 45 percent in 2001 up to 2007.


Majority of individuals agree that the financial crisis began with the housing market of the United States and various factors contributed to the bubble of house prices. The most elaborate signs of the problem were witnessed at the beginning of 2007, when Freddie Mac made an announcement that it had halted the purchase of mortgage securities as risks were at high levels and the New Century Financial Corporation declared itself bankrupt. During the period, the ABC indexes indicated a higher potential for risk defaults. The indexes track the credit prices of default insurance credit on securities and backed by mortgages that are residential (Acharya, et al., 2009).
Despite the initial signs beginning to show early, most individuals agree that the beginning of the crisis was in August 2007. The period was characterized by massive withdrawals of funds for short-term in different markets that were considered as safe havens. The event was shown by the rapid haircuts increase in reports and problems experienced by asset-backed commercial paper (ABCP) givers that had issues in rolling over the unsettled paper. The main issue that caused all the problems stated above was the decline in the house prices in the United States that lead to the rise of concerns on subprime mortgages. The markets for short-term funding and the banking system were all victims of the crisis.
Credit rating agencies (CRAs), undermined the financial instruments backed by assets in 2007. The ratings and subsequently the effect on securities made investors to panic. A huge number of the financial securities that are structured were undervalued between 2007 and 2008 with an average of 6 notches downgrade. The notches were higher than that witnessed in the crisis of 2001 that was an average of 3 and was characterized by the downgrading of corporate bonds. Credit markets continuously tightened. The Federal Reserve was forced to open short-term loaning in order to increase the presence of liquidity. Despite the interventions, the prices of assets continuously declined (Acharya, et al., 2009).
In 2007 February, the resale of homes for single families peaked at a yearly rate of approximately 5.88 million. In September of the same year, the resale experienced a decline to 4.3 million, approximately 25 percent. Further, a projected fall was made for the resale of the single-family homes to up to 5 million in the first quarter of 2008 that would be down by 23 percent for the previous year. The decline was characterized to be similar to that which occurred in the 1929 great depression which was 24 percent. In addition, in Texas, there was a similar decline by an average of 11-40 percent in the period of the S&L crisis that included other oil producing nations in 1989 (Grochulski & Morrison, 2014).
In June, the median price of a home unit for a single family was at $229,000. In September the same year, the median declined to $210, 000 by 8 percent as shown by statistics from the National Association of Realtors. By the end of the year, the prices further declined by 10 percent in relation to the high peak in 2006 (Grochulski & Morrison, 2014). Every new month in the period was characterized by bad news from the market of housing and economists did not agree on the level of severity. The definitions of other fields, including bear market, recession, and correction in the stock market are elaborate, which is not similar in the housing market.
Most citizens believed that the prices of the homes would not decrease further since a majority of the owners of the homes took their houses from the market due to the low prices. The rates for mortgages at the time was 6 percent that was half that experienced during the recession of 1980. The Fed made promises to lower the rates further, hence maintaining the required liquidity within the mortgage industry. The world thought that it would be essential to allow the holders of mortgages to refinance, which would result in the reduction of foreclosures. In the beginning of 2008, failures of institutions were a reflection of the adverse issues going on in the financial market (Fligstein, & Roehrkasse, 2016).
The United States mortgage crisis resulted in the plunging of the prices of property and the economy of the country slowed down with billions in losses by banks. The crisis was established from a change in the method through which funding of mortgages is undertaken, causing a huge exposure to loans in default. The chart above shows the bank losses reporting billions U.S dollars in May 2008.


In March 2007, the president of the Federal Reserve Bank (FDB) iterated that the economy of the United States would grow by 3 percent. A recession is characterized by the negative occurrence of gross domestic product in two quarters consecutively. The announcement that came after the former chairman of FDB was concurrent and sparked a massive sell-off in the stock market that was triggered by the existence of a deficit in the budget of the United States.
Nationalization of Northern Rock
In 2007, there was massive uncertainty in all financial markets. There was an increased default on mortgages that forced most banks to write off losses amounting to billions resulting in the credit crunch. At the time, banks were not willing to lend money to people without a credit history that was perfect. The affected consumers and also businesses could not easily borrow funds for the financing of their expenditure (Fligstein, & Roehrkasse, 2016). The absence of business expenditure affects the forces of supply and demand in the economy. The absence of investment subsequently reduces demand as it results in a decrease in production and the size of workers.
The funding model of Northern Rock PLC. incorporated short-term borrowing from money markets to cater for the issuing of mortgages. Since mortgages are characterized as long-term assets, the approach required the bank to engage short-term liquidity to enable the borrowing roll over. The instability in the financial markets made it difficult for financial institutions to borrow within the money markets from each other (Tomasic, 2009)).
The trend was a clear indication of a potential recession in the United States. The effect, however, had spread globally. The tightening of issued credits by banks was a major issue for Northern Rock bank of the United Kingdom. The bank had borrowed a large amount of money in relation to financing their mortgage that relied on the capital markets to make resells of the mortgages. Due to the impact, Northern Rock sought ass...