Project Materials

THE EFFECT OF THE GLOBAL FINANCIAL CRISIS ON SELECTED MACRO ECONOMIC INDICATORS IN NIGERIA (INFLATION, AGGREGATE SAVINGS, AGGREGATE CONSUMPTION, REVENUE) 2007-2016

Chapter one

INTRODUCTION

1.1 Background of the Study

The US sub-prime housing loan sector had a crisis in the first half of 2007, triggering the global financial crisis. In the US, sub-prime loans are those that do not meet normal credit quality requirements, such as a good borrower credit history, income documentation, and/or a conservative loan-to-value ratio. In 2006, sub-prime lending accounted for approximately one-fifth of new house lending and 15% of total outstanding loans in the US.

During this time, lenders securitised sub-prime loans and sold them to investors. The crisis spread through both conventional mortgage-backed securities and more complicated products like collateralised debt obligations (CDOs).

CDOs function by dividing the claims in a pool of mortgages into tranches, with the most senior tranches receiving the most protection from any losses. Because of this structure, several of these securities had excellent credit ratings despite the fact that the underlying loans were of poor quality on average.

These attributes, combined with their comparatively high payouts, attracted investors. The layering structure might lead to significant losses, even for senior tranches, during a downturn in the US housing market, which happened. When these issues first emerged, in the first half of 2007, the repercussions appeared to be primarily limited to the US financial sector.

The first big impacts on global markets occurred in August 2007. BNP Paribas, a large French bank, suspended three funds that invested in US mortgage securities.

The announcement highlighted that several European banks and associated off-balance-sheet companies have made major investments in these instruments, potentially exposing them to substantial losses.

Furthermore, uncertainty about the size and location of these exposures, along with the overall opaqueness of many of these securities, resulted in a significant loss of investor trust for financial institutions as a whole.

As a result, risk spreads in global credit markets increased significantly, making it more difficult and expensive for banks to receive funding from financial markets.

These innovations increased the load on already overburdened institutions. In the months that followed, the situation grew as additional details regarding the magnitude of the losses were discovered.

Significant developments include the nationalisation of British bank Northern Rock in September 2007, major bank losses in the US and Europe, and Bear Stearns’ rescue in March 2008.