NEWS / Foreign Exchange

Sub-prime mortgage crisis holds market attention

September brought a continuation of the sub-primemortgage crisis in the United States and its impact on the rest of the worldthrough the financial markets.

 Secretary of the Treasury Henry Paulson declaredthat the crisis would be a long one. The European Commissioner for Economic andFinancial Affairs, Joaqu?­n Almunia joined in this view when stating that thevolatility of the markets was behind the decision to lower the forecasts foreconomic growth. That is to say, he recognized that the spread of the damage inthe financial markets to the real economy was indeed a fact. The interbankmarket in the United States continued to rise, as may be seen in thefollowing graph, while the state of liquidity was being maintained. Whileinvestors took refuge in government securities, buying US Treasury bills, thebanks reduced their positions in the interbank market and had difficulty inissuing bonds. In the United States, for example, the outstanding balanceof notes with real security in the private fixed-income market dropped by 251.3billion dollars in just a few weeks. On June 25 there was an outstandingbalance of 1,180 billion dollars, whereas by September 19 this had been reducedto 930 billion dollars.

 That is to say, this was paper issued byvarious companies that fell due and could not be refinanced in the markets becausethey were excessively expensive because of widening of loan differentials. Anotherexample of the problems brought about by the mortgage crisis was the patternfollowed by the British bank Northern Rock. On September 13 it announced thatit had asked for emergency funds from the Bank of England as lender of lastresort with the agreement of the UK Chancellor of the Exchequer for an amountof 3 billion pounds sterling (4.38 billion euros). The reason for the move wasthe difficulty in obtaining funds in the interbank market given that the bankwas financing more than 75% of its loan operations through that market insteadof through deposits.

 After making this announcement, the bank??™sshares collapsed by 32%. In 2000, Northern Rock became part of the FTSE 100stock exchange index which includes the 100 companies with highest capitalizationlisted on the London stock exchange. In spite of having fewbranches, the notable impact of its liquidity crisis in the financial systemwas due to its strong development of financial innovation which allowed it to shiftrisk very rapidly. On September 14, the day after the announcement, there werelong line-ups of customers wanting to withdraw all their savings. In two days thebank had lost 2 billion pounds sterling. On September 17, the share price againplummeted by 35% going from 438 pennies to 283 pennies. That day, theChancellor of the Exchequer announced that the British government and the Bankof England would guarantee all the deposits of Northern Rock without any limit.