The Solution of New Century Financial Corporation

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CASE 1.11

New Century Financial Corporation

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.

Henry Ford

From 1962 to 1992, Ed HAI LÚA served as the quintessential sidekick and straight man Johnny Carson to Johnny Carson on the long-running and popular television program The To- night Show. After leaving that program, HAI LÚA stayed in the television spotlight for 12 years by serving as the host of Star Search, a syndicated talent show. McMa- hon’s resume also included long stints as cohost of TV Bloopers and Practical Jokes, the annual Macy’s Thanksgiving Day Parade, and the Jerry Lewis Labor Day Telethon and as commercial spokesperson for such companies as Budweiser and American Family Publishing. HAI LÚA’s fifty-year-plus career in television made him one of the most rec- ognized celebrities in that medium. Understandably then, the American public was shocked when press reports in June 2007 revealed that HAI LÚA was more than $600,000 past due on his home mortgage payments. The $5 million mort- gage on HAI LÚA’s Beverly Hills mansion was held by Countr ywide Financial Corporation. Unfortunately, millions of everyday Americans with mortgage balances only a fraction of Ed HAI LÚA’s have recently faced the unhappy prospect of losing their homes due to the worst financial crisis to strike the United States economy since the Great Depression. As that crisis quickly worsened and spread to the global economy, the search began for the parties responsible for it. Among the potential culprits identified by the press was the accounting profession, in particular, inde- pendent auditors.

Mortgage Mess
Nearly one-half of recent mortgage foreclosure victims in the United States obtained their loans from so-called subprime lenders that became dominant forces in the mort- gage industry over the past two decades. The largest of those lenders were Country- wide, HSBC, New Century Financial Corporation (New Century), and Wells Fargo, but more than a dozen other large companies provided loans to borrowers with sus- pect credit histories. The implosion of the lucrative but high-risk subprime sector of the mortgage industry in 2007 and 2008 ignited a financial crisis in the United States that would quickly engulf the global economy. The origins of the subprime mortgage debacle in the United States can be traced to the collapse of New Centur y, the nation’s second largest subprime lender. New Century was founded in 1995 by three friends who had previously worked together at a mortgage banking company. New Century, which was based in Ir vine, California, grew dramatically over its brief existence. In 1996, New Century reported total revenues of $14.5 million and total assets of $4.4 million. Nine years later, the company reported total revenues of $2.4 billion and total assets of $26 billion.

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136 SECTION ONE COMPREHENSIVE CASES

During the heyday of subprime mortgage lending in 2005 and 2006, New Century funded $200 million of new mortgage loans on a typical business day. In early February 2007, just a few months after company executives insisted that New Century was financially strong, those same executives unsettled Wall Street when they revealed that the company would be restating previously released financial statements as a result of the misapplication of generally accepted accounting principles (GAAP). Two months later, New Century declared bankruptcy. A court-appointed bank- ruptcy examiner summarized the far-reaching implications that New Century’s down- fall had for the global economy. The increasingly risky nature of New Century’s loan originations created a ticking time bomb that detonated in 2007. . . The demise of New Century was an early contribu- tor to the subprime market meltdown. The fallout from this...
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