FMP10 - Anatomy of the Great Financial Crisis 2007-2009 Flashcards
Describe the historical background and provide an overview of the 2007-2009 financial crisis
- subprime mortgages began to downturn
- banks took huge losses and liquidity problems
- banks refused to lend to each other
- many banks went insolvent
- governments had to step in to protect banks, resulted in spill over into wider economy and loss in wealth and high unemployment worldwide
Describe the build-up to the financial crisis and the factors that played an important role
- increase in subprime mortgages being sold
- mortgages had low starter rates on interest only, meaning no principal being paid off
- required zero down payment so assets very under collateralised
- losses on defaults never felt by the banks, encouraging to not do due diligence and just give the mortgage
Compare the roles of different types of institutions in the financial crisis including banks, financial intermediaries, mortgage brokers, and rating agencies
- Banks kept “AAA” credit exposures to increase yield but without having to increase capital requirements
- Rating agencies were paid to rate and relied on past data (not reflective of current conditions) and due diligence performed by banks - would miss out on cashflows if not AAA
Describe trends in the short-term wholesale funding markets that contributed to the financial crisis, including their impact on systematic risk
In unsecured financing, no collateral posted for repo agreement generally given to very high credit quality.
MBS lost value and SIV credit ratings declined, meaning liquidity in the subprime mortgage asset markets declined massively as could not secure short tern debt
Describe responses made by central banks in response to the crisis
- create long-term lending facilities against high quality collateral
- opening discount window to investment banks and securities firms
- provide liquidity to money markets
- provide funds to be lent against high-quality illiquid asset-backed securities
