Impact Of Debt Crisis On Financial Institutions



For the world’s biggest economy, the US, the day of estimating still seems distant. The more the US dollar rallies, the more anxious the investors get. The prime focus of this article is to explore the impact of debt crisis on financial institutions. Read on.

It has been estimated by the International Monetary Fund that from 2007 to 2009, major U.S. and European banks have lost over a $1 trillion on toxic assets and from bad loans.

These losses are expected to touch $2.8 trillion from 2007-10. While U.S. banks losses were about 60 percent, the British and Euro zone banks lost only 40 percent.

Northern Rock, a medium-sized British bank, was the first to experience the debt crisis impact on financial institutions. The highly leveraged character of its business sent the bank appealing security from the Bank of England, thus leading to investor panic. The idea of nationalizing the institution by Liberal Democrat Shadow Chancellor Vince Cable was initially ignored. In February 2008, however, the British government gave in, taking the bank into public hands. The problems with Northern Rock's were an early indication of the troubles that would soon to ensue with the effect of American debt crisis on financial institutions and banks.

The first to feel the impact of debt crisis were the companies directly involved in home construction and mortgage lending such as Northern Rock and Countrywide Financial. They were no able to obtain financing through the credit markets. The major impact of debt crisis on financial institutions was seen with over 100 mortgage lenders going bankrupt during 2007 and 2008. The effect of American debt crisis on financial institutions peaked in September and October 2008. Several major institutions like the Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, Washington Mutual, Wachovia, and AIG either failed, or were subject to government takeover.

Between 2007 and 2008, Americans lost more than a quarter of their net worth. Early November 2008, saw a broad U.S. stock index, down 45 percent from its 2007 high. The debt crisis impact on financial institutions was seen in the futures markets, which signaled a 30-35% potential drop. Total home equity in the United States, valued at $13 trillion at its peak in 2006, had dropped to $8.8 trillion by mid-2008.

During the same period, there was a loss of $1.2 trillion savings, while investment assets lost $1.2 trillion.

HSBC, the world's largest bank, listed down its holdings related to MBS by $10.5 billion, the first significant loss to be stated. During 2007, over a 100 mortgage companies either closed down, suspended businesses or were sold. Top management did not escape intact. The CEOs of Merrill Lynch and Citigroup resigned within a week of each other in late 2007. With the deepening of the crisis, many more financial firms and institutions either merged, or announced that they were negotiating seeking merger partners. Thus we see that there was a widespread impact of debt crisis on financial institutions globally.

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