THE IMPACT OF GLOBAL FINANCIAL CRISIS ON THE NIGERIAN STOCK MARKET

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THE IMPACT OF GLOBAL FINANCIAL CRISIS ON THE NIGERIAN STOCK MARKET

 

CHAPTER ONE

INTRODUCTION

1.1    BACKGROUND OF THE STUDY

The current global economic meltdown which started in late 2007 was as a result of a liquidity shortfall in the United States banking system. The immediate cause or trigger of the current crisis was the bursting of the United States housing bubble which peaked in approximately 2005–2006. Already-rising default rates on “subprime” and adjustable rate mortgages (ARM) began to increase quickly thereafter. An increase in loan packaging, marketing and incentives such as easy initial terms, and a long-term trend of rising housing prices had encouraged borrowers to take on difficult mortgages in the belief they would be able to quickly refinance at more favorable terms. However, once interest rates began to rise and housing prices started to drop moderately in 2006–2007 in many parts of the U.S., refinancing became more difficult. Defaults and foreclosure activity increased dramatically as easy initial terms expired, home prices failed to go up as anticipated, and ARM interest rates reset higher.

Low interest rates and large inflows of foreign funds created easy credit conditions for a number of years prior to the crisis, fueling a housing construction boom and encouraging debt-financed consumption. The combination of easy credit and money inflow contributed to the United States housing bubble. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load. As part of the housing and credit booms, the number of financial agreements called mortgage-backed securities (MBS) and collateralized debt obligations (CDO), which derived their value from mortgage payments and housing prices, greatly increased. Such financial innovation enabled institutions and investors around the world to invest in the U.S. housing market.

As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime MBS reported significant losses. Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter foreclosure. The ongoing foreclosure epidemic that began in late 2006 in the U.S. continues to drain wealth from consumers and erodes the financial strength of banking institutions. Defaults and losses on other loan types also increased significantly as the crisis expanded from the housing market to other parts of the economy. Total losses are estimated in the trillions of U.S. dollars globally.

While the housing and credit bubbles built, a series of factors caused the financial system to both expand and become increasingly fragile, a process called financialisation.

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THE IMPACT OF GLOBAL FINANCIAL CRISIS ON THE NIGERIAN STOCK MARKET

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