COLLEGE OF BUSINESS AND ACCOUNTANCY

MANUEL S. ENVERGA UNIVERSITY FOUNDATION - LUCENA CITY, PHILIPPINES

An Autonomous University
CHED CEB Res. 076-2009

FINANCIAL MARKETS
C061

Regina P. Basan September 5, 2021

Block 2- BSA- 3rd year Prof. Imelda D. Cabasco

Copyright by Steve Kelly

SUBPRIME MORTGAGE CRISIS

‘The American dream,' as they say in the United States. Most people consider owning
a home to be a sign of success and prosperity. Houses are also regarded as one of the most
reliable investments. The housing market also flourishes due to the fact that it was so easy to get
a home loan. Prior to the subprime mortgage crisis of 2007, the majority of Americans felt that
residential real estate will constantly increase in value. In the American mentality, there have been
two major prevailing logics: 1) real estate will never degrade in value, and 2) individuals would
always pay their mortgages. The subprime mortgage crisis has resulted in unprecedented
homelessness.
To be clear, subprime is a loan issued to the people with bad credit rating and those
who are not eligible for prime loans. It is also characterized with higher interest rates, poor quality
of collateral and is much less favorable to compensate higher credit risk. Despite the facts,
subprime loans are still issued to earn money from default customers, attract people with financial
problems and those who are discriminated.
As the crisis worsens, a large number of people have lost their houses and financially
trapped in their present debts, waiting for their homes to be repossessed. According to Realty
track, over 900,000 houses were repossessed from American families in 2009, with the figure
predicted to rise to over 1 million in 2010. There are now over 2 million properties in foreclosure
at the time of this writing. Progress toward economic equality in the financial industry has been
hampered by instability akin to that seen in the civil rights movement. Also, the individuals who
take subprime mortgages expect that the price of their homes would continue to rise and so they
can finance their homes before the rise of the interest rates. Consequently, the rise of the
mortgages began as to the home prices began to fall, which leads to the foreclosures added to
the inventory of homes available for sale. This further decline the prices of homes putting more
homeowners in a negative position leading to numerous foreclosures.
 The interest rates of subprime borrowers were high and continuously rising. After they
failed to pay their debts, the securities held by mortgages loss its value globally. The lower credit
quality caused a massive default which leads to the subsequent loss of funds and resulted in the
Global Recession of 2008.

REACTION:
I felt bad for the homeowners as the foreclosure of houses increases, but the domino
effect it has as to the financial system is much worse. As we know, the construction of houses is
an essential to the economic growth. Clearly, the decline of it, would affect the GDP. Also, the
losses were suffered not just the homeowners but the entire financial system, as they are
interconnected. The near recession in the US results to the job loss in India. But as for the
solutions of the government, they help lower-income people to renegotiate to their loans and
provide the financial institutions with their needs as stated.

But who is to blame? Basically, it refers to those who contributed to the deadly chain of
events. First, is the federal reserve who continued to reduce fed rates. Next is commercial banks
who re-deployed the funds. The third group is homebuyers, who are borrowers previously failed
to satisfy their repayment obligations. These were people who had racked up a lot of debt and
were about to default. They were always a few months late on their payments, and in most cases,
these persons would be turned down for loans. Although they are not the one who offer the loans,
buying properties beyond their means is questionable, hence it is not surprising that foreclosure
is their last resort. Next is Investment banks, as the lenders sold mortgages in the secondary
market and lastly, the investors who willingly purchase CDOs at low premiums over treasury
bonds, hungry for big returns and fueling more subprime mortgages. Though most parties took
advantage to those who have bad credit and in need a place to live, still, they are small players
compare to the variety of institutions.

It was obviously created by the world’s homeowners, central banks, lenders,

underwriters, investors, and credit agency. But there, lenders are just greedy, freely granting loans
to people who can’t afford them. Based on the parties mentioned above, indeed many can be
blame for it, and many also suffers. Homeowners, unable to sell their homes without taking
massive loss. Lenders don’t have enough money for them. Investors got hit as well, as the value
of securities where they are investing get rid. Investment banks also defaulted on the decline.
Banks involved also affected were not so lucky. To sum up, I’m not surprise to its negative impact,
given that those borrowers have no assets that could be used as collateral, I was just shocked to
the fact that it leads to Global Recession which in fact, supposed to be for local matters. Maybe
because they are interrelated and players in the complex structure of financial system.

Furthermore, players did not see the situation in the bigger picture, I know it wasn’t easy
for everyone involved, many had to lose their homes, loss of jobs, experienced economic
calamities and lose their trust to financial institutions. Even the financial markets were hit, stock
and derivatives were affected, and financial centers encountered unprecedented panic.

Hence, this case will serve as a reminder on how variety of institutions, markets and
instrument related in a systematic manner and should be regulated properly to avoid loss and
sufferings of everyone involve. There is a saying, it’s fine to celebrate success but it is more
important to heed a lesson of failure.
 People queue at a Northern Rock bank branch in Brighton, England.

NORTHERN ROCK BANK CRISIS

The run-on Northern Rock was notable for not being largely a flight from bank
savings to cash, but rather a transfer of deposits from a bank perceived to be in crisis to
other major banks thought to be "safe." This crisis pertains to the experience of Northern
Rock, a substantial and venerable depository institution, that had been growing rapidly
and depending heavily on wholesale markets. Within the year 2007, the authorities within
the United Kingdom, and most private sector observers there, thought that the thought of
a withdrawal on a solvent bank, with pictures of distressed depositors queuing within the
road, was something that occurred in other parts of the earth, like South America. The
problems arose from difficulties of banks to face over the summer of 2007 in raising funds
within the market. The bank's assets were always sufficient to cover its liabilities within
the long-term, but it had a liquidity problem because institutional lenders became nervous
about lending to mortgage banks following the US sub-prime crisis.
REACTION:

Based on the given case of Northern Rock, there is an inappropriate handling

of the situation. The boards and the management of the said firm carries the primary
responsibility to ensure its financial soundness. It is clear that the problem emerged
because of an unfortunate combination of implementation and weakness which leads to
the major external shock of the public. From that, I learned lessons that can be apply nor
only in other countries, but also here in our local. First, the concern personnel should
immediately form a judgment about the sensible action they may take and the extent of
its losses. Second, they should make rapid actions to designate the losses and without a
material break, keep the bank operating. And lastly, without any significant break, the
authorities should ensure that insured depositors have their access to their funds.

Additionally, there is a need to be a legislative framework in place so that

systemic functions in failing banks can continue to function without causing a major
disruption. That is, to ensure timely and coordinated action, a designated entity should
be in charge of intervention in failing banks. It is highly improbable that a run-on Northern
Rock would have occurred if these five measures had been in place, and the UK's record
for over the years without a substantial bank run would have been preserved. Although
it'll not desire it to those that have lost money or their jobs within the Northern Rock
episode, it's fortunate that the come to life call to action has been so effective at such
limited cost. What remains is to require the action before any such serious crisis could
emerge.

There is a lot of factors that contribute to the failure of the bank, such as the
accurate and timely accounting and reporting, proper handling of the troubled institutions
and even the design of the deposit insurance. There is also lack of market discipline that
triggers the situation. Hence, the main conclusion of this crisis is that it pertains to the
securitization and in capital that requires to be address through the institutional structure
of regulation and supervision on the role of the central bank in order to attain the financial
stability.