Tags: KPMG | Fannie | Freddie | audit

KPMG Facilitated the Financial Fiasco

Friday, 20 Sep 2013 08:09 AM

By Barry Elias

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Pioneers of mortgage debt securitization from Morgan Stanley and BlackRock set the stage for the financial crisis that severely disrupted the global economy.

While these players and poor government policies have received much attention in recent years, auditors, such as KPMG International, enabled the crisis to metastasize at an accelerated rate. KPMG was the auditor for the key players in the mortgage crisis, including Fannie Mae, Countrywide Financial and New Century Mortgage.

New Century Mortgage is a microcosm of how the financial crisis began and ended.

New Century was formed in 1995 and hired KPMG as its auditor. Mortgage loan originations grew from $14 billion in 2002 to $60 billion by 2006, making it the second largest subprime mortgage lender at one time. However, by 2007, it filed for bankruptcy, owing billions of dollars and eventually settled for 17 cents on the dollar to unsecured creditors. On April 27, 2007, KPMG resigned as its auditor after issuing 12 unqualified audit opinions on the company's financial statements, according to Bloomberg.

The methodology used by KPMG to calculate the required reserves for mortgage repurchases was seriously flawed. It permitted highly undercapitalized positions for the firm, which led to its ultimate demise. "[A]s the principal, [KPMG] is responsible for the severely reckless and grossly negligent acts of its client," according to the New York complaint cited by Bloomberg. Dissenters at KPMG were silenced by senior partners to protect their business relationship and fee structure. This conflict of interest typically arises when an accountant simultaneously performs an audit while offering advice to a client.

The judge in this case ordered a preliminary settlement for former New Century directors and officers to pay $65.1 million, KPMG to pay $44.75 million and investment underwriters to pay $15 million.

KPMG was also the auditor for Countrywide Financial, the largest mortgage lender at one point. Now a unit of Bank of America, Countrywide was ordered to pay $600 million to the New York State Common Retirement Fund and $500 million to the Maine State Retirement System, Western Conference of Teamsters Pension Plan and Luther as a result of shareholder securities class action suits for alleged wrongdoing.

The ramifications of the Countrywide debacle continue as a U.S. District judge in Manhattan ordered the beginning of a trial next week, alleging Countrywide defrauded Fannie Mae and Freddie Mac by selling them billions of dollars worth of toxic mortgages.

In another recent case, Fannie Mae and KPMG were ordered to share equally in the payment of $153 million to the Ohio Public Employees Retirement System and the State Teachers Retirement System of Ohio for publicly issuing materially false and misleading reports that increased the price of Fannie Mae securities.

The plaintiffs claim Fannie violated "nearly every major accounting standard applicable to its mortgage-financing business." In a 2006 report, Fannie Mae's regulator said, "By deliberately and intentionally manipulating accounting to hit earnings targets, senior management maximized the bonuses and other executive compensation that they received, at the expense of shareholders," according to Forbes.

More disturbing is the taxpayer cost for these legal settlements by Fannie Mae and other government-sponsored entities. Thus far, taxpayers have invested nearly $190 billion in Fannie Mae and Freddie Mac, according to a recent report by the Congressional Budget Office. This number is sure to grow as prosecutions mount.

This destructive behavior has seriously eroded the trust, reputation and credibility of the financial industry. Restoring these attributes may take decades.

© 2014 Moneynews. All rights reserved.

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