TIMELINE INCIDENTS

Timeline Incidents

Timeline Incidents

Task A

The credit crunch is generally acknowledged to have had its origins in the US “sub-prime” mortgage market. Essentially, banks lent too much money to people who were unable to repay their debt. Two particular examples of reported sub-prime lending practices included:

“NINJA loans” i.e. loans to people with No Income, No Job or Assets; and

“exploding ARM mortgages” (where ARM stood for Adjustable Rate Mortgage) — for the first few months, the mortgage rate would be very low (a “teaser rate”), before being “reset” at a sharply increased rate and remaining high, so causing mortgage payments to increase substantially and increasing the risk of default.

As a result, mortgage defaults started to increase rapidly, repossessions rose and house prices fell. Many banks had significantly underestimated the risk that these defaults would affect them; they thought the “securitization” (or repackaging and selling of mortgage portfolios) they had undertaken would protect them, by removing most of the risk from their balance sheets (Elliott, 2007, 1). Many banks left the residual part of that risk, the low-risk debt called “super senior” debt, on their balance sheets. However, the mortgage losses were much greater than banks anticipated; as a result, even the super senior debt was eroded, so damaging banks' balance sheets (Balakrishnan, 2008, 3).

Incidents Timeline in the Credit Crisis

The credit crisis is broadly acknowledged as taking hold in August 2007, and it is possible to crudely identify several key stages in the crisis.

Stage 1 — start of the liquidity crisis (August 2007)

Severe liquidity issues affect financial markets after fears over the US sub-prime housing market were sharply exacerbated by the decision by BNP Paribas to freeze three funds exposed to the stumbling US subprime mortgage market. As a result of the liquidity squeeze, in September UK bank Northern Rock, which is heavily reliant on funding from short-term debt, experiences liquidity problems and has to resort to asking the Bank of England for support, news of which leaks, in turn leading to a run on the bank by its customers (Kennedy, 2008, 3).

Stage 2 — banks face mounting losses (autumn 2007)

The problems in the US sub-prime mortgage market, banks across the world reported large losses so weakening their capital positions. Further, banks were uncertain of the scale of their losses, with frequent revisions being announced; for example, in October Switzerland's UBS bank said that it had made a £4 billion loss on sub-prime mortgages, but in December had increased this estimate by £10 billion (Osborne, 2008, 3).

Stage 3 — Bear Stearns and mounting problems (spring 2008)

Bear Stearns, a large US investment bank, requires emergency funding from the Federal Reserve before being bought by JP Morgan (for £10/share; Bear Stearn shares had traded as high as £172/share in January 2007), while central banks continue to provide extra liquidity and a number of UK banks undertake rights issues to bolster their capital positions (Gilmore, 2008, 4).

Stage 4 — solvency crisis (Lehman Brothers collapses) and near-meltdown (Sept 2008)

Major US investment bank Lehman Brothers filed ...