Subprime Mortgage Crisis Affected Auditors

|

Should the Auditors Have Known? |

|

How the Subprime Mortgage Crisis Affected Auditors |

|

Should the Auditors Have Known? |

|

How the Subprime Mortgage Crisis Affected Auditors |

ACCT 612-9042

April 1, 2012

Jennie Yager

ACCT 612-9042

April 1, 2012

Jennie Yager

A number of factors contributed to the subprime mortgage crisis but the way that these securities were valued cannot be overlooked as a contributing factor. The bundles of mortgage-backed securities were valued by fair value accounting and when the rising prices of houses finally topped out and reversed, the mortgages that were part of these bundles were no longer worth what they had been and in some cases were uncollectible. One of the questions that arose after the crisis hit was where were the auditors? Were there warning signs the auditors missed or since this was a new type of security, were they off the hook?

To provide some background on this, it is necessary to first take a look at what exactly these mortgage-backed securities involved. Banks created mortgages to individuals and then sold them into packages known as Collateralized Debt Obligations (CDOs) and Structured Investment Vehicles (SIVs), the SIVs were short term investments and the CDOs were long term investments. Since most of these instruments consisted of mortgage bundles, when the housing market finally topped out and started trending downward there was an adjustment in housing prices. Prices tumbled and as a result the mortgages on those houses wound up inflated. When the value of the houses dropped, the value of the mortgage bundles had to be adjusted to account for this, this resulted in massive write-downs by many companies since the value of these investments were accounted for by fair value accounting. (Hughes & Jeffers, 2008, p. 57-8)

Fair value accounting is used to value investments with no clear cut value; they are valued at what is considered a fair value. It...