Toxic Assets, Triggering Factor of the World Economic Crisis

Author:Bob RYAN, ACCA

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Keywords:toxic assets, collateralised debt obligations, mortgage, depository institution

Abstract:
In this article there will be presented in brief information on the bank crisis and on the factors which led to the outbrake of the global financial crisis in 2008.\r\nTo understand the roots of this crisis we need to look back at the various attempts made by successive US administrations to enhance the availability of credit for home loans across all levels of income, geographical locations, and social groups.\r\nWhen banks lend through mortgages, credit cards, car loans or other forms of credit, they invariably move to ‘lay off’ their risk by a process of securitisation.\r\nIn the case of sub-prime mortgages, the high levels of risk called for a different type of securitisation, achieved by the creation of derivative-style instruments known as ‘collateralised debt obligations’ or CDOs. \r\nCDOs are, therefore, a mechanism whereby losses are transferred to investors with the highest appetite for risk (such as hedge funds), leaving the bulk of CDOs’ investors (mainly other banks) with a low risk source of cash flow.\r\nWhen the sub-prime mortgages were issued no one knew which ones would eventually default, but the issuers recognised (or, in the case of the US market, presumed) that the overwhelming majority of borrowers would repay their interest and their debt on the due date.\r\nThe banks also faced another problem – how to value CDOs.\r\nTaking into account the complexity of each economy, the professional auditors and accountants must work together in order to identify the best solutions for the financial crisis which swept the entire world.

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