A recession is described as "a widespread decline in the gross domestic product (GDP), employment and trade, lasting from six months to a year". Based on the definition provided above, it would then seem like the United States has been experiencing a recession for a good part of this ending decade. In 2008 a report issued by The National Bureau of Economic Research suggested that the current recession in our country actually started back in 2007, it is often referred to by many as the "the worst financial crisis since the Great Depression".
Due to the abrupt crash and the unusual length of the current economic situation, some quintessential questions were raised by experts within the business and financial arenas, particularly by those in serving in the field of accounting. Some of the fundamental questions asked were: "What caused the financial recession of the most powerful country in the world? Did the auditing profession contribute to the financial meltdown? Will the recession cause changes in the auditing profession?"
It is important to understand what the source of the crisis was in order to first understand how we got into this particular predicament, second identifying the appropriate steps to take that will allow us to correct this economic mishap and third what to do in order to avoid any other fiscal downfalls in the future. It is apparent that there is not one specific source that led our economy into such a dreadful state.
Similar to the Great Depression, various forms of monetary and professional negligence were the primary cause of the recession our society is currently suffering from. By 2007 the United States realized that not only was the housing market crashing due to unpaid mortgages, but creditors were practically throwing out free money to the public when the majority of banks began lending out mortgages at sub-prime rates. The mortgages had been issued to consumers who could not afford to make their monthly payments. The long term effect of this reckless behavior resulted in a large number of foreclosures in the country. People that were living comfortably were suddenly being evicted from their homes and left with almost nothing.
Borrowers were taking out mortgages from banks yet they simply did not have the means to make their monthly payments. At this point the consumer spending wasn't affected. In fact, consumers were still actively spending money that they technically did not have. When Americans finally realized the economic downturn our country had taken, the mentality of vigorous consumption automatically turned into conservation. People stopped purchasing goods that were not categorized as necessities, and in turn retailers suffered losses caused by the slower traffic. This triggered a decline in the number of merchandisers which meant companies had to downsize, people lost their jobs, family owned businesses closed down, and this lead to more loans being defaulted
What are some causes of the current financial recession?
As mentioned earlier, answers to this question will prove to be critical in grasping the complexity of the current state our economy. Furthermore it will also allow us to make a legitimate attempt at hopefully not just solving but also preventing history from repeating itself in the future.
The financial world is in agreement about the origin of this crisis and the reasons that led it to unfold which regrettably caused a domino effect. Kimberly Amadeo, a well known economist states in her 2010 article that "profligate lending allowed many people to buy overpriced properties that they could not, in reality, afford and in time this led to the collapse of the real estate market in 2006".
When interest rates were raised banks pushed mortgages prices up, it forced homeowners who could not afford it anymore to walk away from their mortgages. According to an article by Mike Shedlock 2008, numerous banks and other lending financial institutions such as Lehman Brothers, AIG, Fannie Mae, and Freddie Mac also suffered enormously because of the massive financial losses they incurred. This caused the government to step in to bail the banks out of their financial crisis as a last push at keeping our economy intact.
Did the auditing profession contribute to the financial meltdown?
That is a question that financial professionals have pondered over for a while now, and still come up with conflicting opinions. It has already been established that the current economic condition in which we find ourselves is serious and has caused real distress in people's lives. Even though fingers were not immediately pointed at auditors for being at the center of the recession, they are believed to have played an indirect role in the situation. Regardless of how minor of an effect they had on the outcome, auditors should have been able to help catch numerous mistakes that may have allowed less of an impact than it ended up having.
Although the auditing profession may not have been completely responsible for the downfall, they did slightly contribute to it by incorrectly assessing the different risks associated with their clients' risk model. When it comes to issuing an audit report to the public about the soundness and safety of an entity especially one that has public interest, auditors have the obligation to appropriately evaluate and assign risks regarding their financial statements. In this case where interest rates were being misstated due to miscalculations from the entity side is simply unacceptable and frankly unethical. It is also the auditors' responsibility to review and evaluate how realistic the figures given by the companies are when looking at the bigger picture.
This helps consumers receive accurate opinions based on those conditions and they can actually compare different business entities side by side to make an educated decision.
However, the financial institutions are to blame not accountants. They are the ones that incorrectly measured the level of risk of the applicants resulting in money being loaned out to the public, which in turn led to interest rates to look inconspicuous in consumer's eyes. In this case auditors should have been able to look at the interest rates for the banks loaning the money and should have recognized the relatively high risk both the consumer and the financial institute was taking by taking part in the transaction.
The positive assertion provided by auditors about the safety of all those sub-prime mortgages and other related mortgage products was the other big issue. It gave reasonable assurance to banks and other financial institutions to invest a considerable amount of resources into the housing market while it was on a boom. The funds were secured against pension funds, mutual funds and other financial organizations so essentially the banks were opening themselves up for huge risks because they were assuming that in so many years it will be worth a certain amount of money.
By not catching their client's negligence auditors ultimately allowed this crisis to slowly develop until it finally exploded on the surface. It is safe to assume that auditors may have been able to prevent it from happening by simply informing their clients that the level of risk they assumed was reckless considering the circumstances. They then should have suggested to them the appropriate steps to adopt in order to escape or at least lessen the consequences incase the worst case scenario ever happened. We did see that the financial institutes that were more conservative towards their lending practices were able to withstand this crisis.
Will the recession cause changes in the auditing profession?
The recession will have many effects on the auditing profession, some of which include tighter restrictions that will force auditors to look more closely at the information provided by their clients and used to prepare the financial statements. This will help ensure that the opinion issued after an audit is in fact reliable and thus effective and relevant to users because it will reduce the number of misstatements due to inherent risk.
Another consequence derived from the economic crisis will be to force auditors to take more accountability for the work they put out, especially audit work pertaining to clients that have treated securities available to the public or investment interests that could affect the public. Auditors have to be more accountable meaning they should diligently do their required work and be ethical while doing their jobs due diligently.
This means that rather than accepting the information relied to them by the clients as facts, auditors should use professional skepticism and use that as a starting point to start their investigation. Truly understanding and taking in consideration their client business and more importantly the entire industry environment could help auditors put the gathered information into context that is more appropriate to each company. It will also help them get a better grasp of the authenticity and rationality of that information before issuing important audit opinions that will affect the way public invest money.
Although many researchers agree on the severity of the current economic situation, professionals still have trouble knowing who is truly to blame for the cause of this recession.
However, it is clear that auditors could have assisted in softening the overall impact it had on the financial market.
In conclusion, there is no use crying over spilled milk, what we can do however is do our part in cleaning up the mess. This financial crisis has been dubbed the biggest financial crisis since the Great Depression, and no one individual or one entity can be blamed for our condition at this time. We have to realize that this is the time to learn from our mistakes; more than one group was not doing their jobs. They biggest lesson here is informing all parties of the risks involved this includes the lender as well as the borrowers. The other piece is having a standard in the field so that both parties can make educated decision and are able to compare interest rates side by side and are not left in the dark trying to decode the fine print and what it means.
Work cited page
Gonzalo Ramos, The audit Profession and the Public Interest, 29-31 October 2009
http://normanmarks.wordpress.com/2010/06/29/the-future-of-the-internal-audit-profession/
http://www.stock-market-investors.com/stock-investment-risk/what-caused-the-current-financial-crisis.html
http://www.ffiec.gov/ffiecinfobase/booklets/audit/audit_03_risk%20ass_rb_audit.html
http://www.marketoracle.co.uk/Article5972.html
