The Cause Of The Current Financial Recession Finance Essay - Free Essay Example

Sample details Pages: 5 Words: 1546 Downloads: 7 Date added: 2017/06/26 Category Finance Essay Type Cause and effect essay Did you like this example? During the more minor recession in the early 2000s, then Fed Chairman Alan Greenspan lowered interest rates, making it easier and much more affordable to borrow money. This provided access to many buyers, who previously could not afford to purchase a home, the money needed to purchase a home. With lower interest rates also came an increase in home prices to meet the demand for homes. Lowering interest rates as a way to mitigate the effects of the recession was beneficial until the recession recovered. As the economy rebounded, home prices continued to rise and interest rates remained low, causing irresponsible borrowing practices by both businesses and individuals. (Weisberg 2010) These low interest rates during a time of economic upturn caused home values to sky rocket to unrealistic and unsustainable heights. Don’t waste time! Our writers will create an original "The Cause Of The Current Financial Recession Finance Essay" essay for you Create order High Home Prices Starting in the early 2000s, the housing market in the United States was on a positive and steady incline. Interest rates were low making it easier for larger numbers of people to borrow money to buy homes. As a result of an increase in perspective home buyers, the prices of homes also followed suit and headed north. Homeownership rose as a result, as did the expansion of borrowing in general. Individuals that already had mortgages and owned their homes saw an opportunity to use the equity they had built over the years to take out additional loans (lines of credit) against the value of their homes and began spending the money on home improvements, new cars, vacation, etc. The overall effect of the continued lending, naturally, was an increase in debt. Homeowners were not too concerned with the acquisition of the new debt, because the housing market was booming and home prices were increasing into the foreseeable future. After the honeymoon was over, and the recession began to kick in, home prices began dropping dramatically. New homeowners found that the amount owed to their mortgage company was greater than the value of the home that their mortgage represented. Homeowners that had taken advantage of lines of credit collateralized by their homes found themselves in a bind. The money borrowed against the equity on their house would no longer be covered by the sale of the house, putting owners in a precarious financial situation. This switch from equity to debt created a huge problem for home owners. Individuals found that it would be impossible to sell their homes at a price high enough to recoup the money owed on their mortgage and/or line of credit investments. (Amadeo 2010) This reversal made it impossible for individuals to sell their homes and with an increase in unemployment and a lack of job creation, foreclosures started to sweep across the nation. Bad Lending Practices / Credit Availability During the housing boom, some mortgage companies began offering sub-prime mortgages. These mortgages were geared toward lower income families and had features such as little or no down payment required, long payback periods, and very low interest rates. (Beckman 2010) The problem with these mortgages was that many lenders made loans to individuals without income and employment verification, setting themselves up for failure. In addition to approving these mortgages to people who simply could not afford what they had signed up for, interest rates on the loans were not set. As interest rates went higher and higher, so did mortgage payments. This increase in mortgage payments could not be accommodated by the homeowners, and many began defaulting on their mortgages. Predatory lending practices sought out individuals who did not have the experience or knowledge needed to protect themselves against unsavory lending institutions and found themselves shouldering a weight they could not bear. Unfortunately, while lenders were approving these sub-prime mortgages, securities dealers were bundling up these loans and selling them as mortgage-backed securities (MBS) on the open market. With the dramatic increase in foreclosures, the value of these securities plummeted, leaving investors with worthless investments and huge financial losses. These financial losses threatened the future of many large corporations and resulted in the collapse of many banks and other financial institutions. With the increase in failing businesses came the inevitable increase in unemployment. In turn the rising levels of unemployment meant even those individuals who could afford their mortgage payments before, no longer could. The Main Players While there was no single person or entity that caused the current financial collapse, there are a few main players/contributors to the economic predicament we find ourselves in today. One of the mains players was the United States government, and more specifically the Fed Chairman Alan Greenspan. Alan Greenspan reacted to the recession in the early 2000s by lowering interest rates, making borrowing and lending more affordable. The problem came when the economy turned back up and lending and the housing market reached unsustainable levels. Had interest rates been lowered, mortgage lending would have leveled off again and would have helped to limit credit availability to those who could truly afford it in the long run. The majority of problems came from the financial institutions doing the lending of sub-prime mortgages. Financial institutions that participated in dishonest lending practices accelerated the downfall of the economy. These institutions wanted to increase their organizational value by generating more loans and selling them off. By lending more and more to people who could not afford it, these financial institutions jeopardized the economy to a large extent. The greed of the financial institutions severely clouded their judgment and resulted in product offerings that simply would not stand the test of time, and eroded the economic system to the core. Did the auditing profession contribute to the financial meltdown? Simply put, yes, the auditing profession contributed to the financial meltdown. The auditing profession has the responsibility to advocate for their clients and help make the best decisions possible for the institutions they represent. The problem with the auditing profession did not lie primarily with the external auditor, but more so with the internal auditor. The role of the internal auditor was geared toward generating tangible results that management demanded. Internal auditors were pushed to generate tangible cost savings for their companies which would ultimately result in a better bottom line through the reduction of costs. (Marks 2010) When surveyed, the majority of internal auditors in an Institute of Internal Auditors (IIAs) survey reported that internal auditing could have helped identify key risks to mitigate some of the current economic impacts their organization is facing. (SmartPros 2009) The flaw with internal auditors fell on a lack of focus on risk management. Internal auditors were not focused enough on the financial and organizational consequences of business decisions and therefore allowed management and the organization to make decisions that were not based on adequate risk assessments. This exposed these companies to unnecessarily high risks. In general, internal auditors did not spend enough time analyzing business risks in a meaningful way, and failed to successfully convey their findings to upper management. Will the recession cause changes in the auditing profession? The recession has undoubtedly changed the auditing profession and will continue to do so into the foreseeable future. Changes to the profession can be divided into two main categories, short-term changes and long-term changes. Currently and in the not so distant future, the auditing profession is experiencing a reduction in internal auditing budgets and auditing staff. (Chambers 2010) The decision to downsize budgets and staff is bad because the need for risk management and analysis is increasing. With fewer individuals and fewer resources to assess risk, the occurrence and magnitude of risk will increase over time and organizations will find themselves unable to keep up with their risk assessment needs. In the long run we will most likely see an increase in the need for auditing professionals; unfortunately budget levels will probably remain low due to the uncertainty in the economy. As levels of risk increase, and the complexity of risk also increases, individuals who can interpret those risks and advise proper courses of action to offset those risks will be in high demand. With the current financial crisis we will undoubtedly see an increase in government regulations and an overall shift in the focus of the internal auditing profession. This shift in focus will result in auditors that address the major risks associated with the organizations they represent. A top down approach to risk assessment will ensure that risk is being properly assessed and taken seriously in decision making practices throughout the organization. (Marks 2010) In general, the internal auditing profession will have to reevaluate its current processes and focuses to meet the needs of organizations. This will also be marked by increased visibility and a greater role through consultation of internal auditors in all facets of organizational decision making. Conclusion The current financial crisis resulted from a culmination of many underlying problems. The U.S. government and many financial institutions are partly to blame for the downfall of the economy as well as factors such as low interest rates, high home prices, and poor lending practices. Member of the auditing community also have the responsibility of shouldering a portion of the blame. In any case, changes to government regulation and the role of auditors are inevitable and necessary to get the economy back on track in the short and long run.