Subprime Meltdown - Essay Example

The article begins by discussing the case of New Century and revealing that it represented one of the biggest accounting failures at that time. At one end was the view that the accounting procedures used by the company were faulty and there were major red flags that the company did not watch out for. However, at the other end was the view that the failure of New Century was an inevitable outcome of the overall failure of the U. S Housing Industry and that the company was bound to come down in the midst of a failing market.

However, the report does point out certain red flags that were not taken into account by the company and accounted for its failure. The major issue, as highlighted, was that the company did not undertake rigorous research effort into exploring the background of potential borrowers; that it had no benchmark for assessing the quality of its lending. One of the most obvious flaws was to rule out the income level of the borrower before lending him/her the loan; thus, loans were lent despite insufficient collateral.

Secondly, the company had been involved in unethical practices of advertising low rates that far deviated from the actual as a result of which the borrowers were awestruck when they had to pay the actual market rates. At the same time, the numbers were misleading. Although the dollar value of loans was said to have increased; the number of defaults increased by more than that creating a vicious cycle of debt for the lending companies. They were lending more and more for less and less backup; hence, in effect they were lending more than their ability to do so.

What was more surprising was that the documentation to support these loans was often missing which simply meant that there was great room for fraud or misrepresentation. And that is exactly what happened. Individuals took loans even though they were not eligible for it which paved way for the crisis that followed. At this point one may raise the question that what was the company doing all this time? Was it being a silent watchdog, ignoring the entire activity or was it unaware of the situation?

Does the responsibility of these malpractices lie with the management or not? The answer is unfortunately the former- the company’s top management did not encourage stringent check and balance; the internal controls were not in place making it very easy for individuals to commit fraud or misrepresent their backgrounds while acquiring the loans. No cross-checks were made. This is clearly evident in the findings of the article whereby it was revealed by the Court that fraudulent and unjustified alterations were made in the calculations of repurchases reserves and that, most importantly, these changes were made without any verification from higher authorities, documentation and approval.

Another major inefficiency is highlighted by the case- that of fraudulent audit practices or the failure of audit department to ensure transparency by being bribed or influenced by the company they are auditing. This has been a common practice, especially where regulations are lax. However, even where regulations are stringent such practices exist and are difficult to trace before the revelation of the fraud. Hence, the