Since the early 2008, financial institutions started to go through chaos all over the globe. The stock markets were beginning to crash, businesses were shutting down, and investors were losing their money. This was to indicate that the entire globe had been hit by a period of economic crisis leading to a large number of corporate collapses of banks, investment companies, multinational corporations, etc. This downfall of economic markets is more commonly known as the 'The Global Financial Crisis' or the 'Global Recession of 2009' (IMF, April 2012). These times of crisis led to an increase in unemployment, as jobs were being terminated by laying-off employees to cut costs which led to an increase in poverty. Oil prices and prices of other commodities increased by tenfold, making affordability difficult for the average population. This was followed by a steep fall in international trade. Since the Great Depression of the 1930s, this was the worst crisis that the globe had witnessed.
Regulatory Arrangements of the Accounting and Auditing Professions Contributing to the Global Financial Crisis
It is argued that several factors affected the global financial system, leading to this crisis. In the U.S. markets, it began with the sudden fall of prices in the housing market. Prices of real estate had been on a rise since the early 2000s. This made it difficult for the normal public to purchase real estate properties. Citing the need to intervene, the U.S. government used its authority to convince mortgage companies to lower their rates for the public so that they could acquire loans to purchase real estate properties (Wallison, 2008). Additionally, to further aid the public and mortgage companies, the U.S. Federal Reserve decreased the rate of funds to around one percent for a time period of more than one year (Polleit, 2007). With the easy access of credit-money for the general public, the problems started to rise. The financial system was injected by huge amounts of credit-based money, which eventually led to an unstable economic boom. This boom eventually burst like a bubble as real estate prices went down steeply. As a result, people were left with mortgages more than the price of their properties. This was the initial trigger of the global financial crisis. These conditions highlighted the flaws present in the governance structures. Factors such as inadequate regulation and insufficient oversight were blamed to be the primary reasons leading to the collapse (Andrews, 2008).
Many economists have stated in their researches that the global financial crisis was not a result of only a few mistakes from the global businesses, but arrangements that were made by the regulatory bodies of accounting and auditing had played their parts in the financial collapse as well. The author of Financial Shock, Mark Zandi hashed light upon the various reasons that led to the financial crisis, focusing on the regulatory arrangements prevalent to push the economies into crisis (Zandi, 2009). The author explains that after the Great Depression of the 1930s, many financial regulations were implemented to avoid such a catastrophe to occur again. These regulations maintained low interest rates, as the inflation was also low. But the increasing inflation and the dramatic rise of oil prices in the 1970s began to erode the public confidence in the regulations. Foreign investors started to lose confidence in the U.S. Dollar as the primary currency, and began to secure their finances by purchasing gold. To respond to such stances, the former U.S. President, Richard Nixon adopted a regime of floating interest rates by delinking the U.S. Dollar from gold. As a result, opportunities arose to earn higher rates of interests and created a higher volatility in the financial system (Kuttner, 2007). Coupled by significant changes in the society and emergence of new technologies, deregulation occurred in the United States and many other countries. Additionally, the Glass-Steagall Act of 1933 that put restrictions on commercial banks to from marketing or underwriting securities faced in demise in 1999. This was possible because of the growing flow of capital across countries and increasing powers of the investment bankers (Kuttner, 2007). Furthermore, the implementation of sophisticated computer technologies in the financial systems, aided by the prevalence of immense confidence in the existing financial markets contributed to the decrease of regulations. The governmental agencies functioning to regulate the financial markets became less effective and relaxed. There were many regulatory violations that went almost completely unpunished (Partnoy, 2003).
Such relaxed attitude by the regulatory agencies was shown due to increasing powers of banking and financial institutions which were utilized by using connections in the regulatory bodies. These pushed the governments to deregulate many existing policies. These policies included the insistence of the capital movement be done across countries freely. Several policies that existed in the era of the Great Depression were brought back, such as the separation of investment banking from commercial banking. The Securities and Exchange Commission showed leniency and decreased the enforcement of regulations. The regime of floating interest rates left banks unsupervised as for sake of increased competition, banks were allowed to measure their own riskiness. Moreover, the failure of the federal agencies for regulations to update the regulations according to the increasing speed of innovations of financial practices also brought blame upon the regulatory behavior and arrangements (Johnson, 2009).
Many in the financial communities also believe that the use of mark-to-market accounting is also to be blamed for the global financial collapse. The particular use of this accounting practice in the inactive markets, such as the existing markets of mortgage backed securities, was seen specifically the most blaming part of this accounting practice. The Financial Accounting Standards Board (FASB) released the FAS 157 that defined fair value, was to be used to establish a measuring framework for fair value in Generally Accepted Accounting Principles (GAAP) and expanding disclosure requirements relating to fair value measurements. The issue of this standard regulated the use of mark-to market accounting. The critics of this standard argued that this made the financial institutions to value their assets based on the current market values, even in times of temporary depression. This valuation resulted in the financial institutions huge losses, even though they did not represent the true view. When aggregated, these false losses played their part in aggravating the global financial crisis.
Similar to other countries, in Australia also the global financial crisis had its roots in the prevailing regulatory structure before 2008. Contrasting to the regulations in the U.S., the Australian regulations had built slowly a leniency towards the securitization of the mortgage assets (Mohamed Ariff, 2012). By the time the financial collapse happened, Australia was the second largest asset backed securities issuer after the U.S. The hedge funds sector was the largest in Australia but still had no special regulation in place. The four major banks of Australia had only 40-50% of their assets funded by deposits made domestically. For the rest, they relied heavily on offshore funding, making them more risk prone to the volatility of the global financial markets. Similar to the U.S., the prices of housing had also doubled due to ease of loan availabilities. Although the manner in which the Australian regulatory bodies had acted before the global financial crisis should have engulfed the nation with a great recession, their trades based on exports of resources to China aided Australia to sustain itself during those difficult financial times.
The blame has not been restricted for the financial crisis on only the regulations. The profession of audit has also come under great scrutiny and blame in contributing to the global financial collapse. Although, it can be fairly mentioned, that the leniency and complacency demonstrated by the regulatory bodies transferred their responsibilities on auditors, for the prevention and detection of the potential financial frauds. The primary role of an auditor is to ensure that the financial statements of an entity are free from material misstatements, rather than detecting fraud (Morgenson, 2010). And to perform their roles accordingly, auditors must have clear understanding of the valuation of assets.
Evidently, in the build up towards the financial crisis, many auditors failed in detecting bad practices of lending and accounting that led to the housing bubble and the financial collapse. The auditors should have put in more efforts in understanding the business environments of the financial institutions and should have had realized that the lending practices in place did not solid foundations. Many financial institutions were given clean reports by the audit firms, as they were audited based on the Generally Accepted Accounting Principles (GAAP). Auditors could have prevented companies involved in such lending practices, by applying their professional standards more effectively. It is argued that auditors should not focus entirely on the numbers provided to them by their clients, but rather they should conduct a more investigative approach by using not just the legal responsibilities they are entrusted, but also should act professionally in determining the true and fair view of an entity by using wider responsibilities.