The bundle together sold and dependent on US federal

The financial crisis of 2007/8 reviewed the most serious crisis of
financial industry, different factors had contributed and one of the factors is
financial innovation and subprime mortgage markets. The function of financial
innovation is creating new financial instruments, technologies, organization,
and markets. The outcome of financial innovations is mortgage-backed securities
products and collateralized debt obligations (CDOs) implemented during the period
of financial crisis. The amount of subprime mortgage in US market was estimated
at $ 1.3 trillion and over 7.5 million subprime mortgages are remaining to be
paid. Collateralized Debt Obligations (CDOs) did a big effect on the crisis, its
special purpose vehicle (SPV) had created securities from those purchased
assets and then sell it to investors. Many subprime mortgage bundle together
sold and dependent on US federal government support and guarantees. It had led
to a moral hazard to happen when one party behave inappropriately after the
financial transaction has engaged while another party needs to suffer for the
costs of moral hazard. The banking crisis is another main factor that led to
the financial crisis. For instance, bank runs occur is when the customers
withdraw their deposits as soon as possible because they worry the bank might
fail and it could affect the banking activity. Besides that, banking crisis
includes banking panics and systemic banking crisis, which could lead increasing
defaults in a country and all the banks. Numerous of the financial institution and
the government gave their assistance during the crisis to avoid the financial
system collapse. On September 2008, Lehman Brother filed for bankruptcy, Merrill
Lynch had sold to Bank of America at low prices and AIG had lost billion. In
addition, one of the factors contributed to the financial crisis is agency
problems and asymmetric information. Agency problems happened when mortgage originators
did not hold the actual mortgage but they sold the notes on the secondary
market to get the commissions from the loans. During
2007 to 2008, originators had got information that many of borrowers from these
loans about to default but they still sold these loans to banks. Asymmetric information occurs when the
parties engage in a transaction, there do not have the same information in
between the different parties and it could exist between investors and
companies or investment corporate. Because when investors are evaluating
companies, companies may have good or bad information while investors or stock
analyst is lack of the information lead the risk exists between investment
firms and investors. For instance, the investment firm may advice their
customer to buy a company’s stock while they knew the stock’s price is decreasing.
Banks have to estimate the exact of riskiness with intelligence that precise in
order to do a rational decision.











Explain how these factors impacted upon Northern Rock
and the reasons for the nationalisation (20%)

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innovation and subprime mortgage markets factor had led to financial crisis
while financial innovation is ongoing development on financial products to
achieve specific customer objectives and offset specific risk exposure (For
example default of borrower) to assist obtain financing. The bundling of subprime
mortgages through securitization into collateralized debt obligations (CDO)
sale to investors. Borrowers which less than credit worthy able to purchase a house
through subprime lending because they taking
advantage of collateralized debt obligations (CDO). Northern Rock lending and
offer cheap rates to the customer had made them became the UK’s fifth-largest
mortgage lender. By the way, housing bubbles had occurred when housing prices increased
in early 2006, but it started to decline in 2006 and 2007. After the collapse
of the housing bubble had led to mortgage delinquencies and foreclosures increase,
which is bank has right to take possession of the mortgaged property when the
mortgagor fails to make payment and led the housing-related securities price
decreased.  Besides that, Northern Rock faced
the financial crisis because of fell the standard of underwriting to increase approved on the mortgage had caused people intended
to buy houses that they could not afford led housing prices keep increasing. Increased
of house value led a large number of house owner to borrow against their house
to earn a lot of profit. But after the people not able to repay the mortgage
incur high delinquency rate and the value of these assets decreased at rapid
speed. Banks that were invested in these assets had started faced the lack of liquidity
and deteriorating balance sheets. Deteriorating balance sheets lead financial
institutions into insolvency and these lead to a bank panic. All depositors to
withdraw all funds immediately because they are worry and no idea which bank is
insolvent. Northern Rock started faced problems in raising funds in the money
market to replace maturing money market borrowings. The agency problem and
asymmetric problems arose when credit rating agencies gave asymmetric
information to investors while they consulted with firms to structure a fake
product to achieve the highest rating. Investors have taken on additional risk
when they relied on the asymmetric information. Borrowers get easier to qualify
for prime loans and make subprime to purchase the house that they not
affordable.  Banks had reduced the
importance of proof on income and assets. Besides that, they had lower the
mortgage underwriting standard, loans moved from full documentation to low
documentation and to no documentation. This action had made Northern Rock
accumulated a large number of mortgages and when delinquencies rate increase
made they faced the liquidity crisis. The reason that Northern Rock had
nationalisation is when the subprime housing problems rose up, banks stopped
lending to each other because of the fear towards exposure to bad debts.
Northern Rock became unable to repay loans from the money market because they
lack fund raised after the subprime mortgage crisis
began and the global demand from investors for securitised mortgage was
declined. Northern Rock’s source of funding is completely dried up led to
liquidity problem and forced to ask Bank of England, as lender of last resort
for an emergency financial support. When run on the bank occurred, many
customers queued outside branches to withdraw their savings and led to
liquidity crisis out of control. The bank was taken into state ownership as
result of two unsuccessful bids to take over the bank and announced was to be








Research the post nationalisation outcome and evaluate
whether the net impact has been positive or negative. (20%)

Nationalisation is the process of transforming private
assets into public assets by bringing private assets under the public ownership
of a national government or state. The opposite of nationalisation is privatization,
which is the process of transferring an enterprise or industry from the public
sector to private sector. Another opposite of nationalisation is demutualization,
which is the process of a customer-owned mutual organization changes legal form
to a joint stock company. In 2008, Northern Rock announced expected losses of £585.4m
for the first six months of the year. At the same time they also managed to
repay £9.4bn loan from the Bank of England, to reduce the amount owed to £17.5bn.
In February 2009, Britain passed legislation allowed government to nationalise
Northern Rock. After the government nationalise Northern Rock, Britain decided
sold off Northern Rock by the end of 2009 and the bank was split into two parts
(assets and banking) to help the bank back to the private sector. Northern Rock
Plc, which represents the “superior” bank by including new mortgages and
savings while the “spoiled” bank of Northern Rock is to merge with state-owned
rival Bradford & Bingley, designed to cut costs and expected to generate
greater returns. On 17 November 2011, the government announced had sold
Northern Rock to Virgin Money for £747m. Virgin Money will have to pay the
government an additional £50m to £80m if they successful sells or lists the
combined business on the stock exchange in the next five years. Virgin Money
had combined the two businesses together because Virgin Money has credit cards,
insurances, and investments but lack of mortgages, savings, and current
accounts while Northern Rock fulfilled their requirements. Taxpayers had
injected £1.4bn into Northern Rock plc, while the spoiled part of Northern Rock
is still owed Treasury £21bn and uncertain about the potential losses
contained. The net impact for nationalisation has been positive because through
the nationalisation government had saved the bank from bankruptcy and tried to
keep reducing the job losses. One of the advantages of nationalisation is if
Northern Rock loses more money from mortgage defaults, the taxpayer will take
responsibility for the losses. However, the government could benefit from the
profits of banks if the bank does well. During nationalisation process, the government
helped to enhance the company’s financial conditions purpose to sell the
company at a better price after a few years later. The main reason led to this
financial crisis is financial innovation in mortgage and poor management of the
bank, in fact, nationalisation had helped avoided the collapse of economic or
getting worse circumstances. Through this financial crisis, we able to aware of
the disadvantage of deregulation and how serious the damage could bring to the









Present and analyse the steps which have been take to
prevent the repetition of a similar financial crisis (20%)

One of the reason led to the financial crisis because most
of the commercial and investment banks had been deregulated started in 1980. The
Glass-Steagall Act was repealed in 1999 for split up the powers of commercial
and investment banking to ensure that banks cannot take the risk with the
deposit money. In 1994, a credit default swap (CDS) which is a financial swap
agreement was invented by Blythe Masters from JP Morgan. It designed to
transfer the credit exposure of fixed income products between two or more
parties and it was increased in use in the early 2000s. In the past, borrowers were able borrowed mortgage to
purchase a home that they may not affordable. Many banks had put these
mortgages from housing market together into packages of securities, created
credit default swap (CDS) and known as synthetic collateralized debt
obligations (CDOs). In 2000, the Commodity Futures Modernization Act had exempt
credit default swaps from regulation was passed. Besides that, the U.S.
Securities and Exchange Commission (SEC) and the Commodity Futures Trading
Commission (CFTC) largely exempt credit default swaps from regulation. By the
end of 2007, the amount of outstanding (CDS) was $62.2 trillion and was $25.5
trillion in early 2012. The lack of transparency in credit defaults swaps
market became a concern to regulators. In March 2010, the Depository Trust and
Clearing Corporation (DTCC), an American post-trade financial services company
which provide clearing and settlement services to financial markets announced
gave regulators greater access to its credit default swaps database. Credit rating
agencies (CRAs) is a firm paid by the banks who employ them to rate debt instruments/securities
according to the ability of the debtor to make repayment. These agencies failed
to remain committed to its own credit-rating standards led to the financial
crisis occurred. The agencies had given their highest ratings to over three
trillion dollars of loans to homebuyers with no income proved by documents and
bad credit record. Over half a trillion dollar was losses and hundreds of
billions of dollars’ worth of triple-A securities were downgraded five levels
to a speculative grade. On January 2017, one of the rating agency “Moody’s
Investors Service agreed to pay nearly $864m to settle with US federal and
state authorities over its ratings of risky mortgage securities during 2008
financial crisis. In addition, EU regulator fines Moody’s €1.24m for breaching
credit rating rules and European Securities and Markets Authority (ESMA)
carried out its role to independent oversee of credit rating agencies within
the European Union. ESMA published its market share calculation for EU
registered credit rating agencies (CRAs). It is designed to increase awareness
of the different types of credit ratings offered by each registered CRAs and
helped issuers and related third parties to appoint smaller CRAs. In an
addition, The Basel Committee on Banking Supervision had published Basel ? (Third
Basel Accord) to avoid repetition of the financial crisis.  The main purpose of Basel ? is to enhance
international regulation, risk management and supervision of banks. It required
banks to maintain proper leverage ratios and minimum capital requirements to
avoid the liquidity risk of banks may out of control.





In conclusion, present an opinion as to whether or not
the factor which triggered the 2007/2008 crisis have been addressed and whether
you consider the rescue of Northern Rock to be a good or bad thing (20%)


My opinion toward
the factor which triggered the 2007 / 2008 crisis hasn’t been addressed even after
published Basel ? had strengthened the banking supervisor and regulations. One of the
reason is the mortgage sector forced to shut down after the financial crisis in
2007 / 2008, currently more and more lenders willing lend to people who were
bankruptcy. But in June 2017, emerge new
retail bank Masthaven lend to people who suffered financial problems or who do
not pay their mortgage payments. The financial innovation led a great increase
of the number of default posted on credit files by mobile phone companies and
more clemency on defaults which have been registered by phone companies. There
is an obligation on brokers and lenders to check the borrower before making any
borrowing to ensure the borrowing is sensible and appropriate. Another factor
which is credit default swaps (CDS), a bundle of credit default swaps are tied
to the risk of corporate defaults and it has more than doubled in the first
seven months of 2017. Traders by over-the-counter market estimated have been
issued from $20bn to $30bn this year, compared to $15bn in the whole year of
2016 and $10bn in the year of 2015. Bespoke tranches, type of collateralized
debt obligation (CDO) that a dealer creates for a specific group of investors
are created by allow the investor to pick a bundle of about 100 different
“single-name” of credit default swaps. Since the products are not graded by the
rating agencies, therefore, bespoke tranches possess large amount of credit
hedge funds and it exists a limited investor base. But after the market of pension
funds from the institutional investors in Canada and New Zealand have joined and
it might lead to the risk of defaults. For my opinion, the rescue of Northern
Rock is a good thing because after the rescue Northern Rock had split into “superior
bank”, containing deposits and quality mortgage assets while “spoiled bank”
containing the rest. The government forms UK Asset Resolution (UKAR) and lends
it £48.7bn to take on £68bn of loans from “spoiled” Northern Rock (NRAM
Limited) with the purpose to repay the state bailout. In 2011, Virgin Money
paid £1bn for “superior” Northern Rock, got £14bn of mortgages, and £16.6bn of
deposits. During 2013 to 2016, UKAR had sold NRAM’s unsecured loans and
mortgages to One Savings Bank, Marlin Financial Group, JPMorgan, and Cerberus. In
2017, UKAR had sold £9.7bn of NRAM mortgages and repaid £4.6bn of the
government loan and 93 percent of its borrowers are up to date with their
repayment. The rescued bank has performed well after they get bailout even
though the bank had faced the financial crisis at the beginning because of poor
management and subprime mortgage factor. After learnt from the lesson, UK banks
have raised more than £130bn in the additional capital since 2007 and the UK’s
largest four banks – HSBC, Lloyds, RBS, and Barclays, had launched rights
issues to boost their capital base in 2008 to 2009. 


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