Financial crisis of 2007-2008
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The financial crisis of 2007-2008, referred to in Britain as "the credit crunch", 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]
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[edit] Historical background
The initial liquidity crisis, which, in hind sight, can be seen to have resulted from the incipient Subprime mortgage crisis, was followed by a run on Northern Rock, a major British bank, in mid-September, 2007.[3]
Excesses of the United States housing bubble resulted in many subprime mortgages, which led to the subprime mortgage crisis. Accelerating rates of foreclosure underlaid the developing financial crisis.
Initially the companies affected were those directly related to home construction and mortgage lending such as Northern Rock and Countrywide Financial, and financial institutions which had engaged in securitization of mortgages such as Bear Stearns, but as the crisis accelerated in late summer following placing of Fannie Mae and Freddie Mac into federal conservatorship, the crisis began to affect both the general availability of credit and larger financial institutions not directly connected with mortgage lending, but which had exposure due to holding of mortgage-backed securities or insurance of them such as Lehman Brothers, AIG, Merrill Lynch, and HBOS.[4][5][5][6] Other firms 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]
[edit] 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] On September 19 the U.S. Treasury offered temporary insurance (akin to FDIC insurance of bank accounts) to money market funds.[10]
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.[11]
[edit] Actions of central banks
On September 15, China made its first interest rate cut since 2002. The U.S. Federal Reserve injected $70 billion into the markets. Indonesia reduced its overnight repo rate, at which commercial banks can borrow overnight funds from the central bank, by two percentage points to 10.25 percent. The Reserve Bank of Australia injected nearly $1.5 billion into the banking system, nearly three times as much as the market's estimated requirement. The Reserve Bank of India added almost $1.32 billion, through a refinance operation, its biggest in at least a month.[12] In Taiwan, the central bank said on September 16 that it would cut its required reserve ratios for the first time in eight years. The central bank added $3.59 billion into the foreign-currency interbank market the same day. Bank of Japan pumped $29.3 billion into the financial system on September 17, and the Reserve Bank of Australia added $3.45 billion the same day. The European Central Bank injected $99.8 billion in a one-day money-market auction. The Bank of England pumped in $36 billion. Altogether, central banks throughout the world added more than $200 billion from the beginning of the week to September 17.[13]
[edit] Bailout plan
A plan was floated on September 19 for the United States government to purchase illiquid assets (aka toxic assets) resulting from the subprime mortgage crisis from troubled financial institutions.[14][15]
Consultations of the Secretary of the Treasury, the Chairman of the Federal Reserve, and the Chairman of the U.S. Securities and Exchange Commission with Congressional leaders and the President of the United States coupled with development of plans to advance a comprehensive solution to the problems created by illiquid assets and other measures resulted in some restoration of confidence in markets on September 19, 2008.[16][17]
At the close of the week the Secretary of the Treasury and President Bush announced a proposal for the federal government to buy up to US$ 700 billion of illiquid mortgage backed securities with the intent to 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.[18][19][20][21]
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.[22]
[edit] See also
[edit] Events of 2007
[edit] Events of 2008
- Bear Stearns
- Federal takeover of Fannie Mae and Freddie Mac
- Global stock market crash of September 2008
- American International Group
- Merrill Lynch
- Lehman Brothers
- Economic crisis of 2008
[edit] References
- ^ "A New Kind of Bank Run Tests Old Safeguards" News analysis by Floyd Norris in The New York Times August 10, 2007
- ^ "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" special report by Larry Elliott, economics editor, The Guardian, Tuesday August 5 2008
- ^ "News Release Liquidity Support Facility for Northern Rock plc, Tripartite Statement by HM Treasury, Bank of England and Financial Services Authority 14 September 2007
- ^ "Pain Spreads as Credit Vise Grows Tighter" article by Louis Uchitelle in The New York Times September 18, 2008
- ^ a b c "Lehman Files for Bankruptcy; Merrill Is Sold" article by Andrew Ross Sorkin in The New York Times September 14, 2008
- ^ "Lloyds Bank Is Discussing Purchase of British Lender" article by Julia Werdigier in The New York Times September 17, 2008
- ^ "Washington Mutual Is Said to Consider Sale" article by Geraldine Fabrikant in The New York Times September 17, 2008
- ^ "As Fears Grow, Wall St. Titans See Shares Fall" article by Ben White and Eric Dash in The New York Times September 17, 2008
- ^ "Money Market Funds Enter a World of Risk" article by Tara Siegel Bernard in The New York Times September 17, 2008
- ^ "Treasury Announces Guaranty Program for Money Market Funds"
- ^ "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
- ^ "Asian central banks spend billions to prevent crash", International Herald Tribune (2008-09-16). Retrieved on 2008-09-21.
- ^ "Japan, Australia Inject $33 Billion to Soothe Markets", Bloomberg (2008-09-17). Retrieved on 2008-09-21.
- ^ "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
- ^ "Paulson Argues for Need to Buy Mortgages" article by David Stout in The New York Times September 19, 2008
- ^ "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
- ^ "Congressional Leaders Were Stunned by Warnings" article by David M. Herszenhorn in The New York Times September 19, 2008
- ^ "Bush Officials Urge Swift Action on Rescue Powers}" article by Edmund L. Andrews in The New York Times September 19, 2008
- ^ Draft Proposal for Bailout Plan (September 21, 2008). New York Times
- ^ "Rescue Plan Seeks $700 Billion to Buy Bad Mortgages" article by The Associated Press in The New York Times September 20, 2008
- ^ "$700 Billion Is Sought for Wall Street in Vast Bailout" article by David M. Herszenhorn in The New York Times September 20, 2008
- ^ Schwartz, Nelson D.; Carter Dougherty (2008-09-22). "Foreign Banks Hope Bailout Will Be Global", The New York Times.
[edit] External links and further reading
- "Five Days That Transformed Wall Street"
- How Three Economists View a Financial Rescue Plan" The New York Times September 21, 2008
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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
