Research Proposal: The Effects of Financial Crisis of 2007/2008 on US Banking and Insurance Sectors

CHAPTER 1: INTRODUCTION

1.0  Introduction

Financial crisis, by integrating certain systemic and cyclical causes, is a phenomenon with an immense effect on the global economy, as we see daily circumstances that endanger financial stability around the world economy. The first signs of the onset of the global recession were noticed in 2007. A giant in the financial world of America was faced with a severe problem at a minute’s throw. The condition would again look grim, as Lehman Brothers ‘Bank sent a bankruptcy process soon after the FCD attempts. The presence of other systemic and recurring causes, and any financial turmoil, could be emphasized in many ways, which had been tight even for some time now.

1.1 Background information

Leading analysts have called the financial crisis in 2007-2009 the most significant economic turmoil after the Great Depression and the global consequences of the failure of the major corporations, a trillion-dollar decline in consumer wealth, major policy commitments, and a dramatic decrease in economic activity. The catalyst or initiator of the predicament was the eruption of the US housing bubble that is drawn in about 2005-2006 (Hsu & Moroz, 2009). Subprime and ARM (adjustable mortgage rate) high default rates began to increase quickly afterward. Improved loan opportunities, including simple circumstances and long-term higher house prices, have persuaded debtors to consider tough debts on the premise that their refinancing is easily enhanced. When interest rates started to increase, and the prices of housing in many areas of the United States continued to decline significantly in 2006-2007, however, refinancing became harder  (Epstein & Dutt, 2018). Defects and mortgage activity have significantly increased as home prices did not rise as predicted as the simple initial terms expired, and the ARM rate adjusted. Throughout the years leading up to the commencement of the recession throughout 2007, enormous distant capital from the rapidly expanding Asian economy and oil-producing countries poured into the United States. This fund inflow, combined with the 2002-2004 low American interest rates, has helped to create a simple lending climate that fuels housing and credit bubbling. Then, in the middle of 2007 and 2008, the global financial crisis finally began to have an impact (Dufour & Orhangazi, 2016). In the financial markets in the world, major banks failed or were absorbed, and even the wealthiest nations needed to put in place a rescue plan to save their economies.

1.2 Statement of the problem

Despite some laxities in the US commercial coordination, the financial crisis originated from credit contractions in the banking sector. The recession was very pronounced in the early stages of sub-prime mortgages, as householder payments on adjusted loans became difficult to produce. Such a trend has led to financial institutions using credit contraction in view of their weakening balance sheets to tighten their standards. Financial institutions have also stopped lending and recalled their lines of loans to ensure sufficient resources (Hsiao & Zhang, 2017). The emergence of the US financial crisis posed a serious threat to economic stability and survival. This has driven both institutions and their respective customers to substantial financial losses.

Furthermore, the ugly crisis is characterized by other variables. Subprime loans are included; the shadow banking system is corrupted and destroyed. A further likely explanation and determinant of the crisis which unambiguously exacerbated the severity of this crisis was the widespread miscalculation of the degree of risk inherent in the unregulated collateralized debt obligation and credit deficit swap markets by bank investors. In this principle, banks and investors systematized risk by using low rates to borrow huge amounts, which they could repay only if the housing continued to rise in value.

Taking this trend into consideration, this research report explores the effect on the banking and insurance industry of the financial crisis

1.3 Research objectives

The major aim of this report is to examine the effect on the US banking sector of the latest global financial predicament.

1.3.1 Definite objectives

1. To identify the consequence of banks’ efficiency of the financial predicament.
2. To evaluate the effect on the US banking sector from the financial crisis.
3. To identify issues liable for financial predicament causes in the US banking segment

1.4 Research questions

This paper focuses on the financial crisis banking sector and on how banks were presented with the crisis. The emphasis of this subject is on the part of banks in the financial predicament and what is the banks ‘best measure. Fundamentally, I am examining the roots and financial crisis processes in order to determine the effect on banks in each region. I will, therefore, review how such impacts can be overcome.

The study was designed to address the following main questions in order to accomplish the objectives:

• How are the repercussions of the financial crisis on US banking?
• What are the specific results between the United States and other regions?
• What are the necessary steps in those countries to resolve these impacts?

1.5 Significance of the study

The main determination of this research is to provide individuals and members of the public with relevant information, expertise, and a deeper understanding of the subject matter. This study will assist financial institutions in recognizing the origins, implications, and results of a financial crisis, and the various methods used by fraudsters to defraud financial institutions. The extent of the financial crisis in the US is a source of great concern. In order to encourage financial institutions to take advantage of internal controls to prevent financial misappropriation. This work would allow the economist to know the general dynamics of the crisis and its effect on financial institutions and the economy as a whole. The research results and recommendations will provide a framework for further inquiries on the effect on the US Banking Industry of the financial crisis, on which other researchers may wish to build upon them.

CHAPTER 2: LITERATURE REVIEW

1.0 Introduction

This chapter discusses the literature on the research topic under study. The literature review consists of a systematic position of concept and text study. This tries to describe what was done in connection with the study question

In terms of both of its reach and consequences, after the Bretton Woods mechanism broke down in the early 1970s, the world’s economy experiences perhaps the most severe financial crisis. Their effect is even more systemic than we have seen in the last two or three decades in the financial crisis. Global financial globalization is increasingly becoming more widespread, with a much higher share of world trade and development in Asian countries (Daniel Zeghal & Meriem El Aoun, 2016). For example, the global complexity of the current crisis has not been accompanied by falls in home prices and stock prices as well as issues in the credit market at a time in many developed economies.

2.1 The origin of the financial crisis:

As it is known from loss on US sub-prime mortgage securities, the current financial crisis has caused losses, which first emerged with the US housing downturn in the second half of 2006. The first reason for the financial predicament is that housing bubble growth has precipitated the financial crisis. The charge of the average US house upsurged by 124 between 1997 and 2006. (Economist, 2007) The general median home prices ranged between 2.9 and 3.1 times the median household revenue in the two decades ending in 2001. In 2006, the ratio rose to 4.0. (Cools & Van Toor, 2015). The housing bubble has meant that numerous homeowners refinance their homes at lower rates of interest or fund expenses by purchasing second-class mortgages. The average US housing rates decreased by more than 20 percent by September 2008 from its peak in mid-2006. Most subprime borrowers have been motivated to receive flexible mortgages because they assumed that the house price would continue to rise (Orhangazi, n.d.).  For some predetermined time, these mortgages received lower market interest rates, followed by higher interest rates for the rest of the mortgage duration. Mortgagors who were unable to pay for the advanced expenditures after the initial grace period is over will try refinancing the loans. Refinancing has been made harder as prices in many parts of the US have begun to decline. Creditors who could not avoid higher monthly refinancing payments started to default.

2.2 The process of the financial crisis:

There are indications that there are elevated rates of subprime lending both from government and economic pressures in pre-crisis years. The growth of higher-risk credit plays a significant role in major US venture banks and government-sponsored companies like Fannie Mae and Freddie Mac (Dinesen, 2020).

In 1996 HUD, the “Department of Housing and Urban Development,” specifically addressed the company’s householder and the company’s hybrid business, Fannie Mae and Freddie Mac: ’42 percent of their funding was to be provided for hybrid lenders with incomes below the mid-range in their region’ (Giannikos, Guirguis, & Suen, 2012). Finnie Mae and Freddie Mac have bought HUDs with their own investments with hundreds of billions in subprime securities to make money to help meet affordable housing objectives. Some borrowers may receive loans under easy credit conditions due to deregulation lending. Predatory loans are the custom of unscrupulous borrowers for the unethical intent of entering into ‘unsafe’ or ‘unsound’ loans. The financial crisis was largely established afterward.

Roger and Chris, (2018) has a history of the financial crisis: “Once upon a time greedy banks, primarily in the United States, had made billions by sold mortgages to poor individuals who were not able to afford them. They realized that these loans were unsound, so they diced it and sliced it and sold it to similarly greedy bankers around the world who didn’t know what they paid. The borrower lost, and bankers found that what he had purchased was useless when the housing bubble broke out. Company loans sunk, the market shuddered, and the market ended. The moral reason for this description of the events is that capitalism has collapsed, and we need stricter laws to curb the greed of bankers and ensure that this never happens again.

2.3 The effects of the financial crisis in the world:

A crash of the US sub-prime mortgage market and a turnaround of the housing bubble have had a crushing impact all over the world in many developed economies. In addition, the global financial system has also faced other vulnerabilities. Some financial products and resources have become so complicated and distorted that trust in the entire system is starting to crumble when things get disrupted.

Firstly, financial institutions were affected. Initially, those specifically involved in the building of homes and mortgages, such as Northern Rock and Countrywide Banking, had the effect of being unable to access funding on credit markets. In 2007 and 2008, more than 100 mortgage lenders collapsed. Bear Steams ‘fears about the collapse of the investment bank in March 2008 led to JP Morgan Chase being killed (Giannikos, Guirguis, & Suen, 2012). In September and October 2008, the crisis reached its height. Many big institutions were either destroyed, bought under pressure or experience takeover by the government. Between them were: Lehman Brothers, Fannie Mae, Merrill Lynch, Freddie Mac, and AIG.

Second, the money market was affected. The crisis entered its most crucial stage in September 2008. Mutual funds in the monetary market that capitalize primarily in the business paper provided by companies to finance their activities and payrolls were similar to a bank. During one week, cash market withdrawals amounted to $144.5 billion versus $7.1 billion one week earlier (Giannikos, Guirguis, & Suen, 2012).

Finally, it’s the global economy’s impact. The recession has grown and spread quickly to the global economic shock, triggering many collapses of European banks, drops in numerous stock indices, and major declines in stock and commodity prices. Moreover, with assets sold to repay bonds not available for refinancing on frozen credit markets, the deleveraging of financial institutions further intensified the liquidity crisis and triggered a decline in foreign trade.

Leaders of the world and managers of central banks harmonized measures to alleviate instability, but the predicament continued. Around the end of October 2008, the currency crisis started. This has led many developing countries to pursue funding from the International Monetary Fund, and investors have pushed their capital reserves into strongest currencies such as the euro, the dollar, or Swiss franc.

2.4 The effects of a financial predicament on the US banking system:

The average rate of production of labor and property goods and services in the United States in the fourth quarter of 2008 and during the first quarter of 2009 was about 6 percent down, relative to year-on – the-year operation. By June 2009, the rate of unemployment in the US rose to 9.5 percent, the highest since 1983, and almost twice the rate before the recession. The average workweek was 33, the lowest since the state began collecting the data in 1964. Confidence in the United States ‘banks would periodically decline, and bank lenders’ specie (for example, Gold or Silver) would be demanded back (Cecchetti, 2008). Banks may either meet withdrawals from their own vaults or take away any bubble from the association of the clearinghouse. The lower the balance of your clearing scheme, the greater is the chance that non-center banks are overdrawn.

The effects of a financial predicament on the UK banking system:

The severity of the financial crisis was not only becoming so severe in the USA but also in the United Kingdom when the news that Northern Rock was forced into a rescue operation by the Bank of England arrived in September 2007. Northern Rock Bank is the financial crisis most affected in Britain and the most famous bank for my research.

Northern Rock is the top 5 mortgage owners in the UK with regard to gross lending. The bank also deals with deposits, loans, and insurance plans, as well as mortgages. In 2006, the bank was lent in a contract with Lehman Brothers to subprime financing. While the mortgages were sold through intermediaries under the Northern Rock brand, Lehman Brothers endured the risk. On 14 September 2007, following difficulties in the credit market, the bank was requesting and obtaining a liquidity aid facility from the Bank of England. This has prompted a substantial number of customers to leave outside branches. The bank was partially taken into state ownership on 22 February 2008 (Cecchetti, 2008). The nationalization resulted from two improper offers for the bank to repay the taxpayer’s money in three years. Customers lost trust for every bank in the UK because of the Northern Rock crisis. They started withdrawing money from their savings account, which influenced everyone in the UK.

2.5 Effect of the financial crisis on Insurance firm

The 2007 financial crisis was simply a bank crisis and did not seem to be a threat to the solvency of the entire insurance industry. However, and often in adverse ways, insurance firms have been affected. Most insurance firms appear to have been limited to have direct exposure to the crisis epicenter, American mortgages, and associated securities. Nevertheless, the insurance market has also been significantly impacted by the financial predicament, mainly by investment, despite the worsening of the economy, and the valuation of financial markets and real-world prospects. There have also been an amount of based credit and market risk exposures, both in American insurance companies and insurance undertakings, as well as in sections of many other financial classes dominated by insurance (Shafer, 2019). And, while insurers may have reduced the downward pressure during the financial crisis rather than exacerbated it, some have obviously contributed to downward pressures. Insurance was used by financial instruments at the root of issues, and so it is not shocking that on one or the other side of their accounts, certain institutions in that field have been affected by the crisis.

CHAPTER 3: RESEARCH METHODOLOGY

3.0 Introduction

The methodology and procedures for the conduct of the study are defined in this chapter. It includes research design, sample design, data collection methods, and data analysis technique; such as the chapter explains how the research was performed.

3.1 Research design

The research adopts both quantitative and qualitative approaches to data collection and presentation. According to Oso and Orien 2006, a population survey was designed to pick samples to examine such events by quantitatively identifying samples and drawing generations. The researcher used a simple random sampling approach as it is less selective because each item is selected and reduces cost for study by concentrating surveys on the collection of the item.

3.2 Data collection

For data collection, I will establish a survey. Customized instruments by variables were different from studies to study, and existing measuring instruments were not suitable for this research. A new method has, therefore, been created for this analysis. A pilot survey will be carried out to ensure the validity of the questionnaire before the start of the data collection. To order to provide straightforward and ready responses to the questionnaire, five participants received the questionnaire via email from SurveyMonkey.com.

3.3 Ethical Research

I raised a variety of ethical issues during the study process to protect participants ‘interests. All potential respondents were invited, told of the intent of the study, participation criteria, and the survey rules. The researcher recognized his voluntary involvement in this analysis by signing the consent form. I told respondents, in the consent document, that they could withdraw at any time from the trial by leaving the survey or by not responding at the end of the test.

I will communicate to the respondents, informing them that I would not use any personal details anywhere on the completed survey, and their identity will be confidential and anonymous. The only person to be sure of the identity of participants and the responses to the questionnaires will be the researcher. I converted survey respondents ‘names to Participant 1(P1), Participant 2 (P2), and so on as an additional measure of health.

References

Cecchetti, S. (2008). Crisis and Responses: the Federal Reserve and the Financial Crisis of 2007-2008. doi:10.3386/w14134

Cools, K., & Van Toor, J. (2015). Why Did US Banks Fail? What Went Wrong at US Banks in the Run Up to the Financial Crisis. SSRN Electronic Journal. doi:10.2139/ssrn.2566737

Daniel Zeghal, & Meriem El Aoun. (2016). The Effect of the 2007/2008 Financial Crisis on Enterprise Risk Management Disclosure of Top US Banks. Journal of Modern Accounting and Auditing, 12(1). doi:10.17265/1548-6583/2016.01.003

Dinesen, C. (2020). Bank Failure: Triggering Crisis—How Absent Management in Banks Triggered the 2008 Financial Crisis. Absent Management in Banking, 177-199. doi:10.1007/978-3-030-35824-2_10

Dufour, M., & Orhangazi, Ö. (2016). Growth and distribution after the 2007–2008 US financial crisis: who shouldered the burden of the crisis? Review of Keynesian Economics, 4(2), 151-174. doi:10.4337/roke.2016.02.02

Epstein, G., & Dutt, D. (2018). Public Banks, Public Orientation, and the Great Financial Crisis of 2007–2008. Financial Innovation and Resilience, 327-343. doi:10.1007/978-3-319-90248-7_15

Giannikos, C. I., Guirguis, H., & Suen, M. (2012). The 2008 Financial Crisis and the Dynamics of Price Discovery Among Stock Prices, CDS Spreads, and Bond Spreads for US Financial Firms. SSRN Electronic Journal. doi:10.2139/ssrn.2154049

Hsiao, C. Y., & Zhang, A. Q. (2017). The Impact of the Financial Crisis of 2007 to 09 on the US Tourism Industry and Firm Performance. SSRN Electronic Journal. doi:10.2139/ssrn.3020516

Hsu, J., & Moroz, M. (2009). Shadow Banks and the Financial Crisis of 2007–2008. The Banking Crisis Handbook, 39-56. doi:10.1201/9781439818541-c3

Orhangazi, Ö. (n.d.). Financial deregulation and the 2007–08 US financial crisis. The Demise of Finance-dominated Capitalism, 289-307. doi:10.4337/9781784715076.00014

Roger, M., & Chris, S. (2018). Part II The Financial Crisis of 2007–2011, 7 The Initial Impact of the Financial Crisis on Financial Markets. Legal and Conduct Risk in the Financial Markets. doi:10.1093/law/9780198749271.003.0008

Shafer, J. R. (2019). The Foreign Capital Flow and Domestic Drivers of the US Financial Crisis and Its Spread Globally. The 2008 Global Financial Crisis in Retrospect, 111-138. doi:10.1007/978-3-030-12395-6_7