The 2008 Financial Crisis

The most recent financial crisis in 2007-2009 was the worst recession since the 1930’s was quite evident as it affected the entire economy on a global scale; from large countries to small ones. The starting point and reason behind a financial crisis is varied, they appear in different shapes and sizes which could have originated externally or domestically and emerged from the public or private sector. Consequently with time, they take different forms and spread rapidly across boarders. Which is why Reinhart and Rogoff (2009) fittingly said that the, “financial crises are an equal opportunity menace.”
(Financial Crises: Explanations, Types, and Implications, 2015)

The main thesis of this paper, is to discuss about the financial crisis structure
and to see whether it was avoidable or not. A financial crisis is often associated with a panic or a run on the banks, where in investors sell off assets or withdraw money from savings accounts with the expectation that the value of those assets will drop if they remain at a financial institution. So in short it is a situation in which the value of financial institutions or assets drops rapidly. (Investopedia,2010).

The origin of the 2008 financial crisis was related to several major factors.
One being that top investment bank traders and executives were presented with massive bonuses during a risky timeline, meaning high revenue and profits.
‘Goldman Sachs’ bonus pool totaled $16 billion—an average bonus of $650,000 very unequally distributed across Goldman's 25,000 employees.’ (DiNapoli, 2009). Loses began to escalate in 2008 causing the five largest independent investment banks to lose their independence.
Even so, about ‘700 employees of Merrill Lynch were given bonuses in excess of $1 million from a total bonus pool of $3.6 billion, in spite of the fact that the firm lost $27 billion.’ (Wall Street Journal, 2009A).
This clearly shows that financial firms are willing to take on high risks in the bubble knowing that their decisions may lead the economy into a downward spiral because they aren’t required to return their bonuses when the unavoidable crisis occurs and since they continue to receive substantial bonuses even in the crisis. (Crotty, 2009). Therefore it’s easy to suggest that financial markets require a sizeable reduction of arbitrary incentives that influence the system but this is easier said than done because human greed is extremely difficult to resist and unavoidable, making the financial crisis
inevitable.

The US Government encouraged the growth in nontraditional mortgages. Nontraditional mortgages are those in which lenders do not follow the three Cs requirements; collateral, capacity and credit history. Prior to the crisis government officials produced reports and statements criticizing lenders for sticking to the three Cs and was never disclosed properly. Fannie Mae and Freddie Mac; loan mortage corporations, instead reported that their portfolios included only one or two percent of “subprime” loans. Investors quickly started losing faith in what they were buying and trading, that mortgage securities market collapsed and in 1995 to 2007 US saw the largest housing bubble. (Wallison, n.d.)
This developed into a global phenomenon ‘with real estate prices down from the Irish countryside and the Spanish coast to Baltic seaports and even in parts of northern India.’ (Nytimes.com, 2015)
Auditors, whose job it is to carefully make sure business records are accurate.
(Investopedia,2010), were well aware of the global phenomenon and the approaching crisis in 2008 and therefore were criticized for not sharing sufficient information and for giving almost no warning of the financial crisis. They failed to communicate with supervisors and provided inadequate supervision of financial service firms. They were also criticized for their assessments on systematic risk and were blamed for giving little importance to the prudence concept which added to the crisis. (Dewing I., Russell P. 2015). This makes it quite clear that auditor complacency and inefficiency was a significant contributory factor to the unavoidable
crisis.