Discuss The Factors Which Led To The Financial Crisis Of 2007/8

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Discuss the factors which led to the financial crisis of 2007/8
A decade prior to the 2007/8 global financial crisis, the US and several other advanced companies experienced an uninterrupted trend in the growth of real estate prices. These prices were significantly pronounced in residential property market boom in several nations, including the UK. Accounts from various reviews show consensus that the factors leading to the crisis are centred on asset securitization, government policies that were focused on increasing homeownership, global imbalances, ineffective monetary policies, and weak regulatory oversight in the financial sector. From another perspective, unethical business activities by financial institutions exacerbated the boom in real estate by exploiting loopholes that existed in capital regulation. In this context, the banks were able to substantially increase leverage while maintaining the capital requirements set by the governments.
According to Thakor (2015, p. 160), the banks engaged in weaker capital standards that included lack of sufficient traditional deposit funding. The banks also investment in risky and illiquid assets such as mortgages without the availability of adequate capital. Insights from Acharya and Richardson (2012, p. 12) highlight that the shadow banking system exercised prior to the financial crisis was highly dependent on short-term funding and was encouraged by the laxity of the oversight authorities. Consequently, this led to the asset price bubble, which triggered the financial crisis. Higher asset prices caused leverage sequence where an increase in household value subsequently led to increased debt. Adrian and Shin (2008, p. 2) allude that the increased asset prices contributed to ignorance of the risks financial institutions would face, which offered an opportunity in their balance sheets that facilitated increased leverage and supply of credit.
The increase in home value had an impact on the household sector, which led to an increase in the perceived household wealth. The availability of the equity amassed in homes made house products to upsurge their leverage considerably. Estimates show that the average owner was able to acquire 25 to 30 cents for each dollar with the rise of home equity, which was used for other expenses. Other factors that fuelled the asset price boom included the 2002 explosion of subprime mortgage credit in the US, which reached its peak in mid-2006. Following these activities facilitated by ineffective undertakings by financial institutions and governments triggered the financial crisis. The initial characteristics of failure were identified in early 2007 following losses incurred in the US subprime mortgages. Although these signs were related to the subprime mortgage, later in 2007 the localized consequences emerged as an international incident with damages scattering to Europe, which is exemplified by the challenges faced by Northern Rock mortgage lender in the UK.
Thakor (2015, p. 161) shows that the credit markets continued to tighten calling for interventions through Federal Reserve in the US through short-term lending facilities including other interventions that facilitated increased availability of liquidity for the banks. The distress was not only experienced in the financial institutions, but the consequences were widespread across various economic fronts. There is a consensus that the financial predicament had its basis in the US housing market and spread to other parts of the world due to the significance of the US dollar in the international market. The housing bubble that burst during the crisis increased the challenges faced by the banking institutions. In early 2008 the institutional failures experienced by organizations such as Northern Rock reflected the high levels of stress that was being experienced in the local and global financial markets.
Explain how these factors impacted upon Northern Rock and the reasons for the nationalization
The fall of Northern Rock in 20007 is identified by Marshall et al. (2012, p. 154) as the first major challenge in the UK retail banking sector since 1866. These insights highlight on the impact the financial crisis had on the back. Northern Rock was among the first high profile casualties of the credit crunch. The success of the company was based on its business model that facilitated aggressive growth that made it a key player as well as the victim of the crisis. Marshall et al. (2012, p. 151) reviews that Northern Rock experienced speedy growth and financial success prior to the financial crisis and was recognized as a charitable and corporate sponsor. From another perspective, Marshall et al. (2012, p. 160) review of the Treasury Committee report on the inquiry about the failure of the institutions shows that the company’s failure can be attributed to reckless growth, which can be attributed to ineffective investment strategies. Also, the company employed a defective business approach and a business model that was highly reliant on funding by wholesale markets for loans. These included mortgage-backed securities, the use of covered bonds, the use off-balance sheet vehicle Granite trust, medium and short-term unsecured funding. These undertakings increased the risks faced by the bank since 75% of its total funding was sourced from other platforms, which were non-retail. The achievement of the company using these funding approaches was reliant on its capacity to acquire economic payments by taking advantage of the lower interest rate on funding from the wholesale market compared to the rates that were changed to its loan clients. Also, the company was able to raise money to reimburse its borrowing and enable additional lending. The margins of the organization began facing significant pressure following the changes that were experienced in the interest rates, which resulted in a rise of the expenses incurred on credit. These consequences emerged after the French Bank BNP Paribas reported that its main asset funds that were linked to the sub-prime residential mortgages in the US were incapable of gaining sustainable value. The subsequent impact of the failure in sub-prime residential mortgages was transmitted to other banks after the BNP’s freeze of the short-term money markets, which were a key source of funding for Northern Rock.
Northern Rock was nationalized by the government in 2008 in an attempt to counter the financial problems faced in the financial crisis. The decision of the Treasury to nationalize the company was guided by a compressive assessment of the solutions that could be implemented. The conclusion of the analysis was that public ownership was the most appropriate alternative due to the value of money associated with the approach. The treasury was focused on meeting the objectives of the Bank’s depositors and stopping the run of the institution. Also, the resolve for nationalization lies in the conclusion that the private sector bids for the institution presented insufficient prospects to safeguard the taxpayer’s interests. Fundamentally, nationalization ensured that the saver's money was secure (Lastra, 2008, p. 165). By the government temporarily holding on to the bank, there was a guarantee that it would survive until the market conditions improved and the market value restored. Another reason for nationalization was that a commercial solution would lead to the loss of jobs, creating another challenge for the government (BBC, 2008). These insights show that the primary objective of nationalization was to safeguard the taxpayers’ money. Arguably, if nationalization was the reasonable approach to save the money, then it was the most effective initiative in the long term.
Research the post-nationalization outcome and evaluate whether the net impact has been positive or negative.
Before the financial crisis, Northern Rock was part of the leading companies. The early impact experienced by the bank saw it report a loss of Ј167 million in its annual report released 31st March 2007. By August 5th the same year, the bank announced that within the six months it had made a loss of Ј585.4 million and still owned Ј17.5bn in loan after paying Ј9.4bn to the Bank of England. These challenges made it necessary for considerations to be made on takeovers that would facilitate the sustainability of the organization (Shin, 2009, p. 101). Virgin Group announced its intention to bid for the bank in cooperation with AIG an American based company. Another bidder for Northern Rock included Olivant, an investment company. Others included Cerberus, JC Flowers, Lloyds TSB, Lehman Brothers, Bradford & Bingley, and Terra Firma Capital Partners. Despite these offers, Northern Rock rejects the bids suggesting that they were materially below the previous market value. The Government was left with the mandate to take action that would veto or approve any sale, in the interest of the taxpayers, clients, and taking to account the emerging aspects of financial stability.
On February 17th, 2008 Northern Rock was nationalized following claims that bids offered did not have sufficient value for money to the people. Nationalisation brought the company under temporary ownership by the public, where the government was the only investor through the UK Financial Investments Limited. The bank was also taken under the control of an independent board. The changes triggered by this approach had no impact on the customers. The participation of the UK Financial Investments Limited as the official body in charge of managing the government’s shareholding of Northern Rock and Bradford & Bingley was effective to reduce the direct impact the government had on competition in the banking sector by preventing unfair competition. Nevertheless, insights according to the Office of Fair Trading (OFT) ...