The level of agony for individuals and businesses continues to rise as they experience losses in the value of their real estate holdings. In some circumstances, the fair market value of their property has fallen below the loan or mortgage amount. As a result, many debtors decide to walk away from the loan, resulting in repossession of the property by the lender. As shown in Appendix A the default rates continue to rise (United States), affecting accounting issues such as, revenue recognition, measurement, fair value, and impairment.
The reporting of long-term debt is one of the most controversial areas in financial reporting” (Kieso, 709). This is because long-term debt such as, loans for real estate investments, has a significant impact on a company’s cash flows. A company’s cash flows are affected by long-term debt as gains and losses are reported through an equity account, such as “Other Comprehensive Income” (Investments). Cash flows are also impacted by reporting the permanent impairment of an asset as a realized loss through earnings and regulatory capital.
Individuals and institutions involved in the current credit crisis include: the United States Congress, the Federal Reserve Board, Fannie Mae, Freddie Mac, the Department of Housing and Urban Development (HUD), the Securities and Exchange Commission (SEC), credit agencies, banks, mortgage brokers and consumers (Carey, 2). The Financial Accounting Standards Board (FASB) is focusing on the uprising problems in dealing with the reporting of real estate holdings.
Within the housing market, a home buyer (debtor) must go first to a financial institution or mortgage broker (originator) who will approve and make mortgage loans. Next, the originator may choose to sell the loan to a protected government sponsored enterprises, such as Fannie Mae or Freddie Mac, or a private securitization trust. Thirdly, the entity protecting the loan takes “the responsibility of transforming the individual mortgages into asset-or mortgage-backed securities” (Carey, 92). The securities are also known as “tranches” which are “groups of securities with specific risk and return characteristics” (Carey, 92). Lessees held by the debtor have to recognize their lease payments as an expense. In the future, the lessee may be required to recognize their entire lease debt as a liability under certain circumstances. This will make the lessee incapable to renew their lease or stop their lease commitment early. This provision could lead to increased defaults within the real estate sector.
Finally, the “securitizer” sells the tranches to investors who become the “ultimate lenders” in hedge funds, pension funds, or financial institutions (Carey, 92-93). The different loans held by the lender “should be classified as notes receivable from participants in the financial statements of a defined contribution plan, measured at the outstanding principal amount plus accrued but unpaid interest” (FASB).