Modern finance Essay Example | Topics and Well Written Essays - 2500 words

Modern finance - Essay Example (Campbell, 2008). Apparently, the current crisis may be attributed to the subprime lending made by the different financial institutions. However, at the core of it is a whole plethora of different variables which are not only correlated with each other but also created a combined effect on different macroeconomic variables too. The failure of financial institutions to regularly check in their appetite for taking more risk not only resulted into the current credit crunch but also indicated the degree of the regulatory control over such institutions to discipline their behavior. Northern Rock is such a financial institution in UK which required intervention from the government because of its apparent failure to sustain the losses incurred due to subprime mortgage episode. In this research study, the current credit crunch will be discussed with special focus on Northern Rock as a firm requiring official intervention. The credit crunch started to emerge during 2007 when in US, especially financial institutions started to witness defaults on payments of subprime mortgages. Subprime borrowers are termed as those borrowers are who have relatively high risk due to their past credit history. Therefore, under normal banking rules and practices, lending to such borrowers are riskier as in comparison to other borrowers. It is because of this reason that such borrowers are categorized as subprime and are charged relatively higher rates on the lending made to them. Historically, banks were more conservative in their lending practices and avoided to lend to such borrowers who lacked the capability to repay. However, with the innovation in the financial markets corroborated by liberalization of financial markets allowed financial institutions to innovate and roll out products which carried relatively high risk. This phenomenon was further aggravated with the globalization of the financial markets