Credit Crunch Essay

1561 words - 6 pages

When fair value accounting was first brought in by the International Accounting Standards Boards a few years ago, there were some concerns about the volatility it would bring, but in an optimistic economy it made company figures look good and the matter was left alone. However with a credit crunch in full swing, the matter has again been brought up as figures fall dramatically. Companies, regulators and politicians are all attacking the accountancy profession and accountants are taking the flak for banks making huge write downs in their books. Should companies simply ride out their current financial crisis or should the accountancy profession take some responsibility for assisting economic recovery as it was due to their poor financial reporting regulations that contributed to the credit crunch?

The financial crisis otherwise known as the ‘credit crunch’ of 2007 to the present was triggered by a liquidity shortfall in the US banking system. Hamid Varzi said “The US economy, once the envy of the world, is now viewed across the globe with suspicion.” It has resulted in the bailout of banks by national governments, the downturns in stock markets around the world and the collapse of large financial institutions. It has also affected the property markets severely resulting in many evictions and foreclosures. Many economists have even considered it to be the worst financial crisis since the Great Depression in the 1930s. The crisis has contributed to the failure of key businesses, substantial financial commitments incurred by governments, declines in consumer wealth estimated in the hundreds of billions of US dollars and a significant decline in economic activity. Many different causes have been suggested by financial experts however the credit crunch can be essentially attributable to the bank’s acceptance of massive exposure to risk on the sub-prime mortgages.

The collapse of the housing bubble, which peaked in the US in mid-2006, caused the values of securities tied to real estate pricing to plummet, making refinancing more difficult. Default rates on sub-prime and adjustable rate mortgages (ARM) began to increase quickly thereafter. The US Federal Deposit Insurance Corporation (FDIC) have defined subprime borrowers and lending: “The term subprime refers to the credit characteristics of individual borrowers. Subprime borrowers typically have weakened credit histories that include payment delinquencies and possibly more severe problems such as charge-offs, judgments and bankruptcies. They may also display reduced repayment capacity as measured by credit scores, debt-to-income ratios or other criteria. Subprime loans are loans to borrowers displaying one or more of these characteristics at the time of the purchase.” Such loans have a higher risk default than loans to prime borrowers. If a borrower is failing to make timely mortgage payments to the loan servicer, the lender may take possession of the property and”this process is known as...

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