1 Causes of the crisis:1. Economic recession inthe United StatesThe U.S. economy witnessedan economic recession end of 2007 andearly 2008, it can be seenby tracking the Dow Jones (down by 679 points) and the S & P (decrease byabout 75 points) and the Nasdaq by about95.2 points and the increase of budget deficit by 455 billion dollars by 3.
2%of the GDP and the drop in house prices in the U.S. by 9.5%, then the fluctuationsin the exchange rate of the dollar globally. Thefirst sign that the economy was in trouble occurred in 2006.
That’s whenhousing prices started to fall. At first, realtors applauded. They thought theoverheated housing market would return to a more sustainable level.Realtors didn’trealize there were too many homeowners with questionable credit. Banks hadallowed people to take out loans for 100 percent ormore of the value of their new homes. Many blamed the Community Reinvestment Act. It pushed banks to make loans insubprime areas, but that wasn’t the underlying cause.
The Gramm-Rudman Act was the real villain. Itallowed banks to engage in trading profitable derivatives that they sold toinvestors. These mortgage-backed securities needed mortgages as collateral.The derivatives created an insatiable demand for more and more mortgages.TheFederal Reserve believed the subprime mortgage crisis would only hurt housing.It didn’t know how farthe damage would spread. That’s because it didn’t understand the true causesof the subprime mortgage crisis until later.
Hedge funds and other financial institutions around the world owned themortgage-backed securities. The securities were also in mutual funds, corporate assets and pension funds.The banks had chopped upthe original mortgages and resold them in tranches.That made the derivatives impossible to price.
Whydid stodgy pension funds buy such risky assets? They thought an insuranceproduct called credit default swaps protected them. A traditionalinsurance company known as AIG sold these swaps. When the derivatives lost value,AIG didn’t have enough cash flow to honor all the swaps.Bankspanicked when they realized they would have to absorb the losses.
They stoppedlending to each other. They didn’t want other banks giving them worthlessmortgages as collateral. No one wanted to get stuck holding thebag. As a result, interbank borrowing costs (known as LIBOR) rose. This mistrust within the banking community wasthe primary cause of the 2008 financial crisis, Conclusions and recommendations In the context of thecurrent financial crisis which generated an economic recession, companiesshould pay more attention to the accounting information and explore all thepossibilities to assure their survival and economic stability.
In times of crisis isvital for a company to have a good degree of organization in the accountingdepartment and to work with skilled accountants. The role of accountants is notjust about recording and systematizing data in accounting, but also theinterpretation of accounting information and to provide practical solutions toreduce costs and streamline business activities. The economic instability makesnecessary a tighter control over all economic operations, a responsiblemanagement of all resources, to filter and reduce as much as possible the costsand adapt the existing strategies to the new market conditions. Moreover, acompany’s success lies in its ability to use the information on time, be itaccounting or other nature, and the ability to adapt to themarket dynamics. Intimes of crisis and economic instability, the time that management has for makingcertain decisions can be extremely short, and those decisions- vital. Whatremains to be done in such cases can be summarized in the words of TheodoreRoosevelt: “Do what you can, with what you have, where you are.
” As acompany, you should do your best with the resources you have in the existingeconomic and market conditions, but decide what you can and find what you haveusing the accountinginformation.The accounts reflectthe effects of the decisions and practices adopted and implemented on any levelwithin the company and therefore more attention should be paid to accounting information.Accounting is in this sense a kind of barometer of the changes made bothinternally, within the company, through changes in policies and strategiesadopted, as well as externally,related to theeconomic environment, where it develops its activity. It is therefore veryimportant that the company management to give importance to accountinginformation and try to find solutions on problems it faces. In order todetermine problems and find solutions the next issues should be considered by thecompany’s management:Monitor relationshipswith third parties in order to determine the degree of confidence that can begranted, depending on their financial status and ability to pay. Attempt torecover claims from clients and debtors affected by the economic recession.Renegotiation ofpayment terms to suppliers and prioritize them on payment according to theimpact that the interruption of business activity with them would have.
Finding the necessaryresources to pay the suppliers and creditors, to avoid additional expenditureas penalties or lawsuits in court.Refinancing theexisting loans at lower costs if possible.Substantiation ofdecisions on accounting information and external environmental information.Reduce costs andstreamline the production processes.
Restructuring thecompany both in terms of personnel, and in respect of processes and activities.Resize activity ifneeded and careful allocation of resources.With a professionalaccountant at the helm of accounting, compliance with accounting principles,leading financial and cost accounting properly, orderly, responsible andlegally, any crisis can be overcome. The information that can pass companieseasier through crisis may bereceived withoutdelay. It all depends on how this information is used by the management team.
The value of theaccounting information depends on the optimal decision taken on that basis.This value differs from one information system to another, and so is the costof the information.Accounting informationmay be diverted due to failure of accounting documents to take account of alleconomic events within the company, if it is presented by applying strictlyaccounting principles or changing the assessment and work methods during thefinancial year. Strict application withoutjudgment makes certain accounting estimates to have an approximate character,being the result of a mixture of accounting methods11. Information is worthy ofinterest to the user if permits and promotes decision-making, clarifies theuncertainty over the future of the entity and facilitates the achieving offorecasted earning . Banking crisis : High mortgage approval rates led to a large pool of homebuyers,which drove up housing prices.
This appreciation in value led large numbers ofhomeowners (subprime or not) to borrow against their homes as an apparentwindfall. This “bubble” would be burst by a rising single-familyresidential mortgages delinquency rate beginning in August 2006 and peaking inthe first quarter, 2010The high delinquency rates led to a rapid devaluation offinancial instruments (mortgage-backed securities including bundled loanportfolios, derivatives and credit default swaps). As the value of these assetsplummeted, the market (buyers) for these securities evaporated and banks whowere heavily invested in these assets began to experience a liquiditycrisis. Freddie Mac and Fannie Mae were takenover by the federal government on September 7, 2008. Lehman Brothers filed forbankruptcy on September 15, 2008. Merrill Lynch, AIG, HBOS, Royal Bank of Scotland, Bradford & Bingley, Fortis, Hypo Real Estate, and Alliance & Leicester were allexpected to follow – with a U.S.
federal bailout announced the following daybeginning with $85 billion to AIG. In spite of trillions paid out bythe U.S. federal government, it became much more difficult to borrow money.
Theresulting decrease in buyers caused housing prices to plummet.Impact on financial market US stock marketThe US stock market peaked in October 2007, when the Dow Jones Industrial Average indexexceeded 14,000 points. It then entered a pronounced decline, which acceleratedmarkedly in October 2008. By March 2009, the Dow Jones average had reached atrough of around 6,600. Four years later, it hit an all-time high.
It isprobable, but debated, that the Federal Reserve’s aggressive policy of quantitative easing spurred the partial recovery in thestock market. Market strategist Phil Dow believes distinctions exist”between the current market malaise” and the Great Depression. Hesays the Dow Jones average’s fall of more than 50% over a period of 17 monthsis similar to a 54.7% fall in the Great Depression, followed by a total drop of89% over the following 16 months.
“It’s very troubling if you have amirror image,” said Dow. Floyd Norris, the chieffinancial correspondent of The New York Times, wrote in a blog entry in March 2009 thatthe decline has not been a mirror image of the Great Depression, explainingthat although the decline amounts were nearly the same at the time, the ratesof decline had started much faster in 2007, and that the past year had onlyranked eighth among the worst recorded years of percentage drops in the Dow.The past two years ranked third, however. Financial institutionsThe first notable event signaling a possible financial crisisoccurred in the United Kingdom on August 9, 2007, when BNP Paribas, citing “acomplete evaporation of liquidity”, blocked withdrawals from three hedgefunds. The significance of this event was not immediately recognized but soonled to a panic as investors and savers attempted to liquidate assets depositedin highly leveraged financial institutions.
The International Monetary Fund estimated that large US andEuropean banks lost more than $1 trillion on toxic assets and from badloans from January 2007 to September 2009. These losses are expected to top$2.8 trillion from 2007 to 2010.
US bank losses were forecast to hit$1 trillion and European bank losses will reach $1.6 trillion.The International Monetary Fund (IMF)estimated in 2009 that US banks were about 60% through their losses, butBritish and eurozone banks only 40%.One of the first victims was Northern Rock, a medium-sizedBritish bank.The highly leveraged nature of its business led the bank to requestsecurity from the Bank of England. This in turn ledto investor panic and a bank run206 inmid-September 2007.
Calls by Liberal Democrat Treasury Spokesman Vince Cable to nationalise theinstitution were initially ignored; in February 2008, however, the British government (having failed to find a privatesector buyer) relented, and the bank was taken into public hands. Northern Rock’s problems proved to bean early indication of the troubles that would soon befall other banks andfinancial institutions. international repercussionAlthough the financial crisis wore a distinct”Made in the U.S.A.” label, it did not stop at the water’s edge. The U.
K.government provided $88 billion to buy banks completely or partially andpromised to guarantee $438 billion in bank loans. The government began buyingup to $64 billion worth of shares in the Royal Bank of Scotlandand Lloyds TSB Group after brokering Lloyds’ purchase of the troubled HBOSbank group. The U.K.
government’s hefty stake in the country’s banking systemraised the spectre of an active role in the boardrooms. Barclays, tellingthe government “thanks but no thanks,” instead accepted $11.7 billion fromwealthy investors in Qatar and Abu Dhabi, U.A.E. European Economic and Monetary Affairs Commissioner JoaquínAlmunia presents the EU’s autumn economic forecast during a news conference inBrussels on November 3, 2008.
Thierry Roge—Reuters/Landov Variationsplayed out all through Europe. The governments of the three Beneluxcountries—Belgium, The Netherlands, and Luxembourg—initially bought a49% share in Fortis NV within their respective countries for $16.6billion, though Belgium later sold most of its shares and The Netherlandsnationalized the bank’s Dutch holdings. Germany’s federal governmentrescued a series of state-owned banks and approved a $10.9 billionrecapitalization of Commerzbank. In the banking centre of Switzerland, thegovernment took a 9% ownership stake in UBS. Credit Suisse declined anoffer of government aid and, going the way of Barclays, raised funds insteadfrom the government of Qatar and private investors.
Themost spectacular troubles broke out in the far corners of Europe.In Greece street riots in December reflected, among other things,anger with economic stagnation. Iceland found itself essentially bankrupt,with Hungary and Latvia moving in the same direction.
Iceland’s threelargest banks, privatized in the early 1990s, had grown too large for their owngood, with assets worth 10 times the entire country’s annual economic output.When the global crisis reached Iceland in October, the three banks collapsedunder their own weight. The national government managed to take over theirdomestic branches, but it could not afford their foreign ones.Asin the U.S.
, the financial crisis spilled into Europe’s overall economy.Germany’s economic output, the largest in Europe, contracted at annual rates of0.4% in the second quarter and 0.5% in the third quarter.
Output in the15 euro zone countries shrank by 0.2% in each of the second and thirdquarters, marking the first recession since the euro’s debut in 1999.Inan atmosphere that bordered on panic, governments throughout Europe adoptedpolicies aimed at keeping the recession short and shallow. On monetary policy, the central banksof Europe coordinated their interest-rate reductions. On December 4the European Central Bank, the steward of monetary policy forthe euro zone, engineeredsimultaneous rate cuts with the Bank of England and Sweden’sRiksbank. A week later the Swiss National Bank cut its benchmark rate to arange of 0–1%. On fiscal policy, Europeangovernments for the most part scrambled to approve public-spending programsdesigned to pump money into the economy. The EU drew up a list of $258billion worth of public spending that it hoped would be adopted by its 27member countries.
The French government said that it would spend $33billion over the next two years. Most other countries followed suit, thoughGermany hung back as Chancellor Angela Merkel argued forfiscal restraint.Asia’smajor economies were swept up by the financial crisis, even though most of themsuffered only indirect blows. Japan’sand China’s export-oriented industries suffered from consumerretrenchment in the U.S. and Europe. Compounding the damage,exporters could not find loans in the West to finance their sales. Japan hitthe skids in the second quarter of 2008 with a 3.
7% contraction at an annualrate, followed by 0.5% in the third quarter. Its all-important exports plunged27% in November from 12 months earlier. The government announced a $250 billionpackage of fiscal stimulus in December on top of $50 billion earlier in theyear. Unlike so many others, China’s economy continued to grow but not at thedouble-digit rates of recent years. Exports were actually lower in Novemberthan in the same month a year earlier, quite a change from October’s 19%increase.
The government prepared a two-year $586 billion economicstimulus plan, and the central bank repeatedly cutinterest rates.TheU.S.
, Europe, and Asia had this in common—car makers were at the head of theline of industries pleading for help. The U.S. Senate turned down $14 billionin emergency loans; the car companies got into this mess, senators argued, andit was up to them to get out of it. President Bush, rather than risk the demise of GeneralMotors (GM) and Chrysler, tapped the $700 billion financial sector bailoutfund to provide $17 billion in loans—enough to keep the two companies afloatuntil safely after the Obama administration took over in early 2009. Inaddition, the Treasury invested in a $5 billion equity position with GMAC, GM’sfinancing company, and loaned it another $1 billion.
In Europe, Audi, BMW,Daimler, GM, Peugeot, and Renault announced production cuts, but Europeangovernment officials were reluctant to aid a particular industry for fear thatothers would soon be on their doorstep. Even in China, car sales growth turnednegative. As elsewhere, the industry held out its tin cup, but the governmentleft it empty.Thepressures of the financial crisis seemed to be forging more new alliances.Officials from Washington to Beijing coordinated interest rate cuts and fiscalstimulus packages. Top officials from China, Japan, and SouthKorea—longtime adversaries—met in China and promised a cooperative response tothe crisis. Top-level representatives of the Group of 20 (G-20)—acombination of the world’s richest countries and some of itsfastest-growing—met in Washington in November to lay the groundwork for globalcollaboration.
The G-20’s deliberations were necessarily tentative in light ofthe U.S. presidential transition in progress.Byyear’s end, all of the world’s major economies were in recession or strugglingto stay out of one. In the final four months of 2008, the U.S.
lost nearly twomillion jobs. The unemployment rate shot up to 7.2% in December from itsrecent low of 4.4% in March 2007, and it was almost certain to continue risinginto 2009. Economic output shrank by 0.5% in the third quarter, and announcedlayoffs and severe cutbacks in consumer spending suggested that the fourthquarter saw a sharper contraction. It was doubtful that the worldwide economicpicture would grow brighter anytime soon. Forecast after forecast showed lethargic globaleconomic growth for at least 2009.
“Virtually no country, developing orindustrial, has escaped the impact of the widening crisis,” the World Bankreported in a typical year-end assessment. It forecast anincrease in global economic output of just 0.9% in 2009, the most tepid growthrate since records became available in 1970.Measuredby its impact on global economic output, the recession that had engulfed theworld by the end of 2008 figured to be sharper than any other since the Great Depression. The two periods ofhard times had little else in common, however; the Depression started in themanufacturing sector, while the current crisis had its origins in the financialsector. Perhaps a more apt comparison could be found in the Panic of 1873.
Then, as in 2008, a real estate boom (in Paris, Berlin, and Vienna, rather thanin the U.S.) went sour, loosing a cascade of misfortune. The ensuing collapselasted four years.