As a result the asset backed commercial paper market froze in several countries

As a result the asset backed commercial paper market

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about their own future liquidity needs. As a result, the asset-backed commercial paper market froze in several countries. The rates at which banks would lend to each other in overnight and term money markets started to widen. 0 1 2 3 4 5 US Mortgage Delinquency Rates 30+ days past due, per cent of outstandings Source: Mortgage Bankers Association % Sub-prime Prime 2004 2000 2008 2004 % 2008 2000 0 5 10 15 20 25 Graph 8 Graph 7 0 100 200 300 400 0 100 200 300 400 Global LBO Activity Announced and completed * Deals announced to date Source: Thomson Reuters 2009* US$b US$b 2007 2005 2003 2001 North America Europe Other
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B U L L E T I N | M A Y � � � ��� � � � ��� | A D D R E S S 2 9 Normally these money market rates sit close to the policy rates set by central banks, but that relationship broke down in August 2007, as Graph 9 shows. Investor demand for certain kinds of mortgage- backed securities also dried up in the following months. Lenders that had depended on short-term money markets or securitisation therefore started to find it very difficult to obtain funding. The easing of lending standards during the boom was especially marked in US mortgage markets, and so were its consequences. Compared to loans in most other countries, US mortgages are more likely to be packaged into securities. And if the market price of these securities should fall, accounting treatment often requires that the loss be recognised immediately, which is not the case for a traditional loan portfolio. For these reasons, it should not be surprising that banks’ losses have been concentrated in securities holdings rather than traditional on-balance sheet lending. This meant that investment banks and others with large securities trading and investment books have been especially affected. The first major firm that had to be rescued was Bear Stearns, but many others had already declared losses by then. As shown in Graph 10, total profits in several banking systems started to turn negative. In this environment, banks’ perceptions of risk increased, and they started to tighten lending standards. A feedback loop started to develop. Banks were becoming more risk-averse, but so were their customers, who started to pull back on spending. The major industrialised economies of the United States, euro area and Japan were already experiencing economic contractions by the first half of 2008. As investors and others began to realise the macroeconomic consequences of the turmoil, other asset markets were also affected. Share prices fell sharply all over the world, especially for banks, as shown by the indices in Graph 11. Prices fell even further when Lehman Brothers failed. l l l l l l l 0 100 200 300 0 100 200 300 3-month LIBOR to Swap Spread* 2007 * Spread is to: OIS in Australia and US; EONIA in Europe; and SONIA in UK ** Bank bill to OIS Sources: Bloomberg; Tullett Prebon (Australia) Pty Ltd Europe Bps Bps UK US Australia** S D M J S D M 2008 2009 J Graph 9 Banks’ Profits After tax and minority interests * 10 largest European and 5 largest UK banks Sources: Bloomberg; Federal Deposit Insurance Corporation; banks’ annual and interim reports 2005 2008 US$b
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