Appendix - Subprime Mortgage Crisis
3/7/2011
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The Accounting Profession Role in the Subprime Mortgage Crisis
Table of Contents
Section 1 – Introduction ................................................................................................................... 3
Purpose & Scope ....................................................................................................................................... 3
Background ............................................................................................................................................... 3
Section 2 – Literature Review/Discussion .......................................................................................... 3
What is a subprime mortgage? ................................................................................................................. 3
What was the accounting profession role in the recent subprime mortgage crisis? ............................... 4
Section 3 – Conclusions .................................................................................................................... 5
What the accounting profession could have done differently? ............................................................... 5
Path Forward ............................................................................................................................................. 5
Section 4 - Bibliography .................................................................................................................... 6
Section 5 – Appendix: Subprime Mortgage Crisis .............................................................................. 7
Figures
Figure 1: Subprime Lending Expansion ......................................................................................................... 4
Figure 2: Subprime Mortgage Crisis – Housing Bubble Formation ............................................................... 7
Figure 3: Housing & Financial Market and Government & Industry Responses ......................................... 8
Figure 4: Subprime Mortgage Crisis – Foreclosure & Bank Instability .......................................................... 9
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The Accounting Profession Role in the Subprime Mortgage Crisis
A review of literature of the recent subprime mortgage crisis is examined. The accounting profession role and recommendations on what the accounting profession could have done differently is discussed. A brief synopsis of the causes, effects, and impact of the subprime mortgage crisis is presented in the Appendix of this document.
“No Credit, Bad Credit, Low Income, No savings – NO PROBLEM, just state your income, apply for a loan and you can have the home of your dreams,” t his approach resulted in the recent subprime mortgage crisis. With no credit and income requirements, individuals were seduced by the increasing housing market and took out loans they could not afford.
The subprime mortgage crisis impacted the lives of so many people including my family.
The home was purchased right before the subprime mortgage crisis and currently the home is only worth one-third of the purchase price. Fortunately, with excellent credit and adequate income to make the mortgage payments with ease some individuals are able to refinance the mortgage loan and lower the monthly payments.
A subprime mortgage is normally made out to borrowers with lower credit ratings. The lender views the borrower as having a larger-than-average risk of defaulting on the loan therefore the lending institutions often charge interest on subprime mortgages at a rate that is higher than a conventional mortgage to compensate for carrying more risk.
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1 http://www.thepoliticalsword.com/post/2008/10/23/A-plain-mane28099s-glossary-of-finance-marketterms.aspx
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The Accounting Profession Role in the Subprime Mortgage Crisis
By 2006, the subprime market had grown to 20% of the total U.S. mortgage market, and
75% of these loans were securitized and sold off to investors around the world, facilitating an influx of capital. With credit easily available, more people than ever before were able to buy homes.
2 Figure 1 depicts the subprime lending expansion.
Figure 1: Subprime Lending Expansion
What was the accounting profession role in the recent subprime mortgage crisis?
The accounting profession contributed to the recent subprime mortgage crisis by not applying fundamental accounting concepts, professional implementation and monitoring principles. According to (VanDenburgh, 2008), the subprime credit market crisis nearly brought the $28 trillion credit cycle of the U.S. business economy to a complete standstill in August
2007. There is significant blame to be shared by many other parties, including legislators, regulators, financial firms, lawyers, bond rating companies, realtors, mortgage brokers, and homeowners. According to (Jaffee, 2008) and other sources, subprime mortgage securitization was the primary source of the recent mortgage crisis.
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(Yale School of Management, 2008)
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The Accounting Profession Role in the Subprime Mortgage Crisis
On February 29, 2008, the United States Bankruptcy Court for the District of Delaware released a court-commissioned report, authored by Bankruptcy Court Examiner Michael J.
Missal , which detailed the failure of New Century Financial Corp., the second-largest originator of subprime loans. Although the company had an audit committee, it did not focus on important issues of loan quality, risk, and internal control. New Century "turned a blind eye" to deteriorating loan standards and had "no standard for loan quality."
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Other conditions alleged in the Michael Missal report include: 4
 Borrowers’ income was not verified. No or low document loans became acceptable.
 Appraisals were often deficient. Risk management was overlooked to keep business and bonuses flowing.
 Loans often had low "teaser" rates and were reset to market rates after a year or two.
 Loan originations increased from $14 billion in 2002 to $60 billion in 2006. At the same time, there was an "alarming and steady increase in early payment defaults."
 Senior managers’ bonuses were tied to company performance.
Based on the literature review, this study concludes that the accounting profession significantly impacted the recent subprime mortgage crisis by not applying fundamental accounting concepts, professional implementation and monitoring principles to subprime mortgage borrowers which infested the entire housing and financial market.
To avoid the recent subprime mortgage crisis, the accounting profession needed to:
 Verify borrowers’ income. Ensure loan documentation is completed.
 Review appraisals for completion. Ensure Risk Management is enforced by instituting policies to reprimand individuals whose reckless behavior generate loses.
 Establish a system in which conflicts of interest are identified and avoided.
Lessons learned should be applied to the current emerging economies to establish effective policies to subprime mortgages to avoid the chaos we are currently experiencing.
If we fail to learn from history, we are doom to repeat it!
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(VanDenburgh, 2008)(Harmelink, 2008)
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http://pdfserver.amlaw.com/ca/newcentury01_0327.pdf
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The Accounting Profession Role in the Subprime Mortgage Crisis
(2008, October 23 ). Retrieved March 7, 2011, from A plain man’s glossary of finance market terms: http://www.thepoliticalsword.com/post/2008/10/23/A-plain-mane28099s-glossary-of-finance-marketterms.aspx
Harmelink, V. &. (2008, December 1). Accounting Implications of the Subprime Meltdown. The CPA
Journal .
Jaffee, D. M. (2008, April 11). The US Suprime Mortgage Crisis: Issues Raised & Lessons Learned.
Retrieved March 8, 2011, from http://www.growthcommission.org/storage/cgdev/documents/gcwp028web.pdf
VanDenburgh, W. &. (2008, December 1). Accounting Implications of the Subprime Meltdown . Retrieved
March 7, 2011, from http://www.allbusiness.com/trends-events/audits/11729624-1.html
Yale School of Management . (2008, September 18). Retrieved March 7, 2011, from A Root of the
Financial Crisis: http://mba.yale.edu/news_events/CMS/Articles/6603.shtml
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Appendix - Subprime Mortgage Crisis
The subprime mortgage crisis has major effects on the US economy and impacted individuals, the housing market, financial institutions, and the government. This appendix presented the causes, effects, and impact of the subprime mortgage crisis. Figure 2 indicates the lending decisions by institution and borrowing decisions by individuals as a response to the Housing Bubble Formation.
Figure 2: Subprime Mortgage Crisis – Housing Bubble Formation
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Source of Figure 2: http://en.wikipedia.org/wiki/File:Lending_%26_Borrowing_Decisions_-_10_19_08.png
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Appendix - Subprime Mortgage Crisis
Figure 3 depicts the subprime mortgage crisis effects on the housing market, the financial market, and government and industry responses.
Figure 3: Housing & Financial Market and Government & Industry Responses
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Source of Figure 3: http://en.wikipedia.org/wiki/File:Subprime_Crisis_Diagram_-_X1.png
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Appendix - Subprime Mortgage Crisis
Finally, Figure 4 shows the vicious cycles of foreclosures and bank instability due to the subprime mortgage crisis.
Figure 4: Subprime Mortgage Crisis – Foreclosure & Bank Instability
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Source of Figure 4: http://en.wikipedia.org/wiki/File:Subprime_crisis_-_Foreclosures_%26_Bank_Instability.png
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