Financial Institutions and Markets

(UMED8H-30-1) Assignment 1, 2016

Dao Ngoc Anh_16043533_FIM_A1

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 TABLE OF CONTENTS

CHAPTER I: INTRODUCTION......................................................................................................... 4
CHAPTER II: MAJOR FINDINGS..................................................................................................... 5
1. The major traits of the banking crisis that happened in 2008:...........................5
2. How the banking crisis can have begun:.....................................................................6
2.1. Where did the banking crisis come from?..........................................................6
2.2. The specific example of reasons why the banking crisis occurred in 2008:
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3. The Solution has been used:........................................................................................... 9
4. Lessons for us to face with the next crisis:.................................................................9
CHAPTER IV: CONCLUSION......................................................................................................... 11
CHAPTER V: REFERENCE............................................................................................................. 12
CHAPTER VI: APPENDIX.............................................................................................................. 14

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 TABLE OF FIGURES:

Figure 1: The federal funds target rate from 1999 to 2009.............................................5

Figure 2: The market losses on US credit securities: at April 2008...............................6
Figure 3: Mortgage loans in US from 2002 to 2006.............................................................7
Figure 4: Household debt as proportion of the GDP...........................................................8
Figure 5: House price in some countries between 2002 and 2008................................8

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 CHAPTER I: INTRODUCTION
This assignment will describe the main traits of the banking crisis happened in 2008
and then give a number of reasons why this event occurred by analyzing some financial
or banking data. Next, this essay will show 2 solutions have been used in 2008 to solve
this problem and demonstrate 2 lessons from this banking crisis in 2008 to control the
next crisis in the future.

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 CHAPTER II: MAJOR FINDINGS
The financial crisis in 2008 can be the most horrible event during over 15 years
because the consequence of it in the financial system, especially the banking system has
left until now. Greenpan said: “this crisis is once-in-a-century in the economy”, causing
the consequence as much as the Great Contraction from 1929 to 1933 making the world
economy recede 40 years.

1. The major traits of the banking crisis that happened in 2008:

Cheap loans powered by billions of dollars of investment of the enormous savings

and extras of China and other Asian economies inspired a housing explosion in the
USA. This attracted to a number of people who borrowed money to buy houses that
their ability could not pay to meet their mortgage responsibilities. Because of that, it
led to the breakdown of the banking system under a huge debt.

In February 2007, HSBC had announced the bad loans in 2006 increased
dramatically 20%. In April 2007, The New Century became a collapse. In June 2007,
the financial group which was the biggest in the world, called Merril Lynch sell quickly
their assets in Bear Stearns. In September 2007, the interest rate of LIBOR reached a
peak at 6.7975%. In October 2007, Merril Lynch was public their 8.4 billion dollar loss
in subprime mortgage and many CEOs in the financial companies lost their jobs. At the
end of October 2007, Whitney said that Citigroup would decrease the its dividend and
then it did. In December 2007, the FOMC cut the federal funds rate to 4.25% and the
primary interest rate to 4.75% (Figure 1)

Figure 1: The federal funds target rate from 1999 to 2009

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 In March 16, 2008 JP Morgan bought $2 per share of Bear Stearns and the Federal
Reserve provided $30 billion for Bear Stearns overcoming the bankrupt. In September,
2008, the US government took over Fannie Mae & Freddie Mac, and Merril Lynch was
bought $50 billion by Bank of America. In September 14, 2008 Lehman Brothers could
not find anyone to sell and went bankrupt. Three days later in 2008, the Fed rescued AIG
by providing $85 billion. Many historical banks such as Wachovia and Washington
Mutual started fading in the autumn of 2008. On October 13, 2008, the treasury secretary
Paulson held a meeting with 9 CEOs and after a few hours, the government had taken a
large amount of equity in the Wall Street and the total bailout package went up to $2.25
billion, much higher than $700 billion in expectation. At the end of 2008 and at the
beginning of 2009, the crisis continued and caused many employments and banks
continued declaring report losses (Figure 2).

Figure 2: The market losses on US credit securities: at April 2008

The crisis had not only happened in the USA, but it also spread to the whole world
such as Euro, especially England because all almost of financial organization in England
had joined in the subprime mortgage market in the USA. Since 2007, The Northern Rock
met a bank run problem and was nationalized. And in 2008, a number of banks had
switched their bosses and there were many problems with other banks in Europe.

2. How the banking crisis can have begun:

2.1. Where did the banking crisis come from?

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 Banking crisis springs from the widespread bank run and bankruptcy in the banking
systems. The financial crisis began in 2006 when the interest rate turns to normal levels,
causing people could no longer get a new loan to pay back their old one and the subprime
who had low income could not pay back their loans lead to the housing bubble in the
market. At this time, banks started to sell the subprime mortgage, but in the market,
there were many subprime mortgage and there were a few demands so the price of
housing in America decreased quickly led to the mortgage-backed securities declined.
The dominoes fell, causing investors stopped buying CDOs or lent their money to those
whom had lived depending on the mortgage so the investment banks such as Bear
Stearns and Lehman Brothers could not get new loans so the financial crisis began.

2.2. The specific example of reasons why the banking crisis occurred in 2008:

The crisis began with many subprime mortgage loans in the market because the US
government encouraged the citizen to buy their own houses by keeping the interest rate
lower and at this time people could only pay 20% of the value of houses and pay the rest
of it for 20 years or longer. From 2004 to 2006 the subprime mortgage loans accounted
for 21% of total mortgage loans in US and in 2006, these loans reached $600 billion and
made up over a fifth of total mortgage loans (Figure 3).

Figure 3: Mortgage loans in US from 2002 to 2006

The banks lent to many people and companies to have mortgages, including the group
that could hardly pay back the money to the bank. Thus, the household debt of countries
increasing significantly in those times. In Figure 4, in the EU from 1988 to 2007, the
household debt climbed from 0% to nearly 60%. In the US and the UK, the household
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debt was stable around 60% from 1987 to 2000. After 2000, the household debt grew
slightly and in 2007 in the UK, it reached nearly 100% and in the US it reached above
90%.

Figure 4: Household debt as proportion of the GDP

The increasing in mortgage loans led to the increasing in housing price. When the
demand for house goes up, the price of house increase, too, from 2002 to 2006 in the US
and also other countries (Figure 5). It’s called “Housing Bubble” and it would boom in
some days. Between 2006 and 2008, the price of houses in the USA and other countries
fell dramatically and it made the bubble booming.

Figure 5: House price in some countries between 2002 and 2008

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 The house bubble boomed led to many banks could not sell their mortgage of the
subprime and the crisis began.

3. The Solution has been used:

Facing with the horrible crisis in 2008, the government and financial institution in all
around the world had executed a number of solutions to solve that problem. There are
two remedies, one is private and one is public had been used in the banking crisis in
2008.

The first solution is the private remedy coming from the central banks in each country
by cutting down the interest rate to stabilize the market. In the USA, after continuously
cutting interest rate 2 times in a month (October, 2008), the Fed decided to cut one more
time on 17 December, 2008 led to the lowest interest rate (nearly 0%) during 50 years.
In Europe, the ECB cut the interest rate to 3.75% and England announced cutting down it
to 4.5%, while the central banks in Switzerland, Sweden and in Asia did the same action.

The second public remedy is from the governments by announcing and performing a
number of Economic Stimulus Packages. On 2 November, 2009, the congress and the
White House both agreed about the economic stimulus packages, valuing $789 billion to
rise the financial system. The government of Japan announced the new economic
stimulus package with $51 billion, while in China is $586 billion and Australia is $586
billion. In the Europe, the EC approved the economic stimulus package worth $200 billion
in the EU, helping countries get through the danger of regression.

4. Lessons for us to face with the next crisis:

Nowadays that closely a decade has passed since the banking crisis, there are some
lessons investors and banks can learn from it.

Firstly, the crisis in 2008 proceeded from that banks lent their money to many people
inclusive of the subprime who had lower income or hard to pay back the loans and then
the securitization of those mortgages by banks become CDO and sold to the investor who
did not know much about the risk of their CDOs. Thus, the first lesson for us from this
crisis is that banks should limit their subprime mortgage loans and investors should care
more about their CDOs.

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 Secondly, As debt levels increased and loan requirements reached the lowest mutual
denominator, the increasing in housing prices unexpectedly overturned course. Before
2006, the house price increased in a long time that tricking us to believe in the increasing
price of house and borrow more money to buy more house. Unfortunately, this increasing
in house price was because of the housing bubble which was caused by the banks and the
speculation. It led to the dramatic decreasing in house price.

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 CHAPTER IV: CONCLUSION
This assignment has described some characteristic of the banking crisis arose in 2008
and given some main reasons why the crisis happened and a number of examples to
make it obvious. Finally, this essay demonstrated 2 remedies: private and publish have
been executed and took 2 lessons from the banking crisis in 2008 for the future.

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 CHAPTER V: REFERENCE
2008financialcrisis.umwblogs.org. (2016). Executive Summary. [online] Available at:
http://2008financialcrisis.umwblogs.org/executive-summary/ [Accessed 14 Nov. 2016].

Anon, (2016). [online] Available at:

https://www.moodys.com/microsites/crc2010/papers/ivashina_jfe_paper.pdf
[Accessed 15 Nov. 2016].

Anon, (2016). [online] Available at:

http://finra.complinet.com/net_file_store/new_rulebooks/f/s/FSA_at_slides.pdf
[Accessed 15 Nov. 2016].

Calmes, E. (2016). Fed Cuts Key Rate to a Record Low. [online] Nytimes.com. Available
at: http://www.nytimes.com/2008/12/17/business/economy/17fed.html [Accessed 15
Nov. 2016].

Conservapedia.com. (2016). Financial Crisis of 2008 - Conservapedia. [online] Available

at: http://www.conservapedia.com/Financial_Crisis_of_2008# [Accessed 14 Nov. 2016].

En.wikipedia.org. (2016). Financial crisis. [online] Available at:

https://en.wikipedia.org/wiki/Financial_crisis#Banking_crisis [Accessed 14 Nov. 2016].

Guide, G. (2016). How much longer can the U.S. housing market grow at this amazing
rate?. [online] Global Property Guide. Available at:
http://www.globalpropertyguide.com/North-America/United-States/Price-History
[Accessed 14 Nov. 2016].

Money.cnn.com. (2016). Greenspan: Economy in 'once-in-a-century' crisis - Sep. 14,

2008. [online] Available at:
http://money.cnn.com/2008/09/14/news/economy/greenspan/ [Accessed 14 Nov.
2016].

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 Perlberg, S. (2016). The 25 Scariest Moments Of The Financial Crisis. [online] Business
Insider. Available at: http://www.businessinsider.com/financial-crisis-scariest-
moments-2013-9?op=1/#n-21-2007-merril-lynch-sells-off-assets-in-two-bear-stearns-
hedge-funds-as-the-funds-hemorrhage-billions-of-dollars-on-bad-subprime-bets-3
[Accessed 14 Nov. 2016].

Pilbeam, K. (2010). Finance & financial markets. 1st ed. Basingstoke, Hampshire:

Palgrave Macmillan.

The Economist. (2016). Rising damp. [online] Available at:

http://www.economist.com/node/8829612 [Accessed 15 Nov. 2016].

YouTube. (2016). Overdose: The Next Financial Crisis. [online] Available at:

https://www.youtube.com/watch?v=4ECi6WJpbzE [Accessed 14 Nov. 2016].

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 CHAPTER VI: APPENDIX

Figure 1: The federal funds target rate from 1999 to 2009

Figure 2: The market losses on US credit securities: at April 2008

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Figure 3: Mortgage loans in US from 2002 to 2006

Figure 4: Household debt as proportion of the GDP

Figure 5: House price in some countries between 2002 and 2008

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